· A depreciation of the
shekel has a positive effect on exports: A depreciation of 1 percent leads to
an increase of 0.3–0.6 percent in exports with a lag of two years.
· These estimates of
elasticity are somewhat higher than those found in the past, and the lag of the
effect is longer.
· The exchange rate’s
effect on exports is higher in the manufacturing industries, particularly those
of mixed technological intensity, than in the services industries.
Since 2008, the
Israeli economy has been exposed to a prolonged appreciation of the
shekel. This box examines the connection
between the real exchange rate and exports, particularly since the beginning of
the 2008 financial crisis, and also examines what industries are particularly
sensitive to changes in the exchange.
This analysis will help evaluate the extent to which the appreciation
has weakened exports, and to what extent it is expected to weaken them in the
The appreciation of the shekel lowers the profitability of exports, since
some of the exporters’ expenses (such as wages) are denominated in shekels in
the domestic market while their income is denominated in foreign exchange.
Shrinking profitability may lead to a decline in supply, thus reducing the
volume of exports, and may have a negative impact on employment. Moreover, if
firms stop exporting due to temporary exchange rate shocks, they may have
difficulty returning to the markets when the terms improve—due to the costs of
leaving and entering markets—which would lead to long-term damage.
Studies conducted around the world in the past
concluded that a depreciation of the local currency has a positive impact on
exports, but assessments regarding the intensity of that effect varied from
study to study. Studies in Israel
generally found that a depreciation (appreciation) of 1 percent expands
(contracts) export volumes by about 0.2–0.3 percentage points.
Identifying how the exchange rate affects exports is no simple task,
since the changes in the two variables affect each other: A real depreciation
has a positive effect on exports, while an increase in exports leads—for
different reasons—to a real appreciation, since the increase in the current
account surplus increases the supply of foreign exchange. If these two effects take place simultaneously,
the correlation between the exchange rate and exports is undetermined. However, it is reasonable to assume that
changes in the current account and in capital movements have a rapid effect on
the foreign exchange market, while the exchange rate’s effect on the quantity
of exports is mainly with a lag.
This assumption is essential in identifying the causal connection between
the real exchange rate and exports, and it forms the basis of the examination
presented here. If it is not valid,
biased coefficients will be obtained in the regression, and this is
particularly the cast for the coefficient representing the exchange rate’s
lagged effect on exports. Another assumption at the basis of the analysis is
that, in addition to the observed variables controlled for in the equation, including
world trade, there are no unobserved variables that affect both exports and the
exchange rate in parallel. In this case
as well, biased coefficients will be obtained in the regression if the
assumption is not valid. In view of the
possibility that our assumptions are not fully valid, we must be cautious in
giving a causal interpretation to our findings concerning the link between the
exchange rate and exports.
We estimated the elasticity of the export volume relative to the real
exchange rate through regressions that use annual data from 1995 to 2015, while
controlling for global demand (world trade) and the terms of trade (export
prices divided by import prices)—a
variable that reflects the changes in the costs of imported raw materials,
which affect the costs of production for export, and therefore also export
supply. However, since a reverse
effect—from exports to the terms of trade through export prices—is also
possible, we used the terms of trade variable with a lag of one year.
In addition to the average elasticity in the economy, we also estimated
the elasticity in six manufacturing industries that export most of their output
(textiles, rubber and plastic, pharmaceuticals, electronics, chemicals, and
machinery and equipment), and in the services industry (while distinguishing
between business and tourism services). In order to examine the link between
the exchange rate and the volume of exports (as opposed to its monetary value),
we divided the industry export data by the export prices by industry.
We used two indices alternatively for
the exchange rate: the real effective exchange rate (the ratio between the
Consumer Price Index in Israel and the weighted average of the CPIs in the
trading partners) and exchange rates adjusted for each industry (the industry
export prices, translated into shekels, deflated by the general GDP deflator). While the exchange rates based on industry
export prices better reflect the relevant price ratio for each industry, there
are two problems inherent in them.
First, the measurement of exports prices is of limited quality. In the manufacturing export price index,
there is no proper control over the quality of the products, and the
composition of products may also have an effect on it. In the services industries, there is a
structural difficulty in distinguishing between quantity and price. Second, the industry price is also affected
by technological changes and cost changes, which are expected to lower prices
and thereby lower the industry exchange rate and increase the quantity exported
(increase in supply). In other words, a
negative correlation is created between exports and the industry exchange
rate. In addition, since the security
has a very significant effect on tourism exports, we added a dummy variable for
years in which the security situation worsened (1996, 2001, 2002, 2006, 2009, 2012,
We estimated Equation (1) in two regression frameworks. The first includes a panel of eight
industries, over a period of 19 years. The weight of each industry in the regression
is determined by its average weight in total exports analyzed here. The second framework includes specific
equations for each industry following the SUR method, which
takes into account the fact that the equations are dependent on each other.
the equations, we included the changes in the real exchange rate with a lag of
two years, assuming that the exchange rate does not affect exports within one
estimating the first framework—the overall estimate of all industries included
in the model excluding the unique elasticity of each industry—we found a
positive and significant link between exports and the real exchange rate (both
effective and industry) with a lag of two years: a depreciation of 1 percent
increases the volume of exports by about 0.3–0.6 percent after two years (Table
1). Furthermore, a positive but
insignificant connection was found with a lag of one year. The lag in the effect may be a result of the
fact that agreements between exporters and foreign entities are based on
long-term contracts, covering approximately two years in advance. Moreover, in this range, there are hedging
transactions against the exchange rate. We
therefore focused on the exchange rate with a lag of two years. When conducting the examination through a
variable for the interaction between the period following the global financial
crisis (2009–2015) and the change in the industry exchange rate, we found that
there is no significant change in the effect.
The unique link
between the exchange rate (with a lag of two years) and exports of the various
industries was estimated, as stated, through two regression frameworks: fixed
effects based on panel data, and SUR.
The results of the regressions are presented in Table 1, and show that
in most industries, the exchange rate has a positive and significant effect on
exports. The two estimation methods
produce similar results in most industries.
The results also show that the manufacturing industries, other than
pharmaceuticals, are affected by the exchange rate more than the services and
tourism industries. In the manufacturing
industries, the average effect is about 0.8 percent, while in business services
it is about 0.3 percent. In tourism—an
industry that is very exposed to changes in the security situation—the
coefficient is lower, and in most estimations it is not significant.
manufacturing industries, the mixed-technology industries are more affected by
changes in the exchange rate, and their elasticity is close to one, similar to
the findings in Bank of Israel (2009).
The results in the pharmaceuticals industry vary in accordance with the
exchange rates used in the examination: The real effective exchange rate
produces a positive coefficient that is close to 1, while the industry exchange
rate produces a negative and non-significant coefficient. This may be a result of technological changes
that took place in the industry during the sample period, creating a negative
correlation between the industry exchange rate and exports.
In order to
examine the robustness of the results, we conducted a few examinations, with
the findings remaining as they were: The
elasticity of exports relative to the exchange rate is positive, slightly
higher than the results that were obtained in the past, reaching peak strength
with a lag of two years. These findings
are also true when examining each industry separately, and are particularly the
case in mixed industries.
Lavi Y. and Y. Friedman (2007), “The Real Exchange Rate and Israel’s
Foreign Trade”, Bank of Israel Review, 79, pp. 37–86.
Soffer, Y. (2005), “Measuring the Real Exchange Rate and its Influence on
Exports and Imports”, Issues in Foreign Exchange, 1/05.
Sharabany, R. (2014), “The Effect of Terror, Image and Economic Variables
on Various Types of Tourist Visits to Israel”, Discussion Paper 2014.05, Bank
of Israel Research Department.
Baldwin R. and P. Krugman (1989),
"Persistent Trade Effects of Large Exchange Rate Shocks", The
Quarterly Journal of Economics 104.4: 635–654.
Bank of Israel (2009), Annual Report for 2008, Box 2.3: “The factors
determining manufacturing exports”.
Das S., M. J. Roberts and J. R. Tybout (2007),
"Market Entry Costs, Producer Heterogeneity, and Export Dynamics", Econometrica
IMF (October 2015), World Economic Outlook.
Pradhan M., R.
Balakrishnan, R. Baqir, G. Heenan, S. Nowak, C. Oner, and S. Panth (2011), "Policy Responses to Capital Flows
in Emerging Markets", IMF staff discussion note, SDN/11/10.
and Krugman (1989); Das (2007); Pradhan (2011); IMF (2015); Leigh et
(2005); Lavi and Friedman (2007); Bank of Israel (2009).
slight and temporary appreciation is not expected to have a significant effect
on the quantity of exports, but mainly on profitability. But it is likely that a significant and
prolonged effect on profitability will lead to a quantitative impact, and we
will therefore observe a lagged effect.
to data availability constrictions, we used the same data regarding global
demand and terms of trade for all industries.
manufacturing, we used foreign trade data, and for services we used National
included the effect of the dummy variable only in the examination concerning
the tourism industry.
regression assumes fixed effects for each of the industries, which fixes the
marginal effect of each industry separately, thereby making it possible to
distinguish the existing differences between industries in the average rate of
increase of exports.
Seemingly Unrelated Regressions.
Furthermore, we added a dummy variable for one outlier export observation (in 2000,
the electronic industry increased the quantity of exports by 70 percent). Excluding this dummy variable, higher
elasticities are obtained relative to the exchange rate, particularly in the
estimating the overall export equation using the exchange rate with no lag, it
obtains a negative and significant coefficient, which is consistent with the
possibility that exports affect the exchange rate. We first estimated the equations using lags
of one and two years, and then using only lags of two years.
appreciation survey conducted by the Industrialists Association for 2010 found
that 81 percent of manufacturers make hedging transactions, and among the large
exporters, the rate is even higher, at 93 percent.
Sharabany (2014) found that the elasticity of exports relative to the real
exchange rate is negatively dependent on the level of terrorism. It is 0.3 when there is a high level of
terrorism, and close to 1 when the level of terrorism is low.
Among other things, we estimated a sample that includes only the years
2003–2015; equations where we deleted one year each time; equations where we
deleted certain industries each time; we used an interaction variable for the
tourism industry with no lag; and we used the rate of change in the fourth
quarter relative to the fourth quarter of the previous year.