The Goldman Sachs Group, Inc.
Goldman Sachs Research
A snapshot of the life of an
‘applied’ economist
Kasper Lund-Jensen
+44 (0) 20 7552 0159
kasper.lund-jensen@gs.com
Goldman Sachs International
December 2014
Investors should consider this research as only a single factor in making investment decisions. For Reg AC certification and other important disclosures, see the Disclosure
Appendix, or go to www.gs.com/research/hedge.html.
Goldman Sachs Global Investment Research
1
The costs and motives behind FX
interventions: the case of Bank of Israel
Goldman Sachs Global Investment Research
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Growth has slowed in Israel in recent years…
driven partly by weak exports
10%
30%
GDP growth
9%
GDP grow th
8%
20%
7%
17.4%
15.1%
6.3%
5.8%
6%
15%
5.8%
10.4%
5.1%
5%
4.3%
3.0%
5%
3.2%
3%
2.2%
1.9%
0.9% 1.5%
0%
-0.2%
1.1%
-5% -2.2%
1%
-10%
0%
-0.1%
02
Export growth
-11.9%
-15%
03
6.5%
6.4%
4.6% 4.8%
3.5%
2%
8.0%
10%
4.2%
4%
-1%
Export growth
25%
04
05
06
07
08
09
10
11
12
13
14
02
03
04
05
06
07
08
09
10
11
12
13
14
Source: CBS, Haver Analytics
Goldman Sachs Global Investment Research
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The stagnation in Israel’s exports is driven by
weak external demand…
A weaker currency leads to higher exports after a few
quarters (as the ‘quantity effect’ kicks in)…
Impact on exports following a 1% depreciation of the real
effective exchange rate
…while stronger external demand increases exports
instantaneously
Impact on exports following a 1pp improvement (qoq ann.) in
external demand
Source: Goldman Sachs Global Investment Research, Haver Analytics
Source: Goldman Sachs Global Investment Research, Haver Analytics
Goldman Sachs Global Investment Research
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… but is also a function of the strong Shekel
appreciation
4.1
$/ILS
4.00
4.0
Gas production from the Tamar field (March 2013)
$/ILS
30 per. Mov. Avg. ($/ILS)
3.9
3.8
3.7
3.6
3.5
3.45
Nov-14
Aug-14
May-14
Feb-14
Nov-13
Aug-13
May-13
Feb-13
Nov-12
Aug-12
3.3
May-12
3.4
Source: Goldman Sachs Global Investment Research
Goldman Sachs Global Investment Research
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The (labor intensive) low-tech manufacturing
goods are particularly sensitive to Shekel
appreciation
The manufacturing sector is more sensitive to
the real effective exchange rate…
Impact on exports following a 1% depreciation of the real
effective exchange rate
… except high technology exports, which
have a low price elasticity
Impact on exports following a 1pp improvement in external
demand
Source: Bank of Israel
Source: Goldman Sachs Global Investment Research, Haver Analytics
Goldman Sachs Global Investment Research
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The strong Shekel is therefore a significant
concern for the Bank of Israel
Bank of Israel’s “tool box” to fight FX pressures:
A. Monetary policy (Cut rates by 300bp since mid-2011)
B. FX interventions (Re-introduced this tool in April 2013)
Policy mix has important implications for asset prices.
Goldman Sachs Global Investment Research
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The BoI has eased monetary policy since
mid-2011…
%
BoI Policy Rate, lhs
4
3
2
1
0
08
09
10
11
12
13
14
15
Source: Haver Analytics, Goldman Sachs Global Investment Research
Goldman Sachs Global Investment Research
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… and the BoI re-introduced FX interventions
as a policy tool back in early 2013
Bn USD
Bn USD / %
100
90
4
80
70
3
Jul 08 - Oct 09 Avg: $1.8bn
60
50
2
40
30
1
20
10
0
0
08
09
10
11
FX Interventions (bn US$), lhs
Low cost' FX gas program (scheduled)
BoI Policy Rate, lhs
12
13
14
15
'Low cost' FX gas program
QE
FX reserves (bn US$), rhs
Source: Bank of Israel, Haver Analytics
Goldman Sachs Global Investment Research
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Lower interest rates may fuel the booming
housing market in Israel. Why has the BoI not
relied more aggressively on FX interventions?
10%
Real house price growth (per year)
Since 2008Q1
8%
Since 2012Q1
6%
4%
2%
0%
-2%
-4%
-6%
-8%
IRL
GRC
ESP
NLD
DNK
ITA
USA
JPN
GBR
PRT
FRA
FIN
KOR
NZL
BEL
AUS
SWE
NOR
CAN
DEU
AUT
CHE
ISR
-10%
Source: OECD
Goldman Sachs Global Investment Research
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A build-up in FX reserves is likely to be driven
by three motives:
Flow motives:
To boost competitiveness: FX interventions designed to weaken the currency may be
used to stimulate economic growth via higher net exports. This motive is particularly strong
in current account surplus economies, which naturally experience large capital inflows.
Reduce FX Volatility: FX interventions can also be used to reduce exchange rate volatility
that arises as a result of speculative behaviour or ‘overshooting’ effects (in both directions).
Stock motive:
Precautionary reserves: Large FX reserves reduce the likelihood of a ‘sudden-stop’ in
capital inflows. Given the substantial economic costs associated with such 'sudden-stops',
countries may seek to hold substantial foreign currency reserves and this could have been
an important driver of the acceleration in FX accumulation from the mid-1990s.
Goldman Sachs Global Investment Research
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There are ‘fiscal’ costs associated with FX
reserves…
The costs have risen as the BoI has accumulated larger FX reserves
Costs of FX reserves, per year, for different spreads
Source: Goldman Sachs Global Investment Research
Goldman Sachs Global Investment Research
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…and the benefits diminish arguably after a
certain point.
20
Gains, Costs
18
Costs (A: High carry)
16
Costs (B: Low carry)
14
12
Gains
10
"Marginal benefits equals
marginal costs"
8
6
4
2
FX Reserves (% of short-term external debt)
0
0
100
Optimal FX reserves (A)
('High cost', e.g Turkey)
200
300
Optimal FX reserves (B)
('Low cost', e.g. Czech Rep)
400
Source: Goldman Sachs Global Investment Research
Goldman Sachs Global Investment Research
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Approach I: The ‘optimal’ FX reserves level (which
balances the ‘costs’ and the precautionary benefits)
depends on different factors
The optimal level of FX reserves is inversely
related to the ‘opportunity cost’ spread…
Optimal FX reserves as a function of the opportunity costs
…but depends positively on the degree of risk aversion.
Optimal FX reserves as a function of the risk aversion
Source: Goldman Sachs Global Investment Research, Jeanne and Ranciere (2006)
CORRECT SOURCE
Goldman Sachs Global Investment Research
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The cost-benefit trade-off of FX interventions
is less appealing today than it was back in
2008
The BoI’s FX reserves are above the optimal precautionary savings level.
BoI’s FX reserves vs. optimal level
Source: Goldman Sachs Global Investment Research
Goldman Sachs Global Investment Research
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Approach II: Quantifying the ‘precautionary’
benefits associated with FX reserves
1%
Marginal effect on 'sudden-stop' probability*
(following a 1pp increase in factor)
0%
-1%
-2%
-3%
20pp increase in FX reserves
(% of short-term external debt)
-4%
-5%
CA surplus (% of GDP)
FX reserves
(% of short-term
external debt)
Currency overvaluation
(in %)
GDP growth (in %)
Source: Goldman Sachs Global Investment Research
Goldman Sachs Global Investment Research
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Optimal level of CB FX reserves across EMs
(note that the Czech National Bank recently
introduced a ‘peg’ against the Euro)
500
450
400
FX reserves
(% of short-term
external debt)
'Optimal' level
of precautionary
reserves
350
300
250
200
150
100
50
0
Indonesia
Malaysia
Thailand
India
China
Chile
Mexico
Colombia
Brazil
Peru
Ukraine
Turkey
Poland
Czech
Republic
Hungary
South Africa
Israel
Russia
Source: Goldman Sachs Global Investment Research, IMF
Goldman Sachs Global Investment Research
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Central banks in emerging markets have
increased their FX reserves over the past
decades
35
FX reserves (% of GDP)
30
Median
25
CEEMEA Avg
AEJ Avg
20
LATAM Avg
15
10
5
0
1980
1984
1988
1992
1996
2000
2004
2008
2012
Source: Goldman Sachs Global Investment Research
Goldman Sachs Global Investment Research
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Shekel Outlook
Goldman Sachs Global Investment Research
19
Shekel Outlook – where are we going from
here? GS F’cast: $/ILS at 4.00 in 12 months.
4.1
$/ILS
4.00
4.0
Gas production from the Tamar field (March 2013)
$/ILS
30 per. Mov. Avg. ($/ILS)
3.9
3.8
3.7
3.6
3.5
3.45
Nov-14
Aug-14
May-14
Feb-14
Nov-13
Aug-13
May-13
Feb-13
Nov-12
Aug-12
3.3
May-12
3.4
Source: Goldman Sachs Global Investment Research
Goldman Sachs Global Investment Research
20
The Shekel continues to be overvalued
according to our preferred valuation metrics
5.0
$/ILS
$ILS > PPP: Israel price
level is below the US
USD/ILS
PPP Exchange Rate
GSDEER
4.0
$/ILS < PPP: Israel price
level is above the US
3.0
96
98
00
02
04
06
08
10
12
14
Source: Goldman Sachs Global Investment Research, World Bank
Goldman Sachs Global Investment Research
21
Institutional investors have bough large
amounts of foreign assets in recent years (but
since end-2012 they have been hedged).
25.0
% of total portf olio
20.0
21.9
22.8
12.6
12.8
21.0
20.5
17.6
15.9
15.0
13.6
11.4
10.0
9.9
10.9
11.4
8.6
7.3
7.6
10.8
12.4
12.6
12.5
8.8
8.4
5.0
D om es tic fi nancial investors foreign asset expos ure
D om es tic fi nancial investors F X exposure
0.0
2006
2007
2008
2009
2010
2011
2012
2013
14Q1
14Q2
14Q3
Source: Bank of Israel
Goldman Sachs Global Investment Research
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Institutional investors' hedging demand
weakened in August and, especially, in
September.
2.0
1.5
Bn $
1.4
Jan-Jul: Foreign as s et purc has es are f ully 'hedged'
1.0
1.2
1.6
0.5
0.9
0.5
0.0
0.2
0.5
0.0
0.8
0.6
-0.5
- 0.9
- 1.0
0.5
0.2
0.0
-0.4
-0.5
0.7 0.3
0.6
- 0.3
-0.3
- 0.2
-0.5
-1.4
-0.5
-1.8
-1.0
C hange i n FX derivati ve exposure
-1.5
FX deriv ativ e ex pos ure ri ses
in September
T ransac tions in F X indexed ass ets
T ransac tions in F X denom inated as sets
-2.0
T otal FX transacti ons (i ncl. derivati ves)
-2.5
Jan-14
F eb-14
M ar-14
Apr-14
M ay-14
Jun-14
Jul -14
Aug-14
Sep-14
Source: Bank of Israel
Goldman Sachs Global Investment Research
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Deflation risks have strengthened the BoI’s
motive to weaken the currency…
Goldman Sachs Global Investment Research
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… and the BoI may hit the ‘zero lower bound’
and cut rates by 20bp (to 0.05%) in December
or 2015Q1…
Bn USD
Bn USD / %
100
90
4
80
70
3
Jul 08 - Oct 09 Avg: $1.8bn
60
50
2
40
30
1
20
10
0
0
08
09
10
11
FX Interventions (bn US$), lhs
Low cost' FX gas program (scheduled)
BoI Policy Rate, lhs
12
13
14
'Low cost' FX gas program
QE
FX reserves (bn US$), rhs
15
Source: Bank of Israel, Goldman Sachs Global Investment Research
Goldman Sachs Global Investment Research
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… as the Shekel sell-off will not be strong enough to
prevent headline inflation from moving into negative
territory (due to fall in FX pass-through to inflation).
Goldman Sachs Global Investment Research
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Disclaimer
I, Kasper Lund-Jensen, hereby certify that all of the views expressed in this report accurately reflect my personal views, which have not been influenced by considerations of the firm’s business or client
relationships.
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