Israel’s economy ready to roar: Analysts: "Radical" monetary loosening helped limit the recession's effects.

Israel's economy is "ready to roar", according to Barclays Capital analysts Daniel Hewitt, Koon Chow, and Arko Sen. Finding that Israel passed through the global recession with only light damage, the analysts say the economy is ready to resume growing.

The analysts see three main reasons why Israel made it through the recession better than other economies. Israel's financial sector was not as vulnerable, "radical" monetary loosening by the Bank of Israel limited a decline in domestic demand, and that decline was also offset by improvements in net exports.

Barclays expects Israel's real GDP to grow 2.9 percent in 2010 and by 3.1 percent in 2011, with gross public debt falling to 76 percent of GDP in 2010, and 74.3 percent of GDP in 2011.

Barclays predicts that the shekel-dollar rate will fall to NIS 3.50/$ by the end of 2010, and will fall even further to NIS 3.40/$ by the end of 2011.

Barclays seems impressed with the Bank of Israel's handling of monetary policy during the recession. "Monetary policy was put on emergency loosening rates lowered to 0.5 percent and M1 money growth exceeding 60 percent. While this is similar to monetary policies in the G-3 countries among others, there are large differences. Inflation never dropped as much in Israel and growth declines were mild. Israel has had negative real interest rates since 2008. Thus, Israeli monetary policy has been pre-emptive rather than reactive. It is possible, even likely in our opinion, that if the Bank of Israel had not loosened monetary policy this much, the recession in Israel would have been deeper and could have experienced deflation (perhaps like Chile, Czech, Cyprus, and Malaysia). The Bank of Israel seems to have succeeded in counter-cyclical monetary policy."

The analysts note that Israel's fiscal policy played a smaller role in combating the effects of the recession, with what the analysts call a modest spending stimulus. However, the analysts do note Israel's falling government debt, and say that the current government is committed to responsible public finances and lowering public debt. "The public debt level is currently 77 percent of GDP, down from over 100 percent several years ago and Israel has benefited from an improved expenditure structure (for instance, military spending has decreased as a share of GDP). This cut in spending provides more room for private sector expansion. Still, spending pressures do exist, and there is some risk that expenditures will increase to take up the slack created by rising tax revenues."

The analysts warn that as a consequence of the "radical monetary policy" there is a higher inflation risk, but that the Bank of Israel appears committed to a process of gradual interest rate hikes which it says will bring rates to 3 percent by the end of 2010. They note that the shekel's appreciation should help to lower inflation.

Fitch maintains Israel's credit rating

Fitch: Israel is one of only four A-rated countries that will emerge from the recession in 2009.

Fitch Ratings are reiterated Israel's sovereign debt rating at A, with a "Stable" outlook. The rating is for Israel's long-term foreign currency issuer default rating. Israel's domestic bond rating was maintained at A+, also with a "Stable" outlook. Fitch follows Moody's Investors Service and S&P, both of which recently reiterated their credit ratings for Israel.

Fitch said that Israel is one of only four A-rated countries that will emerge from the recession in 2009. It said that the Israeli economy survived the global economic crisis in better shape than many similar economies. Israel's recession was easier than in similar European and Asian countries, and it was most felt in lower tax revenues.

Fitch partly attributed Israel's good performance to the Bank of Israel's aggressive monetary policy, including its exchange rate policy and increasing its foreign currency reserves. Additional factors were a stable, problem-free banking system, and the lack of bubbles in the domestic market. Israel's high-tech and services industries demonstrated stability in the face of falling global demand caused by the economic crisis, and those industries' exports led to an unprecedented current accounts surplus in 2009.

Fitch warned that Israel's high debt-to-GDP ratio was still the main factor limiting the country's sovereign rating, but said that fiscal anchors, such as the spending cap and deficit target, had slashed the ratio from 100% at the end of 2003 to 78% at the end of 2008. While still high, there are countries with a higher debt-to-GDP ratio.

Israel Thrives During Economic Meltdown

By Dan Senor and Sol Singer

Israel has thrived during the global collapse—thanks to an entrepreneurial culture built on compulsory military service. Dan Senor and Saul Singer on why U.S. companies should take notes.

For all the press coverage of the Middle East, there is one side of Israel that gets scant attention: the country’s economy has the highest concentration of innovation and entrepreneurialism in the world today. For years, multinational technology companies and global investors have been beating a path to Israel. Even in 2008—a year of global economic turmoil—per capita venture investments in Israel were 2.5 times greater than in the United States, more than 30 times greater than in Europe, 80 times greater than in China, and 350 times greater than in India. And Israel still boasts the highest density of start-ups in the world (a total of 3,850 start-ups, one for every 1,844 Israelis). More Israeli companies are on NASDAQ than companies from all of Europe, China, India, Korea, and Japan combined.

The root of Israel’s economic dynamism—and the way it weathered a global downturn—can be traced to government policies that cultivate a unique entrepreneurialism. These include innovative immigration policies and disproportionate research and development spending (Israel is the world leader in the percentage of the economy that is spent on R&D). But the real turbocharger has been its universal military training and national service program.

Here's how it works. While students in other countries are preoccupied with deciding which college to attend, Israelis are weighing the merits of different military units. And just as students elsewhere are thinking about what they need to do to get into the best schools, many Israelis are positioning themselves to be recruited by the elite units of the IDF (Israel Defense Forces).

One IDF Army officer with whom we spoke knew when he was just twelve years old that he wanted to learn Arabic, partly because he realized even then that it might help him get accepted into the best intelligence units.

One year before reaching draft age, all seventeen-year-old males and females are called to report to IDF recruiting centers for an initial one-day screening that includes aptitude and psychological exams, interviews, and a medical evaluation. At the end of the day, a health and psychometric classification is determined and service possibilities are presented to the young candidate in a personal interview.

Those who complete the training together remain as a team throughout their regular and reserve service. Their unit becomes a second family. They remain in the reserves until they are in their mid-forties.

While it’s difficult to get into the top Israeli universities, the nation’s equivalent of Harvard, Princeton, and Yale are the IDF’s elite units. The unit in which an applicant served tells prospective employers what kind of selection process he or she navigated, and what skills and relevant experience he or she may already possess.

“In Israel, one’s academic past is somehow less important than the military past. One of the questions asked in every job interview is, Where did you serve in the army?” says Gil Kerbs, an intelligence unit alumnus who today works in Israel’s venture capital industry, specializing in China’s technology market. The advantage that Israel’s economy and its society gains from this equally dispersed national service experience was driven home to us by neither an Israeli nor an American—but rather by Gary Shainberg, an eighteen-year veteran of the British navy. Today, he is vice president for technology and innovation at British Telecom.

“There is something about the DNA of Israeli innovation that is unexplainable,” Shainberg said. But he did have the beginnings of a theory.

“I think it comes down to maturity. That’s because nowhere else in the world where people work in a center of technology innovation do they also have to do national service.”

At the age of 18, Israelis go into the army for a minimum of two to three years. If they don’t reenlist, they typically enroll at a university.

“There’s a massive percentage of Israelis who go to university out of the army compared to anywhere else in the world,” said Shainberg.

In fact, according to the Organisation for Economic Co-operation and Development (OECD), 45 percent of Israelis are university-educated, which is among the highest percentages in the world. And according to a recent IMD World Competitiveness Yearbook, Israel was ranked second among sixty developed nations on the criterion of whether “university education meets the needs of a competitive economy.”

By the time students finish college, they’re in their mid-twenties; some already have graduate degrees, and a large number are married. “All this changes the mental ability of the individual,” Shainberg reasoned. “They’re much more mature; they’ve got more life experience. Innovation is all about finding ideas.”

Innovation often depends on having a different perspective. Perspective comes from experience. Real experience also typically comes with age or maturity. But in Israel, you get experience, perspective, and maturity at a younger age, because the society jams so many transformative experiences into Israelis when they’re barely out of high school. By the time they get to college, their heads are in a different place than those of their American counterparts.

“You’ve got a whole different perspective on life. I think it’s that later education, the younger marriage, the military experience—and I spent eighteen years in the [British] navy, so I can sort of empathize with that sort of thing,” Shainberg went on. “In the military, you’re in an environment where you have to think on your feet. You have to make life-and-death decisions. You learn about discipline. You learn about training your mind to do things, especially if you’re frontline or you’re doing something operational. And that can only be good and useful in the business world.”

This maturity is especially powerful when mixed with an almost childish impatience.

Since their country’s founding, Israelis have been keenly aware that the future—both near and distant—is always in question. Every moment has strategic importance. As Mark Gerson, an American entrepreneur who has invested in several Israeli start-ups, described it, “When an Israeli man wants to date a woman, he asks her out that night. When an Israeli entrepreneur has a business idea, he will start it that week. The notion that one should accumulate credentials before launching a venture simply does not exist. This is actually good in business. Too much time can only teach you what can go wrong, not what could be transformative.”

The IDF also offers recruits another valuable experience: a unique space within Israeli society where young men and women work closely and intensely with peers from different cultural, socioeconomic, and religious backgrounds. A young Jew from Russia, another from Ethiopia, a secular sabra (native-born Israeli) from a swanky Tel Aviv suburb, a yeshiva student from Jerusalem, and a kibbutznik from a farming family might all meet in the same unit. They’ll spend two to three years serving together full-time, and then spend another twenty-plus years of annual service in the reserves.

The IDF was structured to rely heavily on reserve forces, since there is no way for such a small country to maintain a sufficiently large standing army. So for combat soldiers, connections made in the army are constantly renewed through decades of reserve duty. For a few weeks a year, or sometimes just a week at a time, Israelis depart from their professional and personal lives to train with their military unit. Not surprisingly, many business connections are made during the long hours of operations, guard duty, and training.

While a majority of Israeli entrepreneurs were profoundly influenced by their stint in the IDF, a military background is hardly common in Silicon Valley or widespread in the senior echelons of corporate America.

As Israeli entrepreneur Jon Medved—who has sold several start-ups to large American companies—told us, “When it comes to U.S. military résumés, Silicon Valley is illiterate. It’s a shame. What a waste of the kick-ass leadership talent coming out of Iraq and Afghanistan. The American business world doesn’t quite know what to do with them.”

In Israel it is the opposite. While Israeli businesses still look for private-sector experience, military service provides the critical standardized metric for employers—all of whom know what it means to be an officer or to have served in an elite unit.

Dan Senor, a professional investor, is an adjunct senior fellow at the Council on Foreign Relations and author of Start-up Nation: The Story of Israel's Economic Miracle. From 2003-2004, he was based in Baghdad as a senior adviser to the U.S.-led Coalition in Iraq.

Saul Singer is a columnist for the Jerusalem Post, where he also served for six years as editorial page editor.

Moody's, S&P, Reaffirm Israel's Rating

Moody's reaffirmed Israel's A1 rating after their annual trip to Israel this past June, 2009.

In addition, Standard & Poor's also re-affirmed their A rating for Israel following their visit this past July, 2009.

Fitch also made their annual visit this past July and should release their rating update soon.

Israel's rating reaffirmation in the midst of a global financial crisis where many countries are being downgraded shows the strength and stability of the Israeli economy.

(Source: Ministry of Finance – Debt Management Unit, Accountant General).