The Smart Money Is on Israel, Again

By Harry Langman

Published August 13, 2004, issue of August 13, 2004.
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Last year, total foreign investment in Israeli companies was 61% higher than in 2002 and the Tel Aviv Stock Exchange rose 50%. After four years of negative economic news, the smart money is investing Israel.

As an export-oriented country, Israel’s economic well-being is closely tied to that of the United States and other Western nations. So when the technology bubble burst near the end of 2000 and economies around the world began to slow down, Israel’s economy also faltered. With technology accounting for almost half of Israel’s exports, the lower global demand for technology translated into lower exports and fewer investments in Israeli companies. The intifada compounded these problems, with the tourism, construction and agricultural industries particularly hard-hit.

Before the technology crash, 2000 was a record year for Israel with 7.5% GDP growth and a 24% increase in exports of goods and services. One year later, economic growth had sputtered to -0.9% and exports had declined by 11.5%. Unemployment, which stood at 8.8% in 2000, increased to 10.3% in 2002. In response, the government implemented a series of economic reforms. Initiated in 2002, they gained momentum in 2003 when income, sales and corporate taxes were reduced to stimulate spending.

To boost competitiveness, Israel accelerated its effort to privatize state-owned entities, selling shares in companies like El-Al Israel Airlines, Bank Leumi and Zim Israel Navigation Company. The Israeli government also embarked on a series of budget cuts to rein in spending, and lowered dividend and corporate taxes on major investments to attract foreign investors.

With these changes in effect, Israel’s economy was prepared to recover when the American market began to pick up in mid-2003. Boosted by renewed global demand, exports of goods and services increased 6% in 2003 — as compared with a 3% decline the year before. Israel’s economy grew slightly, by 1.3%, the first year of positive growth since 2000. The improved geopolitical situation — a drop in the number of terrorist attacks in Israel and the capture of Saddam Hussein — also contributed to a cautious economic optimism.

By late 2003, foreign investors began to return to Israel. International investment in Israeli securities jumped 638% last year, as foreign investors poured $354 million into the Tel Aviv Stock Exchange, up from $48 million in 2002. Direct investment, which comprises acquisitions of Israeli companies and expansion of factories and other facilities, also increased, to $3.7 billion in 2003 from $1.6 billion in 2002 — a 128% rise.

The Eastman Kodak Company, for example, acquired two Israeli companies in 2003: Algotec Systems Ltd., a digital medical imaging company, for $42.5 million, and Scitex Digital Printing, which specializes in high-speed digital printing, for $250 million. In early 2004, Fidelity invested about $10 million in the Internet telephony company AudioCodes and became the largest shareholder in Radware, increasing its holdings to 13% of the company from 2.6%.

Israel’s start-up market is also beginning to see renewed activity. Intel, for example, acquired Mobilian Corporation, a fledgling wireless chip manufacturer. Domestic venture capital activity is also on the rise. In the first quarter of the year, Israeli venture capital funds raised $563 million from foreign institutional investors, more than three times the amount raised in all of 2003.

The recent fund-raising success of Markstone Capital, Israel’s largest private equity fund, illustrates the extent of renewed investor optimism. The company originally planned to raise $500 million in two rounds of fund raising. Its first round alone earlier this year garnered $400 million — $150 million more than expected — with the New York State Common Retirement Fund, the largest investor at $200 million.

Now, halfway through 2004, Israel continues on a slow but steady road to recovery. GDP in the first quarter grew by 5.1%, and exports increased 25%. Rising consumer demand indicates greater confidence in the economy, and an increase in imports of raw materials suggests a renewed vigor in industrial production. Taking these factors into account, the Bank of Israel is predicting that the economy will grow 3.4% by the end of the year, in line with other advanced economies.

Israel has weathered one of the worst economic storms in its history. Although challenges such as high unemployment remain, the outlook is vastly improved. With the economy back on track, investors are eyeing Israel once again.

Harry Langman is the Israeli Finance Ministry’s chief fiscal officer for the Western Hemisphere.






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