http://www.bloomberg.com/bw/stories/2008-07-23/israel-turns-to-outsourcing-as-the-shekel-soarsbusinessweek-business-news-stock-market-and-financial-advice

For years the cost advantage of Israel's high-tech industry over Silicon Valley and other tech hot spots was a major selling point. This led global giants like Intel (INTC), Motorola (MOT), and Microsoft (MSFT) to set up major R&D operations in Israel, and was the catalyst for local success stories like Check Point Software Technologies (CHKP), Nice Systems (NICE), and Amdocs (DOX). That's no longer the case. "The cost of an Israeli engineer is now on par with the U.S., while his Romanian counterpart is just one-third," says Tzvi Friedman, CEO and president of Alvarion. An Israeli high-tech engineer makes about $90,000 at the latest exchange rate.

Other companies are looking farther afield in an effort to cut costs. "We're in advanced discussions with several companies in India on moving some of our development work over there," says Shmuel Arvatz, chief financial officer at Click Software Technologies. The Tel Aviv-based optimization software company has already frozen wages for part of its Israeli staff. Alvarion and Click Software have not yet been forced to lay off workers in Israel, as demand for their products remains strong. But that has not been the case with a growing list of companies, including Retalix, Metalink, and the Israeli subsidiary of Polycom, which was shut down last month.

Bank of Israel Intervenes

So far there have not been significant layoffs in the high-tech sector, but there are growing fears that this could change as the global slowdown in the U.S. and Europe spreads. The main problem: Wages are in shekels, while revenue is in dollars. The greenback has dropped in value by 30% against the shekel since March 2007, with half of the decline during the first half of this year (BusinessWeek, 2/7/08). The shekel's performance has been attributed largely to the strong growth of the Israeli economy over the past four years.

To make matters worse, wages in the industry have risen an average of 8% in the past two years. On July 10, the shekel was trading at 3.22 to the dollar, its highest level in nearly 13 years. That same day, Bank of Israel Governor Stanley Fischer announced that the central bank would enter the foreign currency market and buy up $100 million daily in an effort to rein in the shekel. The dollar has risen by around 6% since the Bank of Israel's intervention, but many say the correction only partly offsets the meteoric rise of the shekel over the past two years.

The shekel's strength has not had an effect on high-tech exports, which accounted for 41% of the $20 billion in industrial exports in the first half of 2008. They rose at a 22% clip. But many experts believe the statistics are deceiving, since many deals were signed months ago and are not profitable at today's exchange rates. Dozens of companies have already lowered their earnings guidance for 2008. "High-tech companies are going to have to rethink their model of hiring in Israel and how to compensate employees if they want to remain profitable, in line with global standards," says Daniel Meron, technology analyst at RBC Capital Markets.