Credit Risk Resisting War Tops Emerging Nations: Israel Markets

Israeli credit risk is improving while sentiment in the largest emerging markets deteriorates, highlighting the nation's resistance to regional upheaval and U.S. Federal Reserve policy shifts.

Israel's credit default swaps have fallen 23 basis points, or 0.23 percentage point, this year to 112 on Oct. 23, while contracts for Turkey, Brazil, Russia, India and China all increased as prospects for reduced stimulus in the triggered an outflow from developing markets. Turkey's swaps have climbed 51 basis points this year to 178.

Even the worsening security environment among Israel's neighbors hasn't dented investor confidence. Since May, Israel has seen the civil war in Syria intensify, with the use of chemical weapons threatening to internationalize the conflict. Political turmoil has also deepened in another neighbor, Egypt, where the army's takeover in July led to escalating violence.

"The periodic geopolitical crises in the region don't have significant influence on either Israeli markets or the government's ability to manage the economy," said Ori Greenfeld, chief economist at Clal Finance Investment Management Ltd. in Tel Aviv.

Israel's main stock index has added 15 percent in dollar terms this year, while the MSCI Emerging Markets benchmark dropped 2 percent.

'Prosperous and Diverse'

The shekel has been the biggest gainer among 31 major currencies tracked by Bloomberg this year, rising 6.1 percent against the dollar. Its strength has been driven by the start of natural gas production off Israel's Mediterranean coast, which is poised to turn the country into an energy exporter.

Israel's economy is "prosperous and diverse," and the gas output will strengthen its external finances, Standard & Poor's said last month, affirming its A+ debt rating, the fifth-highest grade. The International Monetary Fund forecasts growth of 3.8 percent this year and 3.3 percent in 2014.

Credit default swaps in Estonia and the Czech Republic, which Standard & Poor's rates AA-. one level higher than Israel, had climbed 6 and 9 basis points respectively by yesterday since Bernanke's May 22 comments. Israel's swaps fell 5 basis points over the same time.

Energy-importing countries such as India and Turkey have been among the worst-hit in the emerging-market decline prompted by Bernanke's comments.

Credit-default swaps for the State Bank of India (SBIN), a proxy for the sovereign, have risen by almost two thirds since May 22, while the rupee slid about 10 percent. In Turkey, swaps jumped by about half, and the currency dropped about 6 percent.

Gas Finds

Israel's credit risk has been shielded from the global concerns over a Fed reversal "because investors believe the shekel will keep appreciating due to the new natural gas finds, Israel's strong current-account surplus, and the about $80 billion in foreign currency reserves held by the Bank of Israel," said Ofer Klein, head of economics and research at Harel Insurance & Financial Services.

Israel had a current-account surplus of $1.79 billion in the second quarter. Income from gas production may add as much as $3 billion this year, and for every $1 billion increase the shekel gains about 1 percent, according to the Bank of Israel.

The IMF predicts an Israeli surplus of 3 percent of GDP next year, compared with deficits of 3.8 percent in India and 7.2 percent in Turkey

Regional political risks did push Israeli credit-default swaps higher in August and early September, narrowing the gap with other emerging markets. They reached a 2013 high of 147 basis points on Sept. 5, as the U.S. weighed military action against Syria's government.

Iran Risks

Since Sept. 9, when President Barack Obama welcomed a Russian proposal for averting the use of force, the swaps have dropped 37 basis points.

The prospect of Israeli strikes against Iran, aimed at stopping the country's nuclear program, has also receded as the U.S. and allies step up talks with the Islamic republic after its new president, Hassan Rouhani, said he's ready for a deal.

That's a risk that may return, said Elliot Hentov, the primary analyst for S&P's Israel report, in a phone interview. "If this diplomatic initiative fails, the proponents for military action will become stronger, and 12 months from now we could be seeing a very different picture."

For now, "Israel is like an island in the ocean with all sorts of storms raging around it," Hentov said. "Most of its adversaries are busy with other priorities, thus deflecting much of its risk."