1. This statement reviews economic and financial developments in Israel since the circulation of the staff report for the Article IV consultation (SM/00/45, 3/1/2000). This information does not alter the thrust of the staff appraisal.

2. According to recently revised Central Bureau of Statistics (CBS) estimates, GDP grew by 2.2 percent in 1999, compared with a previous estimate of 2 percent. Real activity in 1999 was led by domestic demand, in particular private consumption and a sharp rebound in nonresidential investment. This estimate implies that for the second straight year per capita income declined slightly, following very rapid per capita growth in the early and mid-1990s.

3. New CBS seasonally adjusted quarterly GDP data indicate that GDP growth was about 5½ percent in annual terms in the second half of 1999, rather than 4½ percent as had previously been estimated. This suggests that the recovery may be stronger than hitherto estimated, and has led some observers to increase the annual growth rate estimates for 1999 to about 2½ percent. Recently released “Consensus Forecasts” for 2000–01 also indicate an overall improvement in the economy’s outlook.

4. Consumer prices declined in the first two months of 2000, continuing a trend that begun in October 1999. The overall consumer price index fell by close to 1 percent in January–February 2000, influenced by a seasonal decrease in the prices of clothing and footwear and the effects of a strengthening sheqel on the exchange rate linked-housing component of the price index. The underlying CPI—which excludes fresh fruits and vegetables, and housing—also declined, albeit just slightly, in the first two months of this year. In the 12-months to February, inflation was 1.6 percent for the overall CPI (1.7 percent for the underlying index). The bond-market derived measure of inflation expectations has remained generally below the lower end of the inflation target for 2000 (3 percent) in the first two and a half months of this year.

5. The central government operational balance posted a NIS 1 billion surplus during January—February of this year, marking a substantial improvement over the NIS 0.8 billion deficit observed in the corresponding period of 1999. In nominal terms, revenues have risen by about 20 percent relative to the comparable period in 1999, whereas expenditures have increased by about 10 percent. This turnaround largely reflects the difference between current economic activity levels and those observed in early 1999.

6. The trade deficit in the first two months of the year was about US$1.4 billion, 12 percent larger than the deficit accumulated in the corresponding period of 1999—but foreign trade was disrupted by a port strike in January 2000. Export growth has picked up since the third quarter of 1999 and has been in line with import growth in the last three months.

7. The sheqel has appreciated by 4.3 percent relative to the U.S. dollar since the end of 1999, and the exchange rate is now just 4 percent above the lower (appreciated) limit of its 44 percent-wide band. This appreciation has been driven by the still substantial, although diminishing, sheqel-dollar interest rate differential, and has also reflected the strength of portfolio and foreign direct investment inflows primarily into the high-technology sector. The strengthening sheqel and the quiescent behavior of inflation have led the Bank of Israel to cut its discount rate by 160 basis points in the four months since November 1999. These developments support the staffs view that there is scope for further gradual, cautious, cuts in interest rates.

8. The Tel Aviv Stock Exchange (TASK) general share price index rose by 64 percent in 1999, and reached record levels at the beginning of March 2000, before declining slightly in the wake of the recent weakness in some of the major international stock exchanges. Last year’s strong performance of the TASE has been attributed to the worldwide share price boom, the Israeli economic recovery, declining inflation, and progress on the peace process. It should be noted that real estate prices have increased only modestly, and that there are no signs of a generalized asset price boom in Israel.

9. In March the government raised US$500 million through a very successful global bond offering. The offering, which consisted of 10-year notes that were priced at 144 basis points above 10-year U.S. treasuries, came after Moody’s and Standard and Poors changed their outlook on Israel to positive from stable. The agencies attributed the improved credit rating outlook to the revitalization of the peace process, and Israel’s progress in implementing structural reforms and in reducing inflation and the budget deficit.