The Strong Shekel: From Economic Challenge to Strategic Risk

The shekel's exchange rate may indicate changes in the extent of Israel's strategic and economic power in the world. The shekel responds to a variety of financial, geopolitical, and structural factors, reflecting the level of national resilience that combines geopolitics, security, and clusters of technological and strategic power.

The strengthening of the shekel over time reflects the impact of structural achievements such as a leading high-tech sector, a consistent current account surplus, Israel's natural gas revolution, and significant net foreign assets. However, rapid appreciation erodes the profitability of exporters. In an era where military superiority, cyber capabilities, and advanced combat systems rely on civilian developments and dual-use technologies, damage to the local innovation base due to the aggregate impact on profitability is of strategic importance. Therefore, periods of shekel strengthening are no longer just a macroeconomic challenge, but a strategic risk that indirectly affects national security.

Bank of Israel and Risk Management

With the outbreak of the "Iron Swords" war in October 2023, the Bank of Israel announced an unprecedented program to sell up to $30 billion and conduct swap transactions to curb abnormal depreciation and provide liquidity. This move demonstrated the necessity of high reserves as macro-financial insurance, giving the state "strategic depth" and financial immunity in times of emergency.

Looking ahead to a potential "geopolitical appreciation regime": deepening partnerships with the Abraham Accords countries and the promotion of international projects like the IMEC corridor (India-Middle East-Europe) will attract foreign sovereign investments into local strategic infrastructure. While this enables growth, it also creates potential additional pressure for the shekel to strengthen.

Five Mechanisms of Appreciation

To establish recommendations, one must analyze the shekel's appreciation trend based on five main mechanisms:

High-tech sector and FDI: Flourishing sectors and exits create flows of foreign currency conversion into shekels to finance local activity.
Financial mechanism: Interest rate differentials and Carry Trade transactions, where investors view Israel as a regional "safe haven."
Natural gas revolution: Changes in the balance of payments by reducing energy imports and creating regional exports, exposing the economy to "Dutch Disease" risks.
Institutional appreciation: A pro-cyclical mechanism where institutional bodies hedge foreign assets, amplifying fluctuations based on global stock market trends.
Geopolitical risk premium: Changes in security risk assessments and international alliances that translate into exchange rate volatility.

Policy Recommendations

Protecting national interests requires a combined toolbox approach:

Foreign currency reserves: Continued management as a financial safety net for emergencies.
Wealth Fund: Substantial strengthening of the "Fund for Israeli Citizens" through increased investment abroad.
Soft regulation: Reducing the pro-cyclicality of institutional hedging without restricting foreign investments.
Local financial instruments: Development of "national asset-linked bonds" backed by infrastructure and government companies to offer attractive local investment alternatives.

Dr. Gil Bufman is the former Chief Economist of Bank Leumi.