No one is talking much about the first cause of the recent devaluation even though it is the most important. ¿Natural devaluation¿ that happens as the economy settles into price stability.
For the past seven years the shekel has posted real revaluation against the dollar ¿ shekel devaluation was much lower than the gaps between inflation in Israel and inflation in the countries with whom we do business.
Two forces powered the revaluation: the first was Bank of Israel¿s disinflation policy, maintaining significantly higher interest rates than abroad expressly to lower inflation. The interest rate led the public to divert assets from foreign currency to shekels and liabilities from shekels to foreign currency. The second force was the massive wave of foreign investment in Israel, motivated first by the peace process and later by the technology boom.
It was impossible to predict if and when foreign investment in Israel would weaken, stop or turn around, but it was clear as day that the disinflation policy would eventually run its natural course and Israeli interest rates would get in line with their foreign counterparts. And that is really what happened in the past year, first slowly and with great caution, and finally in a sharp drop.
Other side of the coin
The devaluation that heralded the end of the disinflation period is natural and necessary and is a mirror image of the inevitable revaluation that had preceded it for years. The interest rate drop leads companies and households to tailor their assets and financial liabilities to the new situation by increasing currency-linked assets and decreasing dollar loans.