Contrary to what recent polls suggested, the Likud party won the Israeli elections. It’s unclear what led to this surprise development, but what happens now? BBH EM Strategist Dr. Win Thin explores the political and economic repercussions.
Contrary to what recent polls had suggested, Likud has won the Israeli elections. With nearly all votes counted, Likud will hold 30 out of 120 seats in the Knesset. The Opposition party (Zionist Union) failed to make good on polls that suggested voters were ready for an alternative to Likud, winning only 24 seats.
It’s unclear what led to this surprise development. Perhaps it was Netanyau’s harder push towards the right days before the vote, when he said Likud would not allow the establishment of a Palestinian state. This doubling down move to the right contradicted his earlier position of being in favor of the proverbial “two-state solution.”
So what happens now? President Rivlin has asked Likud to form a government, which Netanyahu pledged to do quickly. The other parties after Likud (30 seats) and Zionist Union (24) include the Joint List of four small Arab parties (14), former Finance Minister Lapid’s centrist and secular Yesh Atid (11), secular and center-right Kulanu (10), right-wing pro-settler Jewish Home (8), orthodox Shas (7), orthodox United Torah Judaism (6), right-wing nationalist Yisrael Beiteinu (6), and left-wing Meretz (4).
The 2013 elections resulted in a coalition of Likud, Yisrael Beiteinu, Yesh Atid, and Jewish Home that together held 68 out of 120 Knesset seats. Elections became necessary after Lapid was dismissed in December as Finance Minister over clashes with Netanyahu. Official statements suggest Netanyahu has reached out to Jewish Home, Yisrael Beiteinu, Kulanu, and the orthodox parties Shas and United Torah Judaism to become coalition members. This obviously leaves out Lapid’s centrist Yesh Atid. Without the centrist Kulanu, these parties would only hold 57 seats and so Netanyahu will have to reach out to other, perhaps more centrist parties. If Netanyahu can draw in his former Communications Minister Moshe Kahlon’s centrist Kulanu party, its 10 seats would bring the coalition up to a working majority of 67 seats.
The victory by Likud means an unprecedented fourth term for Netanyahu. Given Netanyahu’s hard-right tilt pre-election, this could mean an expansion of settlements and greater popular tensions domestically. Externally, it will likely mean a deepening of the rift in international relations between Israel and the US – well, at least with Obama and the Democrats. However, having to bring in a centrist party like Kulanu into the coalition could limit this rightward drift.
As many commentators have opined, the elections were not really about economics. The fundamental backdrop remains solid, though some believe growing inequality in the country means that the benefits to growth are not being distributed evenly. S&P said the election results have no ratings implications, and we agree. Our model views Israel as A+/A1/A+, which is where both S&P and Moody’s rate it.
GDP growth is seen at 3.1% this year, up from 2.4% in 2014. The current account surplus should remain near 3% of GDP this year, but we note exports have slowed noticeably in recent months. Indeed, exports have contracted y/y for five straight months through February.
The central bank remains concerned about deflation risks, surprising markets with a 15 bp cut in the policy rate to 0.10% back in February. With rates really now at the zero bound, the next move would likely involve unorthodox measures such as asset purchases. It has done this before, during the depths of the financial crisis.
For now, however, we believe policymakers will continue to rely on a weaker shekel as the main lever of further stimulus. The next target for USD/ILS is the 2012 high near 4.10. After that is the 2009 high near 4.2760 and then the 2007 high near 4.37. In the context of broad-based EM weakness that we see ahead, these targets are well within reach.