Investors wait on Sharon

Sharon's performance is vital to Israel's economy

By Avril Stephens, CNN.com Europe writer

LONDON, England (CNN) -- The success or failure of prime minister designate Ariel Sharon in forming a national unity government will have a knock-on effect on Israel's economy and foreign investment.

The uncertainty which has already surrounded the Mideast peace talks and February's special prime ministerial election has seen $368 million of foreign investment stream out of the country's economy during the last quarter of 2000 -- about 11.5 percent of the total held by foreigners in the Tel Aviv stock market.

If Sharon fails to form a coalition government the resulting in heightened uncertainty and possible tension with Palestinians could worsen the situation, a top emerging markets investment company has said.

Harlan Zimmerman, emerging European fund manager at Foreign & Colonial, which invests $4 billion of pension money in the emerging markets, said the feeling in the investment community is that Sharon will fail to form a national government.

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"He only has about 62 seats to play with, and a lot of people think he is not going to get a unified government, or that it will not last long -- resulting in new elections."

Zimmerman added the increased tension could hit Israel in three ways.

It could have an adverse impact on tourism; the labour supply -- as Israel would be likely to close its borders to Palestinians who provide cheap labour -- and a lack of foreign investment through falling confidence.

Foreign investment during 2000 amounted to $11 billion -- up from $9 billion the previous year. The figure represents about 10 percent of Israel's total Gross Domestic Product (GDP) which is only $110 billion.

Hi-tech gloom

Tension could deter companies including Intel from investing in Israel while companies such as Lucent could be deterred from moving into the area.

It could also put off venture capitalist funds investing in Israel -- already showing a slow down as a result of the dot.coms gloom.

Investors buying stocks directly in the Tel Aviv stock market are already causing a net outflow of funds amid election jitters.

Also, if Sharon fails in his plans to form a national unity coalition and has to "buy off" right-wing and religious groups with extra money for housing spending and education "it could have an adverse impact on the government deficit budget."

But the impact on the U.S. and European economies would only kick-in if an extreme situation arose.

Zimmerman said: "The only scenario for that would be if relations got so frosty and there was a polarisation in relations between Arab countries and the U.S..

"If that was the case it could have an impact on the price of oil as the Arab world would push up the price -- such as it did in the early 1970s following the Yom Kippur War in 1973."

The surrounding Arab economies are unlikely to be affected by a lack of investment in Israel because an expected boom from Israeli investment has not materialised.

It had been expected that, following agreements between Israel and Jordan as well as Egypt in the mid-1990s, closer economic relations would follow and that they would benefit from Israel's hi-tech companies, but this did not happen.

Exports represent a third of Israel's Gross Domestic Product (GDP) -- with hi-tech industries making up 75 percent of that.

Its technology boom has already started to slow-down in the general economic downturn that is also affecting the U.S..

Expectations of GDP growth is 2.5 percent to 3 percent for 2001 -- down from the 6 percent of last year.

Zimmerman added: "Generally, there will be a slow down. It is a question of whether it will be more or less severe as a result of Sharon's actions."

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