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By Steven Scheer
JERUSALEM (Reuters) - Prime Minister Benjamin Netanyahu was starting a meeting with his team of Middle East peace negotiators last week when Leo Leiderman, his second choice to lead the Bank of Israel, called.
Just 48 hours earlier, on July 31, Leiderman had agreed to replace central bank governor Stanley Fischer, who once taught U.S. Federal Reserve Chairman Ben Bernanke and whose reputation had lifted Israel's international economic profile.
Leiderman, the second nominee to drop out in less than a week, had changed his mind for undisclosed personal reasons, raising questions not only over Netanyahu's judgment but also much wider concerns about Israel's economic management.
The news drew a characteristic response from Israel's Finance Minister Yair Lapid, until last year a popular television talkshow host, who joked on his Facebook page that economics professors were "a very colorful and wild bunch".
But the withdrawal was no joke for Israel's credibility, with a risk of the vacuum left by Fischer, who had announced in January that he would leave in June, remaining for many weeks.
Compounding the uncertainty, the top ranks of Israel's stock exchange are also in turmoil. The chief executive officer and chairman both resigned last month amidst acrimony over plunging trading volumes and increased government regulations.
"In the last four months, very significant mistakes have been made and people feel there is no economic leadership," said one senior government official, speaking on condition of anonymity. "This is going to frighten potential investors."
Netanyahu's first choice for central bank chief was Jacob Frenkel, who ran the bank in the 1990s and is currently chairman of JPMorgan Chase International.
He pulled out after Israel's press reported an incident in a shop in Hong Kong's airport in 2006. He was not charged and said he had withdrawn his bid because of a "witch hunt".
Leiderman has not explained his decision, leaving the media to debate whether it was because of revelations that he used to consult astrologers or other skeletons in his cupboard.
Some politicians question whether the intrusive, public system of vetting candidates will deter top talent.
"Only a madman would offer his candidacy for governor of the Bank of Israel," the chairman of parliament's finance committee, Nissan Slomiansky, told a hearing on Wednesday.
Others question whether Netanyahu, focused on geo-political concerns such as the newly resumed Palestinian peace talks, is paying enough attention to economic issues.
Barclays Capital emerging markets economist, Daniel Hewitt says mass protests on the streets of Israel in 2011 forced Netanyahu, a fan of free markets, to change tack.
"Before, he had an economic agenda," Hewitt said. "He was on a path to lowering taxes and deregulation, but the demonstrations derailed him... Economics became less important in his agenda and foreign affairs became more important."
The government has denied dropping the ball on the economy and Netanyahu has said he regretted the decision of both Frenkel and Leiderman to withdraw their central bank candidacies.
Some economists argue that government policy drawn up in the wake of the social protests, aimed at lowering prices and tackling Israel's powerful conglomerates, have exacerbated the problems afflicting the Tel Aviv Stock Exchange (TASE).
Reforms of the telecommunications sector aimed at boosting competition, combined with pledges by Netanyahu and Lapid to hike some corporate tax rates have sent investors fleeing.
"You would have to pause before you invest in Israeli stocks," said veteran stock market analyst Richard Gussow.
"Who knows what is next? The pendulum has swung too far and politicians who want to win votes push regulation that is detrimental to the economy and the stock market," he added.
Trading on TASE has slid to a daily average of 1.1 billion shekels ($309 million) this year, from two billion in 2010.
Israel's Securities Authority (ISA) has accused TASE's management of failing to adopt to a changing environment.
When he resigned last month, TASE Chairman Saul Bronfeld blamed interference from the ISA, government regulations and wider economic concerns for deterring investors.
Israel's economic outlook would be the envy of many other nations, with the economy set to grow by 3.8 percent in 2013, but dark clouds lie on the horizon.
The country's emergence as an energy-rich nation risks pushing up the value of the shekel because it no longer has to import so much dollar-denominated fuel and can even start making exports, altering the shape of its balance of payments.
Perhaps counter-intuitively, the government's failure to find a new central bank governor has caused the shekel to strengthen rather than weaken, with speculators testing the resolve of the bank to push back against market forces.
The currency hit a two-year high against the dollar this week. Since the end of May, it has gained some 5 percent, with half that move coming since Fischer left.
"It is less important who will be the next governor, but rather that a decision should be made soon," said Nir Omid, head of investments at financial services company Tamir Fishman.
Fischer's deputy Karnit Flug has been put in temporary charge. Twice overlooked as a permanent choice, she says she will quit once a successor is in place.
Barry Topf, senior advisor to the governor and a member of the bank's monetary policy committee, told Reuters the shekel had been more stable than other currencies during recent market volatility and denied the bank was rudderless.
Guided by Fischer's macro-economic know-how, Israel's economy flourished, posting the highest growth rates in the West between 2009 and 2012. Israel was the only developed country whose sovereign credit rating was raised during that time.
Lapid, whose new political party came a surprise second in January elections, has no economic experience and some of his decision-making has come under attack, including an abrupt announcement that the budget deficit target was being hiked.
His office declined any comment. The minister has previously said he inherited a budget hole he did not have time to plug.
Lapid still has far to go to establish his credentials. A poll this week on the parliamentary TV channel said 78 percent of Israelis do not trust him as finance minister.
"He is not a media star anymore. He is responsible for the economy so he needs to change his attitude," the senior government official said. "Any problem and he makes jokes."
(Editing by Crispian Balmer and Alexander Smith)