Strong Shekel Signals Strategic and Economic Challenges for Israel
The strength of the Israeli shekel reflects significant shifts in Israel's strategic and economic power globally, influenced by financial, geopolitical, and structural factors. While a strong shekel indicates achievements such as a leading high-tech sector, consistent current account surpluses, natural gas developments, and substantial foreign assets, rapid appreciation can erode exporters' profitability. This erosion poses strategic risks, especially as Israel's military superiority and advanced cyber and defense systems rely heavily on civilian technological innovation. A weakened innovation base due to currency strength threatens national security and could lead to the relocation of technological activities abroad.
In response to these challenges, the Bank of Israel implemented an unprecedented $30 billion foreign currency sale and swap program during the outbreak of the "Iron Swords" war in October 2023 to curb excessive depreciation and maintain liquidity. This move underscored the importance of large foreign currency reserves as a macro-financial insurance providing strategic depth and financial resilience in emergencies. Israel's exchange rate regime transitioned from a managed band to a floating rate system in 2005, allowing the Bank of Israel discretionary intervention to stabilize the shekel amid economic and geopolitical shocks.
Five main mechanisms drive the shekel's appreciation: the booming high-tech sector and foreign direct investment; financial factors including interest rate differentials and carry trades; the natural gas revolution altering Israel's balance of payments and risking "Dutch disease"; institutional investors' hedging activities linked to global equity markets; and geopolitical risk premiums reflecting security and alliance stability. The Bank of Israel has historically used foreign currency purchases and interest rate policies to manage volatility and competitiveness.
To address the challenges of a strong shekel, several policy tools are recommended: maintaining substantial foreign currency reserves as a financial and strategic safety net; significantly expanding the sovereign wealth fund's overseas investments to mitigate structural appreciation pressures; implementing soft regulation to reduce pro-cyclical hedging by institutional investors without restricting their foreign investments; and developing long-term local financial instruments, such as national asset-linked bonds, to channel pension savings into productive domestic projects. These measures aim not to artificially weaken the shekel but to manage risks, reduce exchange rate volatility, and preserve Israel's economic competitiveness and national resilience over the long term.
Dr. Gil Bafman, former chief economist at Bank Leumi, emphasizes that safeguarding national interests regarding the exchange rate requires coordinated economic policy and a strategic, multi-tool approach.
