A recovery in the making

A strong high-tech sector boosts Israel’s economy

Following three years of relatively slow growth, the Israeli economy is beginning to show signs of recovery.

GDP growth is expected to increase to 3.4% this year from an estimated 2.2% in 1999, and to continue to improve in 2001. The economy’s expected turnaround can be attributed to several factors: a sharp increase in domestic investment, higher earnings from tourism, greater industrial exports, and increasing imports of raw materials and capital goods, which are expected to fuel housing and the development of infrastructure.

The economy’s long-term growth prospects should be supported by structural reform and privatization initiatives in telecommunications, the distribution of electricity, oil refining and banking as well as a revival of tourism. It is also expected that the government will boost increased competition in commercial television broadcasting, allow more charter and regular flights and update regulations on motor-vehicle imports. A freer economy should encourage additional foreign investments –particularly in the high-tech sector, in which Israel is a global market leader. Consumer confidence should also improve in a stronger economy.

The Israeli market was up 56.3% in U.S.-dollar terms on the MSCI Index in 1999, fuelled largely by its technology sector, whose performance closely matched the rise of the Nasdaq in the U.S. Although market leadership was narrow, the broader market probably will benefit this year from positive sentiments over ongoing peace talks with some of Israel’s neighbours, and an increasing push in privatization and structural reform.

Israel has one main stock exchange, Tel Aviv (TASE), with 649 listed companies at the end of June 1999. The number of listings increased sharply between 1992 and 1994, to 638 from 378, but has remained flat since then. Listing criteria on the TASE were liberalized last year to make it easier for companies with short operating histories to get on the exchange. Companies with one year’s experience and limited equity now need US$1 million to be listed on the TASE and US$4 million to maintain the listing. Many Israeli companies that trade on the TASE are cross-listed on overseas exchanges, especially in the U.S. and Europe, as U.S. depository receipts or shares and global depository receipts or shares. Almost 100 Israeli companies trade on Nasdaq.

Foreign investors can purchase shares on the TASE without restriction. They are subject to taxes on dividends at source of up to 25%, depending on tax treaty arrangements. Currently, there are no taxes on capital gains but this could change later this year. Recently, the U.S. Securities and Exchange Commission recognized the TASE as a “designated offshore securities market,” making it easier for U.S. residents to trade on this exchange.

Trading days on the TASE are different than those in North America – from Sunday through Thursday, closed for the Jewish Sabbath, which begins at sundown Friday and lasts until sundown Saturday. The TASE implemented a new computerized, order-driven trading system in 1997, combining the advantages of a call market with those of continuous trading. The system was developed at the Chicago Stock Exchange.

Canada and Israel maintain strong trade relations, having established the Canada-Israel Free Trade Agreement in January 1997. At the end of 1998, two-way trade between the countries amounted to almost $600 million, with Israel enjoying a significantly favourable trade balance. Canada’s major imports from Israel include precious stones, mechanical and electrical machinery and equipment, various tools and instruments, chemicals and plastics. Its principal exports include aluminum, mechanical appliances, sulphur and construction materials. Israel’s main export market is the U.S., followed by Japan and Hong Kong.

Analysts believe that valuations for Israeli stocks are attractive relative to the EMEA (Europe, Middle East, Africa) region. However, they do not yet have strong earnings-per-share momentum to drive them higher.

One drawback is that market performance currently is concentrated in the technology and interest-sensitive sectors, both of which are influenced by developments in the U.S. market. But broader-based performance should materialize as economic growth picks up.

As an emerging market, Israel is one of the few that offers the safety and stability of a 50-year-old democratic political and economic system. The TASE was established in 1953, having evolved out of the Exchange Bureau for Securities, which was set up in 1935 prior to the formation of the State of Israel. The country’s solid infrastructure is backed by the most advanced telecommunications system in the Middle East.

Today, Israel is regarded as one of the world’s leading industrialized nations, and it has one of the world’s most highly educated populations.

With the stage for continued economic expansion, Israel is susceptible to economic and security setbacks. The success of regional political stability and peace with its Arab neighbours are crucial to the country’s growth. Nonetheless, the country’s security risks are offset by its strong relationship with the U.S., which supports it diplomatically and financially.

On the economic front, nominal interest rates are expected to stay largely unchanged during the year, monetary policy should remain tight, inflation is forecast to rise only marginally and the shekel should hold its ground.

Dwarka Lakhan

Dwarka Lakhan is a pioneer in emerging markets journalism in Canada. His first emerging markets article, “Africa Joins Ranks of the Emerging,” appeared in Investment Executive, Canada’s leading newspaper for financial advisors, in September 1994. Since then he has written hundreds of articles on the full spectrum of emerging markets and has conducted more than two thousand interviews with emerging and frontier markets investment professionals.

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