By Steven Scheer
JERUSALEM, April 12 (Reuters) - The Bank of Israel's exit from foreign exchange market intervention will likely not be abrupt and partly hinges on the pace of United States and European interest rate increases, a senior central bank official said on Tuesday.
In an attempt to prevent a rapid appreciation of the shekel and damage to exports -- which account for more than 40 percent of economic activity -- the Bank of Israel has bought nearly $50 billion of foreign currency in the last three years.
Barry Topf, head of the market operations division at the central bank, said the policy has been a definitive success but the bank seeks to stop being a player in the market.
"The exit strategy is a bit of a tango -- it's probably dependent on what we do and also probably dependent on economic developments globally," Topf said in an interview with Reuters.
"This is a very unusual process where interest rates are zero or close to zero in major economies and major reserve currencies. That will not last forever and hopefully they will be able to move out of that soon and that will play a major role in returning the whole system to a better balance," he said.
After buying $10 billion in 2010, the central bank has so far bought about $2.5 billion so far in 2011 -- $2.09 billion of which came in January.
Topf, who last week was named senior adviser on monetary policy to Bank of Israel Governor Stanley Fischer and who will be a voting member of the new monetary policy council currently being formulated, noted purchases in the first quarter were below 2010 levels.
"It's not going to be an abrupt stop. We don't want to make an abrupt stop," Topf said. "What will probably be is the realisation dawning on people that we are playing a smaller and smaller and eventually no role in the market.
"We can't keep buying forever. So, it will have to return to the state it was," he added.
A key benefit of the purchases has been the ability of the Bank of Israel to raise short-term interest rates without worrying about the impact on the exchange rate, Topf said. The central bank has raised its benchmark rate nine times by a total of 2.5 percentage points to 3 percent since August 2009.
FOREX RESERVES SOAR
A main consideration for the intervention policy has been to protect Israel's exporters.
"We were able to bring the economy through the crisis without forcing it to go through a wrenching readjustment to a very overvalued exchange rate," Topf said.
"To expect exporters to find new markets in a contracting market, to diversify geographically when markets are contracting would have been an almost impossible feat and the real cost of that would be very, very great," he said. "Now, we are three years later and exporters have held up profitably."
The dollar buying has brought Israel's foreign currency reserves to $74.5 billion, a level Topf said was not excessive and lower than many other countries. He said estimates of what level of reserves are considered adequate have jumped as a result of the global financial crisis.
Topf declined to say what the central bank deems as an acceptable level of reserves. He also dismissed criticism in the Israeli media that the central bank is losing money on its reserves, saying the losses mean the Israeli economy is doing well and the public benefits from the economic growth.
Still, Topf said the central bank was preparing the groundwork to invest the reserves in equities to increase profits.
The shekel stands at a 2-1/2-year high of 3.44 per dollar. Topf said the Bank of Israel doesn't just look at the dollar-shekel rate but euro-shekel and other currencies in high-growth countries Israel competes with for investment.
While analysts have blamed part of the shekel's strength on speculative flows, Topf said that was an imprecise term.
"What we have seen in the last few months is a greater role for very short-term investments in the Israeli economy," he said. "Whether speculative or not speculative, they are inherently more unstable and more risky because they are short-term and can be reversed quickly and have the potential to disrupt the economy. Once we saw this shift to shorter-term investments ... we thought that was something that deserved a response."
That came in January when it imposed a reserve requirement on some foreign exchange derivative deals.
Topf said the move has been effective and has changed the trend "and in some cases reversed the trend".
"If we see the need to take more steps, we will," he said. "It depends on the pace and extent of those flows." (Editing by Stephen Nisbet)