Last week's figures showing a fourth consecutive month of declining housing prices did not surprise Meitav Dash Investments Ltd. (TASE:MTDS) chief economist Alex Zabezhinsky. While many noted the ongoing decline in prices with satisfaction, a macroeconomist like Zabezhinsky regards it primarily as a sign of the beginning of an economic downturn and the postponement of the Bank of Israel's plans to raise the interest rate, at best, assuming that no unpleasant surprises make the situation even worse. Zabezhinsky reached this conclusion even before the recent index figures were published, and explained his opinion of them at the request of "Globes."
"Globes": The economy is still growing at a good pace, unemployment is at an all-time low, Israelis are traveling abroad in record numbers, wages are up, tax revenues are outstripping the forecasts, and inflation is negligible. Where exactly do you see signs of a slowdown?
Zabezhinsky: "Beneath the surface. 2017 growth in Israel was lower than in the preceding year. Private consumption was up 3.3%, the smallest rise since 2012. The trend in Israel was exceptional in comparison with other countries, because the rest of the world grew at an accelerated rate. Only a few countries, of which Israel was one, had lower growth in 2017 than in 2016. Some of the reasons for this are technical, to do with vehicle purchases being brought forward or other factors, but others, which explain the slowdown, are structural economic reasons."
What do you mean by "structural reasons"?
"This is a routine development in the business cycle in an economy that involves a slowdown, not necessarily a dramatic crisis like the subprime crisis. The roots of this downturn go back to 2008, when most of the developed world was suffering from the consequences of the severe credit crunch, while the Israeli economy grew at a strong pace. At least some of this growth was 'steroid growth' resulting from a steep rise in prices in the real estate market and rapid growth in consumer and housing credit. Now comes the stage of byproducts of that rapid growth, which was based on increased debt and higher home prices."
Now, of all times, when the rest of the world is recovering, we will enter a slowdown?
"The force of the slowdown could be lower here because worldwide markets are growing, but this also depends on local factors, such as how large the preceding bubble was. The downturn in the real estate market is usually the first and most significant sign of the 'hangover,' and the figures show an ongoing fall in housing prices and the number of deals.
"Another interesting figure came from the housing inventory index this week, publication of which has been resumed. On the one hand, inventory fell, but on the other hand, the monthly supply, meaning the time that it takes to sell a housing unit, has become longer. Today, we are around 13 months - the average time for selling a housing unit - the highest figure I can remember in recent years. The housing item in the most recent (February) Consumer Price Index also unexpectedly fell 0.3%. One month doesn't mean much, but it does mean that that there is no rising trend in rents right now, contrary to predictions."
So real estate will drag down the entire economy?
"Accumulated experience from around the world shows that a halt in the real estate market following a rapid and prolonged boom has almost always led to slower growth. Real estate is a very large section of the economy, and when it cools off, it has a collateral effect. The clearest effect is lower investment in construction. People buy fewer housing units, contractors are stuck with more inventory, and more construction companies get into difficulties.
"Later, we have a decline in the number of people moving house, which decreases expenses incurred in moving, such as renovations, purchases of electrical appliances, and furniture. A third effect is what is referred to as the 'wealth effect' - the feeling among homeowners that they have gotten rich on paper as a result of the increase in the value of their homes, which makes them spend more money. This also works in the other direction - they reduce spending when the wealth effect wanes.
"In the outlying areas, in addition to the difficulty in selling, it is difficult to rent out a home at a price that generates a suitable return on an investment. As a result, the 'wealth feeling' of investors is severely dampened, and sometimes even pushes them into economic difficulties. Stagnation in the real estate market has already caused increased payment arrears on mortgages in recent months.
"In addition to the increase in mortgages, loans to households for purposes other than buying housing have also increased in recent years. The boom in credit of this type was even more exceptional than the increase in mortgages. This trend is now also rapidly coming to a halt. Growth in non-housing bank credit has slowed substantially. A year ago, the annual rate of growth was 6-7%, but it has now fallen to 2-3%."
But Israelis' debts are not high in comparison with other countries, so there is no fear of a bubble.
"It is true that the ratio of total debt to GDP in Israel is not higher than the OECD average. This week, however, a Bank of Israel report was published showing the lowest 60% owe 27% of the debt, while the OECD average is 14%. This means that while debt in Israel may not be high, its quality is poorer, because there are more debtors with relatively less repayment capability. This problematic figure is arising at a very sensitive point in the business cycle."
The Bank of Israel attributes the decline in consumer credit to its new instructions, not to an economic slowdown.
"This is true, but the other side of the coin is that risk has risen. The CEO of Bank Leumi recently stated explicitly that the bank had decided to freeze any increase in consumer credit because of the risks it incurs. The banks and credit card companies substantially increased their provisions for consumer credit losses on 2017. The restriction on providing consumer credit is directly affecting economic growth. We saw one of the clearest consequences of this in the decrease in deliveries of new vehicles in the early months of this year, compared with last year. This has not happened in Israel since the 2008-2009 crisis. As the restrictions on credit worsen, economic growth will be affected, because borrowers seeking to refinance their loans will be pressured by their increased risk. As growth is affected, credit providers will make the terms for credit even tougher."
Are there other signs of a slowdown?
"Other than areas involving the consumer and the real estate market, economic growth is threatened by developments in exports. Exports from Israel are already under the gun as a result of the strong shekel. According to the annual report of the Israel Export and International Cooperation Institute, the annual real rate of increase in Israeli exports in 2007-2012 was almost the lowest in the OECD. Because the effect of a high shekel-dollar exchange rate on exports is felt with a delay of 1-2 years, the shekel appreciation will continue to have the same negative impact on exports that it has had for the past two years."
So the interest rate is not expected to rise, as declared by the Bank of Israel.
"In my opinion, in six months we will begin to hear people say that the interest rate should be lowered, but in truth, it can't be lowered any further. The slowdown could take the Bank of Israel's plan to begin raising the rate off the agenda. When economic growth is 2% plus, instead of 3% plus, inflation is negligible, and the shekel is strong, you don't start raising the interest rate."
Published by Globes [online], Israel Business News - www.globes-online.com - on March 19, 2018
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