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Unrest in Israel's High-Tech Industry

Violence, as Well as Economic Slowdown, Is Keeping Investors at Bay


TEL AVIV — Last year, the red-hot high-tech sector handed Israel its most prosperous year in recent memory and helped turn it into one of the great economic success stories of the decade.

What a difference a year makes. Israel's high-tech leaders are girding for leaner times, citing a free fall in technology-heavy Nasdaq stocks, uncertainty over the recent election of hawkish Likud Party leader Ariel Sharon as prime minister and, worst of all, violence in the Palestinian territories.

For months, executives of high-tech companies have insisted that their businesses were more affected by Nasdaq than by Nablus, a reference to a militant Palestinian town in the West Bank. Now they are slowly acknowledging that the 5-month-old intifada, or uprising, is beginning to take some toll on the economic climate inside Israel.

The inflow of foreign venture capital is slowing. Dun & Bradstreet, which sells financial data on millions of businesses worldwide, recently downgraded Israel's impressive credit rating a notch, citing the heightened political unrest.

And only this week, the Finance Ministry said the escalating violence in the Palestinian territories--along with the U.S. economic slowdown--was responsible for its slashing 2001 growth estimates from nearly 6% to between 2% to 3%.

Many international investors, who during the 1990s flocked to Israel to grab a piece of its Internet-driven economy, are staying away because of a U.S. State Department advisory warning travelers to avoid the strife-torn nation. An Israeli venture capital firm promoting high-tech businesses recently hosted a conference in Amsterdam because clients were reluctant to visit Israel.

Increasingly, international customers are worried that the unrest could affect their ability to get Israeli goods.

"People are asking: What will happen to our businesses if you can't make or deliver your product because of all the trouble that is going on?" said Chemi Peres, managing director of Polaris Venture Capital, Israel's most successful venture fund. "They are seeing us through a CNN window, when many of us know that's not the reality."

Peres was referring to international media coverage of the intifada, which so far has claimed the lives of about 400 people, most of them Palestinians.

Some high-tech executives worry that their lot could worsen if Sharon, a retired army general who is reviled in the Arab world, appears inflexible in dealing with the Palestinians.

"Israel faces critical times," said Augusto Lopez-Claros, a senior economist with Lehman Bros. in London who tracks the Israeli economy. "Clearly the main risks in 2001 are political."

Mindful of the stakes, high-tech industry leaders are trying to exert some influence on the political situation. Some recently paid for a newspaper ad calling on Sharon and his rivals in the center-left Labor Party to put aside differences and form a coalition government--a move that Labor agreed to this week.

Top executives of high-tech companies also joined other industrialists who held a series of meetings with the prime minister-elect, lecturing him about the need for national and regional stability.

Sharon, who is more familiar with tanks than tech, is paying heed--for now. Since defeating Prime Minister Ehud Barak in the Feb. 6 election, he has been taking private lessons in economics from former Bank of Israel Gov. Yaacov Frenkel.

Stopping a Tech Brain Drain

Like any good student, he told the top-selling Yediot Aharonot newspaper that he's filled his notebook. "There are many things in economics which I still don't know," he said.

But one of his first tasks as prime minister, Sharon promised, would be to "implement tax laws that stop high-tech companies and brains from leaving the country."

High-technology executives have long complained that the country's antiquated tax laws were causing the majority of Israeli start-ups to incorporate in Delaware and other tax-friendly havens. If Israel's capital gains taxes were reformed, they say, many of those companies would stay at home.

Raanan Gissin, Sharon's spokesman, said the prime minister-elect believes that a unity government is the first step toward projecting stability, luring back investors and maintaining a high credit rating.

"Mr. Sharon is making all the right noises," said Yossi Vardi, a venture capitalist who invests mainly in high-tech companies.

But "the big question is what kind of approach Sharon will take to the Israeli-Palestinian problem," said Peres of Polaris, which manages a $500-million portfolio.

"We only hope the peace process will continue," said Peres, the son of former Prime Minister Shimon Peres. The elder Peres is expected to serve as foreign affairs minister in Sharon's government.

Though some business leaders worry that Sharon's reputation as a coldhearted warrior could hurt him, others are betting that Sharon will soften his hard-line policies toward the Palestinians.

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