Analysis: Bad timing for an economic upgrade

The decision last week by Morgan Stanley Capital Index (MSCI) to reclassify Israel’s economy from “emerging” to “developed” was greeted by Israeli economists with mixed feelings.

Everyone agreed that it was evidence of the improved regulation of local money markets and the robustness shown by the Israeli economy in the face of the global downturn. The Bank of Israel and other establishment sources saw it as an affirmation of their policies and a “coming of age” of the Israeli market.

Private-sector analysts were less certain.

Israeli companies have proved attractive to investment funds that specialise in emerging markets. Israel has a disproportionately large portion of these investments. While the reclassification will open the way for more staid investors, in the short term the fear among many is that MSCI’s decision, to take effect in May 2010, will cause a departure of foreign investment.

The drops that greeted the news on the Tel-Aviv Bourse on Wednesday, followed by a rally this week, reflected the uncertainty over the benefits.

“Obviously no one thinks that it is a bad thing that our economy is seen as better regulated,” said one trader, “but we are less sure about the timing.”

There are major reasons for the disquiet. While Israel has weathered the global financial storm in relatively better shape than other economies, there are still many worrying signs. On Monday, the Bank of Israel updated its combined financial index to reflect the continuing slowdown in most parts of the economy, which shrunk by an annual rate of 3.9 per cent of GDP in the first quarter of 2009.

Unemployment is also sharply up, while the government’s deficit doubled in May due to mounting expenditure and a slump in tax revenues. Analysts are afraid that while in the long run, the reclassification will bring more high-quality investment into the country, it will hamper efforts to break lose from the recession in the short-term.

The Middle East columnist for Dow Jones, Amotz Asa-El, believes that the reclassification is a fundamentally positive development.

“Being categorised as an emerging economy,” he explains, “means that the country attracts money, earmarked primarily for risky destinations, such as Russia. In the past this has crippled economies like Thailand, where investors flocked but then fled overnight for momentary and local reasons. Once your economy is classified as developed, you have an increased chance of attracting solid investments. They are more difficult to draw in but once invested, they are here to stay.”

Last updated: 2:26pm, November 8 2010