Israel
2012 Article IV Consultation: Staff Report; Informational Annex; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Israel

This 2012 Article IV Consultation reports that Israel has emerged from the 2008–09 global crisis with strong economic growth, a resilient banking system, and unemployment at historic lows. Exports, at 40 percent of GDP, depend on global demand for high-technology products, such as electronics and pharmaceuticals, and communications. One-third of exports go directly to Europe, with more routed there indirectly. Given the country’s weak direct trade linkages to the region, regional tensions mainly affect Israel through security, investor and consumer confidence, and public finances.

Abstract

This 2012 Article IV Consultation reports that Israel has emerged from the 2008–09 global crisis with strong economic growth, a resilient banking system, and unemployment at historic lows. Exports, at 40 percent of GDP, depend on global demand for high-technology products, such as electronics and pharmaceuticals, and communications. One-third of exports go directly to Europe, with more routed there indirectly. Given the country’s weak direct trade linkages to the region, regional tensions mainly affect Israel through security, investor and consumer confidence, and public finances.

THE CHALLENGES AHEAD

External and domestic strains cloud the outlook

1. Israel emerged from the 2008–09 global crisis with strong economic growth, a resilient banking system, and unemployment at historic lows. In this context, policies were gradually tightened through mid 2011 (Table and Figures 1 and 2).

Figure 1.
Figure 1.

Israel: The Long-Term View, 1996–2011

Citation: IMF Staff Country Reports 2012, 070; 10.5089/9781475502725.002.A001

Sources: Haver Analytics; Bank of Israel; and IMF staff calculations.
Figure 2.
Figure 2.

Israel: Recent Economic Developments, 2007–11

Citation: IMF Staff Country Reports 2012, 070; 10.5089/9781475502725.002.A001

Sources: Bank Hapoalim/Israeli Purchasing and Logistics Managers Association; Bureau of Economic Analysis; Central Bureau of Statistics; and Statistical Office of the European Communities.

2. But the external outlook has again deteriorated. Although the world economy is expected to avoid recession?assuming the euro area crisis is resolved?growth projections for 2012 and 2013 have been marked down substantially. And regional tensions have also risen (Annex I).

3. In addition, extensive peaceful social protests?in part reflecting a decade of stagnant real wages and concentration of economic power?took place in 2011 and could resurface.

World Economic Outlook

(January 2012 update, annual percent change)

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Source: IMF World Economic Outlook Update, January 2012.

4. And inequality and poverty—both already high—are set to rise further reflecting low participation and rapid growth of the Arab-Israeli and Haredi communities (see SIP Chapter I).

What are the channels through which these factors will affect Israel?

5. Exports, at 40 percent of GDP, depend on global demand for high-technology products, such as electronics and pharmaceuticals, and communications. One third of exports go directly to Europe, with more routed there indirectly. But if global weakness is reflected in international oil prices, this will help as Israel is a large net energy importer.

A01ufig01

Israel’s GDP and Global Demand

(Annual percent change)

Citation: IMF Staff Country Reports 2012, 070; 10.5089/9781475502725.002.A001

Source: IMF World Economic Outlook Update, January 2012.
A01ufig02

Israel: Manufacturing Exports (excluding diamonds) by Technological Intensity

(SA, January 2007 = 100)

Citation: IMF Staff Country Reports 2012, 070; 10.5089/9781475502725.002.A001

Source: Haver Analytics.1/ Parentheses indicate shares in total manufacturing exports.
A01ufig04

Israel: high-tech exports and US IT Industry

(Y/Ypercent change)

Citation: IMF Staff Country Reports 2012, 070; 10.5089/9781475502725.002.A001

Source: Haver Analytics.1/ Coincident indicators of activity in the US IT sector, including IT investment, consumption, employment, production, and shipments.

6. Links through the financial sector are limited. Banks’ cross border activities are moderate: their total foreign assets and liabilities amount to 10 percent and 14 percent of GDP, respectively, with negligible direct exposures to peripheral advanced European countries. And, operations of foreign-owned financial institutions in Israel are negligible. Likewise, wholesale funding of banks is low, but stress will likely appear from the domestic corporate bond market (Figure 3).

Figure 3.
Figure 3.

Israel: Selected Financial Market Indicators, 2008–12

Citation: IMF Staff Country Reports 2012, 070; 10.5089/9781475502725.002.A001

Sources: Bloomberg; Datastream;Moody’s KMV; and Tel Aviv Stock Exchange.

7. Given the country’s weak direct trade linkages to the region, regional tensions mainly affect Israel through security, investor and consumer confidence, and via the public finances.

A01ufig03

Israel: Exports Destination in 2011

Citation: IMF Staff Country Reports 2012, 070; 10.5089/9781475502725.002.A001

Source: Haver Analytics.

8. Similarly, social pressures mainly affect fiscal choices, on taxation and spending. The “Trajtenberg Committee” (Box 1), set up to help the government plan a response to the social protests, has made a range of proposals for taxation and spending adjustments, most of which have been approved by the Knesset.

9. If continued, participation and demographic trends in minority communities will soon significantly lower the potential growth of the economy, with implications for overall income growth, inequality, and fiscal sustainability.

A01ufig05

Israel: Banks Foreign Assets and Liabilities

(Percent of GDP)

Citation: IMF Staff Country Reports 2012, 070; 10.5089/9781475502725.002.A001

Source: Haver Analytics.

IS ISRAEL PREPARED?

Israel has strong fundamentals

10. Externally, foreign exchange reserves have increased steadily since 2008 to reach $77 billion, some 10 months of total imports, and above 130 percent of short-term external debt. For the first time over the last two decades, the net international investment position has turned to a surplus (6 percent of GDP, Tables 2 and 3).

11. Institutional frameworks are also strong.

Table 1.

Israel: Selected Economic Indicators, 2007–13

(Percent change; unless otherwise indicated)

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Sources: Haver Analytics; Bank of Israel, Central Bureau of Statistics; World Bank; and IMF staff estimates and projections.

Poverty rate from National Insurance Institute of Israel.

As at end-February 2012.

Table 2.

Israel: Balance of Payments Accounts, 2007–17

(In billions of U.S. dollars; unless otherwise indicated)

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Sources: Central Bureau of Statistics.

IMF staff estimates and projections.

Excludes reserve assets.

Negative (positive) sign denotes increase (decrease) in reserves.

Data for 2012 is as at end-February 2012.

Table 3.

Israel: International Investment Position, 2003–11

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Source: Haver Analytics.

12. In particular, Israel’s new fiscal rule, embedded in the 2010 Deficit Reduction and Budgetary Expenditure Limitation Law, and reflected in the 2011-12 “two year” budget, comprises two disciplinary elements:

  • The expenditure rule adjusts the cap on real expenditure growth as public debt approaches 60 percent of GDP.

  • The headline budget deficit is targeted to fall to 2, 1½, and 1 percent of GDP in 2012, 2013, and 2014 respectively.

13. Furthermore, Central Bank legislation has been reinforced. The 2010 Bank of Israel (BoI) Law now stipulates price stability as the primary objective of monetary policy, and has strengthened the BoI’s autonomy, transparency, and governance.

14. The FSAP Update, conducted as part of this consultation, concludes that the financial system is stable, with the BoI maintaining strongly proactive supervisory practices, which have preempted the systemic risks seen elsewhere (Figure 4 and Tables 4 and 5).

Figure 4.
Figure 4.

Israel: Performance of Banks, 2005–11

Citation: IMF Staff Country Reports 2012, 070; 10.5089/9781475502725.002.A001

Source: The Bank of Israel; and SNL database.1/ Israeli banks are colored in red; the comparator samples consist of major banks in Europe, US, and Canada.
Table 4.

Israel: Financial System Structure, 2005–10

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Sources: Bank of Israel, Ministry of Finance, and Israel Securities Authority.
Table 5.

Israel: Financial Soundness Indicators?Five Major Banks, 2005–11

(In percent; unless otherwise indicated)

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Sources: Bank of Israel, and IMF staff estimates.

The market share of five major banks (in assets) is about 95 percent of the whole banking system.

From 2009, the calculation of capital base follows rules under Basel II.

15. Israel also enjoys the option to issue sovereign bonds under Section 502(7) of the US Federal Credit Reform Act of 1990. While only some 7½ percent of Israeli public debt is currently covered by these guarantees—some 40 percent is untapped—, and further use of the scheme is subject to key formal limits, the guarantees provide contingent reassurance.

16. Moreover, following recent discoveries of new natural gas fields, the total estimated value of which is some 50 percent of 2011 GDP, Israel will become a net energy exporter in coming years. Looking ahead, the taxation of natural resources has been rationalized, and provisions are being made to place the proceeds in a sovereign wealth fund.

17. This overall assessment of fundamentals is reflected in Standard & Poor’s rating upgrade from A to A+ on long-term foreign currency credit rating in September 2011. CDS spreads on the sovereigns have risen somewhat recently, but remain far below those of the stressed European countries.

And economic performance was strong in 2010 and into 2011

18. Output rebounded quickly from the global downturn as early as 2009 Q2, with growth of ¾ percent in 2009 and 4¾ percent in 2010. This was initially led by a pick-up in exports and private consumption, with a strong recovery in investment.

Israel: Recent Developments, 2009-11

(Percent change from the previous period, SAAR; unless otherwise indicated)

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Source: Haver Analytics; IMF staff estimates and projections.

Contributions of GDP growth.

19. This was also quickly reflected in a return of employment to pre global crisis levels. The unemployment rate fell to a historical-low of 5½ percent, and wage pressures remained moderate, in part reflecting the increased entry of lower-wage earners. Unit labor cost growth was flat in 2011. But participation rates remain very low around 56–58 percent.

A01ufig06

Israel: Labor Costs

(Y/Y percent change)

Citation: IMF Staff Country Reports 2012, 070; 10.5089/9781475502725.002.A001

Source: Haver Analytics.

Macroeconomic policies were adjusted appropriately given the resumption of growth during 2009

20. On the fiscal side, the 2010 overall balance strengthened by 1½ percentage points of GDP (Table 6).

Table 6.

Israel: Central Government Accounts, 2007–14

(In percent of GDP; unless otherwise indicated)

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Sources: Data provided by the Israeli authorities; and Fund staff estimates.

Data as per the national defintion, cash basis, covers the budgetary sector and NII, excluding net credit.

Excludes the ILA profits from land sales, which have been recorded in financial transactions since 2009.