Israel: Staff Report for the 2015 Article IV Consultation

Israel came through the crisis relatively well, and unemployment has continued to fall to multi-decade lows. But policy makers are confronted with several challenges. The fiscal deficit remains stubbornly high, leaving limited buffers to respond to shocks. Inflation is negative-well below the Bank of Israel's (BOI) target-but housing prices continue to rise, posing financial sector risks. Labor productivity is low and the gap relative to the US is widening. And income inequality is among the highest across all advanced countries.

Abstract

Israel came through the crisis relatively well, and unemployment has continued to fall to multi-decade lows. But policy makers are confronted with several challenges. The fiscal deficit remains stubbornly high, leaving limited buffers to respond to shocks. Inflation is negative-well below the Bank of Israel's (BOI) target-but housing prices continue to rise, posing financial sector risks. Labor productivity is low and the gap relative to the US is widening. And income inequality is among the highest across all advanced countries.

Context

1. Israel is a small open economy, well-integrated in the world economy through trade and capital market channels. Israel’s exports account for one third of GDP, with the United States, Europe and emerging Asia its major trade partners. Israel has strong comparative advantages in the high-tech industry, which accounts for more than 40 percent of total manufacturing exports, but economy-wide labor productivity is low, and the poverty rate is among the highest in the OECD.

2. Israel was less affected by the 2009 crisis than many other countries, in part due to the absence of pre-crisis asset and lending booms. It is the only advanced economy where growth has exceeded pre-crisis WEO projections (Figure 1).

Figure 1.
Figure 1.

Israel: The Long View, 1996–2014

Citation: IMF Staff Country Reports 2015, 261; 10.5089/9781513536057.002.A001

Sources: Bank of Israel;Central Bureau of Statistics; IMF Information Notice System; and IMF staff calculations.

3. Unemployment has continued to decline, to 5.3 percent in 2015Q1—a multi-decade low. Thus continues the Israeli employment miracle: in the past 25 years, employment has grown by 3½ percent annually.1

A01ufig1

Israel: Employment, Population, and Growth

(Percent; 4y moving averge)

Citation: IMF Staff Country Reports 2015, 261; 10.5089/9781513536057.002.A001

Sources: Central Bureau of Statistics; and IMF staff calculations.
A01ufig2

Real GDP Growth: Forecast vs. Actual, 2007–12

(Percent)

Citation: IMF Staff Country Reports 2015, 261; 10.5089/9781513536057.002.A001

Source: WEO database, October 2007 and October 2014.
A01ufig3

Employment and Population Growth

(five year annual average, percent)

Citation: IMF Staff Country Reports 2015, 261; 10.5089/9781513536057.002.A001

Sources: Total Economy Database; Central Bureau of Statistics; and Haver Analytics.
A01ufig4

Israel: GDP per worker and GDP per capita

(Percent; 4y moving average)

Citation: IMF Staff Country Reports 2015, 261; 10.5089/9781513536057.002.A001

Sources: Central Bureau of Statistics; and IMF staff calculations.

4. Growth has slowed in recent years to around 3 percent. Both potential and actual growth have slowed—the latter held back by sluggish partner country growth, the strong shekel and—in 2014—the conflict in Gaza (Figure 2 and Table 1). In per capita terms, growth is about 1 percent.

Figure 2.
Figure 2.

Israel: Recent Economic Developments, 2010–15

Citation: IMF Staff Country Reports 2015, 261; 10.5089/9781513536057.002.A001

Sources: Bank Hapoalim/Israeli Purchasing and Logistics Managers Association;Bureau of Economic Analysis; Central Bureau of Statistics; Statistical Office of the European Communities;and IMF staff calculations.
Table 1.

Israel: Selected Economic Indicators, 2010–20

(Percent change, unless otherwise indicated)

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

Percent of potential GDP.

National Accounts data.

5. Policy makers are confronted with several problems:

  • Despite relatively high growth post-crisis, Israel has one of the highest structural fiscal deficits in the OECD. Repeated upward revisions to fiscal targets have delayed progress in deficit reduction.

  • Inflation is negative, but house prices keep soaring. Over the past 3 years, the BOI has cut the monetary policy rate from 3.25 to 0.10 percent. Low energy prices and an appreciating shekel have dampened inflation, although recent data showed an uptick in inflation and inflation expectations. Low interest rates have contributed to a housing price boom, with prices nearly doubling since the beginning of 2007.

  • Labor productivity is low and the gap relative to the United States is widening. Productivity will come under further pressure from the rapidly rising share in the population of the Haredi and Israeli Arabs—groups with generally lower-than-average education levels.

  • Income inequality is high. This reflects both high inequality of labor-income, with a high share of both high-paying and low-paying jobs relative to other countries; as well as less redistribution through the tax/transfer system than in other countries. Poverty is concentrated among the Israeli-Arab and Haredi populations, which have lower labor force participation rates, less education, and larger families, but even among the non-Haredi Jews, income inequality is higher than in almost all advanced economies.

A01ufig5

Structural Balance in 2014

(Percent of Potential GDP)

Citation: IMF Staff Country Reports 2015, 261; 10.5089/9781513536057.002.A001

Source: IMF’s Fiscal Monitor Database, April 2015.
A01ufig6

Labor productivity

(Real GDP per worker in US$ thousands; period average)

Citation: IMF Staff Country Reports 2015, 261; 10.5089/9781513536057.002.A001

Source: Total Economy Database.
A01ufig7

Israel: Earnings Dispersion

Citation: IMF Staff Country Reports 2015, 261; 10.5089/9781513536057.002.A001

Sources: OECD; and IMF staff calculations.

6. Traction of Fund policy advice. Many policy actions have been in line with Fund advice, including the BOI policy of keeping monetary policy accommodative while tightening macroprudential policy to contain a build-up of risk in the housing market and efforts to increase the labor force participation of the Haredi and Arab-Israeli populations. The record on fiscal policy advice has been weaker, with repeated adjustments of fiscal targets. In the area of financial sector policy, the establishment of a Financial Stability Committee (FSC) as recommended in previous Article IV consultations has yet to materialize.

Outlook

7. Staff expects growth of 3 percent in 2015, as rapid employment growth, falling import prices, and near-zero interest rates boost private consumption (Table 1). Weak partner country growth and strong demand for imports continue to weigh on net exports in the near term. The output gap is near zero, and inflation is projected to recover to around 0.7 percent at the end of the year. Beyond 2015, medium-term growth is projected at around 3–3¼ percent a year—in line with potential GDP growth.

8. Risks to the outlook are balanced. External downside risks include disappointing growth in Israel’s trading partners, geopolitical tensions in the Middle East, and a renewed appreciation of the shekel resulting from a longer episode of loose monetary policy in large advanced economies. In this context, prospective US monetary tightening could actually help Israel, as it would likely diminish re-emerging appreciation pressures on the shekel, especially if it reflects stronger growth prospects in the United States. Contagion from Greece is likely to be limited, as there are few financial and trade links. Domestic risks include a housing price bust, which could affect growth and financial system stability. Upside risks include a faster- and stronger-than-expected recovery in the global economy and a further increase in natural gas investment (Annex I).

The authorities’ views

9. The authorities’ views on developments and risks were very similar to staff’s. They had become more optimistic in recent months on near-term growth and noted that it was increasingly domestically-driven, with strong private consumption growth and relatively weak exports and investment. They estimated potential GDP growth at around 3 percent and thought that the output gap was small. It was difficult to determine the NAIRU, but it had likely been trending down: in the past ten years there had been a sharp increase in participation and a drop in unemployment. They did not believe that global market turmoil would lead to capital outflows—past episodes had been associated with safe haven inflows. In this context, they noted Israel’s strong external position, with current account surpluses and large reserve buffers. In any event, with the financial sector largely domestically financed, they agreed that capital outflows would likely support growth through a weaker shekel.

10. They agreed with the key policy challenges, which include strengthening the economy’s resilience to shocks, increasing medium-term growth, and integrating the Haredi and Israeli-Arab populations. They remained committed to reducing fiscal deficits but noted the need to increase investment on infrastructure and education to close the productivity gap with other advanced economies. They recognized the impact of low interest rates on housing prices and welcomed recent indication of easing downward pressures on inflation. On the housing market, they have initiated programs to ease supply constraints. They shared staff’s view that potential growth will come under pressure as the share of the Haredi and Israeli Arabs in the population rises rapidly in the near future.

Policy Discussions

A. Fiscal Policy

Israel’s fiscal deficit is too high, but reducing it has been challenging, in part because deficit reduction plans have been deferred repeatedly. The new government, facing spending pressures and desiring to keep tax rates low, needs to avoid following past patterns.

Background

11. Israel has a high, structural, and persistent fiscal deficit.

  • By international accounting standards, the central government fiscal deficit2 is almost 1 percentage point higher than the 2½–3 percent reported.3

  • Israel’s deficit is structural. The current deficit originates from tax cuts between 2003 and 2010 that were not offset by sufficient expenditure reductions.4 It does not reflect cyclical weakness; the output gap is near zero, and employment growth has been strong.

  • Efforts to reduce the deficit have repeatedly been deferred. In theory, Israel has an expenditure rule and a deficit rule underpinned by a debt target, but they have been revised so often that in practice there is no effective fiscal anchor. The deficit ceiling has been revised twenty times since 1991; the expenditure ceiling has been revised 6 times since 2004.

A01ufig8

Israel - Central Government Deficit Target Adjustments

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 261; 10.5089/9781513536057.002.A001

Sources: MoF, Brender (2013), IMF (2014), IMF (2015)

12. This pattern was set to repeat itself last year, but politics got in the way. Planned upward revisions of deficit targets for 2014–18 were interrupted by the fall of the government and early elections. As a result, despite an unpredicted large spending need for Operation Protective Edge (1 percent of GDP in total, of which 0.7 percent of GDP was covered in 2014), the central government deficit met the original target in 2014 (2.8 percent of GDP).

13. The 2015 budget will only be adopted by parliament in November. Until then, monthly expenditure limits are governed by the “1/12-rule”—monthly spending cannot exceed one twelfth of the 2014 budget including debt service (plus inflation). As debt repayments are projected to be much lower this year, the ceiling is not very binding, and spending is expected to grow in line with GDP growth. Overall, the deficit is expected to stay around 2.8 percent of GDP this year, exceeding the target stipulated in the Deficit Reduction Law (2.5 percent of GDP) (Tables 45).

Table 2.

Israel: Balance of Payments, 2010–20

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

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Sources: Central Bureau of Statistics; Haver Analytics; and IMF staff estimates and projections.

Excludes reserve assets.

Table 3.

Israel: International Investment Position, 2007–14

(In percent of GDP)

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Sources: Central Bureau of Statistics; and Haver Analytics.
Table 4.

Israel: Summary of Central Government Operations, 2010–151

(In percent of GDP; unless otherwise indicated)

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Sources: Israeli Ministry of Finance; and IMF staff estimates and projections.

Data as per the Ministry of Finance definition, on a cash basis, covering the budgetary sector and the National Insurance Institute.

Registered spending but for which the equivalent cash has not yet been disbursed, hence it does not appear in financing.

Budget.

Table 5.

Israel: General Government Operations, 2008–14

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Source: IMF Government Financial Statistics and Israeli Central Bureau of Statistics.

Policy discussions

14. The fiscal deficit needs to be reduced. Current levels leave few buffers to deal with shocks, such as a housing price correction, renewed conflicts, or a sharp recession. The debt ratio has practically stabilized after a period of decline and will begin to rise again if deficits are not reduced. The DSA shows that under the baseline, debt would increase gradually to 69 percent of GDP by 2020, while under a growth-shock or sharp housing correction scenario, it could rise well above 75 percent of GDP by then (Annex II).

15. Reducing the deficit will be a challenge. Under the current law, the deficit should be reduced to 2 percent of GDP next year and 1½ percent of GDP in 2019 (on national standards). Achieving these targets would go a long way towards addressing the fiscal problem, with the debt ratio converging to 50 percent of GDP over the longer term. This will, however, require substantial efforts.

  • Measures of around 1 percent of GDP will be needed to stick to the current expenditure ceiling. This is because planned initiatives in the coalition agreement and previous commitments would raise spending above the current ceiling.

  • Moreover, even if the expenditure ceiling is met, it is not tight enough to bring about the desired deficit reduction. The real growth rate of the expenditure ceiling (around 2.6 percent) is barely below the growth rate of real GDP (3 percent), implying only a modest drop in the spending ratio.5

16. This challenge should be addressed upfront, and not put off to the future. Staff advocated for an explicit revenue and expenditure plan for the entire 2016–20 period, consistent with the deficit targets:

  • Without a mechanism to ensure that multi-year spending commitments are in line with the expenditure ceiling, the expenditure ceiling will likely need to be revised up. Thus, commitment control of new multi-year projects needs to be strengthened through, inter alia, enhancing top-down budgeting, undertaking spending reviews, and improving cost estimates of multi-year projects.

  • To achieve the desired deficit reduction, either the expenditure ceiling should be lowered sufficiently to attain the deficit target, or, alternatively, commensurate revenue increases should be explicitly planned.

17. Policymakers need to decide how to reduce the deficit. Consolidation measures should have the minimum possible impact on growth—suggesting in general a preference for cutting current over capital spending and towards indirect rather than direct taxes—and reflect areas where revenues are low or spending is high relative to comparator norms (Figure 3). While civilian spending is low in Israel compared to other advanced economies, there is likely still scope for efficiency gains in both defense and non-defense spending (for example, through better targeting of social benefits). Tax expenditures are also relatively high. Thus, the authorities should consider a mix of revenue and expenditure measures to achieve the deficit targets.

Figure 3.
Figure 3.

Comparisons of Key Fiscal Indicators

Citation: IMF Staff Country Reports 2015, 261; 10.5089/9781513536057.002.A001

Sources: IMF’s Fiscal Monitor Database; International Bureau of Fiscal Documentation; and OECD database.1/Data for Greece, Iceland, Korea, Poland, and Switzerland are for 2012.2/Projections from April 2015 Fiscal Monitor.

18. Next year’s budget should take an important first step in reducing the deficit. The 2015 budget will likely be passed only in November—too late to introduce new measures. As the fiscal deficit for this year is likely to exceed the deficit target in the current law (2¾ percent of GDP rather than 2½ percent), reflecting a boost in defense spending, the original target for 2016 (2 percent of GDP) may no longer be feasible. Nevertheless, the deficit in 2016 should be brought down by at least half a percent, equivalent to the reduction envisaged in the Deficit Reduction Law.

The authorities’ views

19. The authorities intend to reduce the deficit gradually, but not at the pace indicated in the Deficit Reduction Law. They emphasized that Israel’s fiscal position is significantly stronger than a decade ago, when debt was above 90 percent of GDP and the general government deficit around 7½ percent of GDP. They think that accommodating high-priority growth-enhancing spending (e.g., education, key infrastructure projects) is important and justifies amending the Deficit Reduction Law to slow the pace of fiscal consolidation.

20. Views differed on the composition of fiscal adjustment. The Ministry of Finance (MoF) noted that while the level of civilian expenditures in Israel is relatively low compared to other OECD countries, economic “outcomes” associated with such spending are high, as evidenced by low mortality and high life expectancy. In addition, they argued that there remains further scope for improving government efficiency and reducing administrative spending without lowering social and welfare spending. Accordingly, the MoF indicated that fiscal adjustment should come mainly from expenditure cuts, but did not preclude revenue mobilization efforts including broadening the tax base by rationalizing tax exemptions and introducing new taxation (e.g., estate tax). By contrast, the BOI was more cautious about reducing the size of the civilian budget and emphasized the scope for revenue gains from rationalizing tax exemptions.

21. The authorities plan to undertake steps to strengthening the medium-term fiscal framework. The MoF intends to prepare a fiscal policy statement prior to the publication of the upcoming budget, including the size of the consolidation needs in the medium term with possible measures to satisfy the need. In addition, they aim to initiate spending reviews in the coming year.

B. Monetary and Exchange Rate Policies

While inflation is currently negative, this does not reflect domestic weakness. The tapering off of the energy price declines, the lagged impact of the shekel depreciation in the second half of 2014, and strengthening of the domestic economy will likely bring inflation back to the target band in 2016. The shekel is broadly in line with fundamentals.

Background

22. Inflation is currently negative—well outside the BOI’s target band of 1–3 percent (Figure 45). Low inflation is in large part imported, the result of low inflation in partner countries, the appreciation of the shekel (between the summer of 2012 and the summer of 2014, the shekel appreciated by 17 percent in nominal effective terms) and the drop in oil prices.6

Figure 4.
Figure 4.

Israel: Selected Monetary Indicators

Citation: IMF Staff Country Reports 2015, 261; 10.5089/9781513536057.002.A001

Sources: Bank of Israel; HaverAnalytics; and IMF staff calculations.
Figure 5.
Figure 5.

Israel: Selected Financial Indicators, 2011–15

Citation: IMF Staff Country Reports 2015, 261; 10.5089/9781513536057.002.A001

Sources: Bloomberg; Datastream; and Moody’s KMV.
A01ufig9

Israel: Contribution to CPI Inflation

(Percentage points)

Citation: IMF Staff Country Reports 2015, 261; 10.5089/9781513536057.002.A001

Sources: Bank of Israel; Haver analytics; and IMF staff calculations.1/ The constant term includes the constants in the regression framework and any insignificant external factors. “Other domestic” are the residuals and base effects from the core and expectations equations, while “Other external” are the base effects and residuals from the non-core inflation equation. See SIP on Low Inflation in Israel -Should We Worry About It?

23. The BOI has reduced policy interest rates by 2.4 percentage points since mid-2012 to 0.1 percent in March 2015.7 Two interest rates cuts in August and September 2014 halted the appreciation of the shekel, and triggered a sharp depreciation against the US dollar. When the shekel rebounded in early 2015, the BOI reduced policy rates once more. The BOI has also intervened in the foreign exchange market aiming to smooth excess volatility.

A01ufig10

Israel: GDP Deflator and NEER

(Percent; Y/y change)

Citation: IMF Staff Country Reports 2015, 261; 10.5089/9781513536057.002.A001

Source: Haver Analytics.

Policy discussions

24. Even though inflation is currently outside the band, in staff’s view no further monetary easing is needed at this stage.

  • Staff analysis suggests that inflation will likely return to within the target band next year. A Philips curve model confirms that the growth pick-up, the shekel depreciation since last summer, and tapering energy price declines will bring inflation back to within the band.

  • Markets also expect the low CPI inflation to be temporary, as longer-term inflation expectations have remained well-anchored.

  • Indeed, GDP inflation has already bounced back to 2¾ percent y/y in the first quarter; CPI inflation has not followed suit because of the strong terms of trade gains.

  • The overall policy mix is already very accommodative, with near-zero interest rates, and broadly neutral fiscal policy. The output gap is small at best and unemployment has come down sharply in recent years.

A01ufig11

Israel: GDP Deflator and CPI

(Percent; Y/y change)

Citation: IMF Staff Country Reports 2015, 261; 10.5089/9781513536057.002.A001

Source: Haver Analytics.
A01ufig12

Israel: Terms of Trade and GDP Deflator-CPI Difference

(Percent; Y/y change)

Citation: IMF Staff Country Reports 2015, 261; 10.5089/9781513536057.002.A001

Source: Haver Analytics.

25. In staff’s views, at current levels, the shekel is broadly in line with fundamentals. Evidence from exchange rate models is mixed, but the average of three existing estimates suggests the shekel is around its fundamental value:8

  • The IMF external balance assessment (EBA) macroeconomic balance approach suggests the shekel is undervalued in 2014, reflecting that the current account in 2014 (4.3 percent of GDP) was well above the EBA estimated norm (-0.2 percent of GDP).9 However, in staff’s view the EBA current account norm is too low, as it does not take into account some important structural shifts including the expansion of mandatory household pension saving in 2008. A modified EBA macroeconomic balance approach—adding a fixed effect dummy and pension contributions as share of GDP as additional variables—suggests a current account norm of 2 percent of GDP, suggesting that the shekel was undervalued by about 9 percent in May 2015.10

  • The EBA-like REER regression approach suggests that the shekel was 0.1 percent above its fundamental value in 2014, implying an overvaluation of 0.5 percent as of May 2015.

  • Finally, a CGER REER panel regression type model suggests an overvaluation in the medium term of 6.8 percent.

A01ufig13

Israel’s Current Account

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 261; 10.5089/9781513536057.002.A001

Source: Haver Analytics.

The authorities’ views

26. The BOI shared the view that low inflation was mostly imported, and agreed with staff that no additional monetary easing was required at this stage. The BOI forecasts that inflation will reach the lower end of the target band in 2016Q1. Inflation would be further strengthened by tightening in the domestic labor market which would lead to an increase in wage costs. Thus, the BOI sees less of a need for unconventional monetary policy measures, even as these tools remain part of the toolbox.

27. Monetary policy committee members noted that interest rate decisions reflected difficult trade-offs. Rising housing prices suggested that higher interest rates were needed to contain associated financial risks, but—given its impact on growth and inflation—committee members could not ignore the impact of monetary tightening on the exchange rate. They also noted that to a considerable extent upward pressure on the exchange rate had not been the result of ‘fundamentals,’ but reflected spillovers from other countries’ loose monetary policies.

28. In BOI’s view, the shekel is somewhat overvalued. This was most visible in sluggish exports, even after accounting for the impact of weak world trade. The current account surplus had increased in 2014 (to 4.3 percent of GDP), but this had been the result of a sudden drop in the repatriation of multinational firm profits and the decline in oil prices, not improved competitiveness. The current account surplus further reflected transfers from the US government (about 1 percent of GDP annually) and the replacement of imported energy with domestic gas production.

C. Housing Sector Policy

To contain further housing price increases, supply needs to be boosted. Concerted efforts among relevant ministries and local governments are needed. To contain the increase in leverage, macro-prudential measures should be used.

Background

29. Both demand and supply factors have contributed to the housing price boom (Figure 7).

  • Demand has been boosted by the decline in interest rates, the increasing population, and growing household incomes. While the real estate tax system in Israel is broadly in line with global standards, distortions from the tax system and an underregulated rental market also create a bias towards homeownership.11

  • Demand increased just when housing supply had dropped to a post-immigration boom low. Boosting supply has been hard: Israel’s supply elasticity to prices is low compared to other advanced economies—the result of a highly centralized approach to land development (the state owns 93 percent of Israel’s land), the long process of obtaining licenses and building permits, and lack of support from local governments for high density projects.

Figure 6.
Figure 6.

Exchange Rates and BOP, 2000–15

Citation: IMF Staff Country Reports 2015, 261; 10.5089/9781513536057.002.A001

Sources: Bank of Israel; Central Bureau of Statistics; Haver Analytics; OECD; and IMF staff calculations.1/ Start ups are included only from 2010.2/ Includes medicalservices, communications, R&D, and IT services.
Figure 7.
Figure 7.

Israel: Housing Market, 1996–2014

Citation: IMF Staff Country Reports 2015, 261; 10.5089/9781513536057.002.A001

Sources: Bank of Israel; Central Bureau of Statistics; OECD; and IMF staff calculations.
A01ufig14

Israel: Completion of Residential Dwellings

(Thousand)

Citation: IMF Staff Country Reports 2015, 261; 10.5089/9781513536057.002.A001

Sources: Central Bureau of Statistics; Haver Analytics.

30. Macroprudential measures taken by the BOI have contained the increase in household leverage. Since 2009, the BOI has introduced a wide range of macroprudential tools to address vulnerabilities and boost banks’ loss absorption capacity (Annex III). As a result, household credit to GDP has remained low compared to other advanced economies. Nevertheless, the exposure of banks to real estate and construction has increased (section D).

31. Staff estimates suggest housing prices are currently some 30 percent overvalued. A housing price correction could depress consumption through its wealth effects, and would particularly affect those that have bought a house in recent years.

Policy discussions

32. To contain housing price increases, supply will need to be boosted.

  • Planning procedures should be simplified. Planning procedures are cumbersome, and the time between initiating new building initiatives and finishing construction can range between 8 and 21 years.

  • The zoning of available land and its release for development should be accelerated. This would allow the private sector to respond more effectively to rising demand. Moreover, the authorities could consider eliminating restrictions to building in big cities, adopted to discourage urbanization, and instead implementing incentives for greater investment in infrastructure, education, and job creation in the periphery.

  • Local governments should be given the means to support the construction of high density residential buildings. Since property tax rates are lower for residential properties and for smaller units, local governments prefer commercial properties and luxury buildings over high density residential buildings. Thus, local authorities are reluctant to support large projects, further delaying construction. Higher intergovernmental transfers should be considered to help finance the cost of additional infrastructure and services required by new residential developments.

A01ufig15

Duration of Construction Process in Israel

(Years)

Citation: IMF Staff Country Reports 2015, 261; 10.5089/9781513536057.002.A001

1/ Permit from the local committee.2/ Tender publication and decision regarding the winner.Source: Taub Center, State of the Nation Report 2014.

33. Macroprudential policy should continue to be actively used to contain housing-related risks to financial stability. Options include further tightening limits on loan-to-value (LTV) and payment-to-income (PTI) ratios or accelerating the implementation of the recently-announced measure to gradually increase capital surcharges by 1 percent of outstanding mortgage lending.

The authorities’ views

34. The authorities pointed to a variety of initiatives to boost housing supply. The central government has been signing agreements with local governments to facilitate central government financing of infrastructure needed for new development. A committee to identify land for development and expedite the planning process has been established. Power to approve building plans has been decentralized to local committees. The new government has also put several authorities involved in the process, such as the Israel Land Authority and the Planning Committee, under the command of the MoF to improve coordination and shorten the planning process.

35. The authorities also noted that macroprudential measures have effectively reduced the riskiness of new mortgages. The average LTV and PTI ratios of new loans have declined significantly to low levels (52 and 26 percent, respectively). Analysis of mortgages initiated between 2010 and 2013 by income decile also suggests that most mortgages were taken out by high income households, who are typically more resilient to shocks.

D. Financial Sector Policy

The financial system appears sound and the role of the non-banking sector has increased. Risks from exposure to real estate and construction, and from overly compressed corporate bond spreads, should be carefully monitored.

Background

36. In the past decade, Israel’s financial system has changed substantially (Figures 810 and Tables 9–12).

  • The role of the non-bank financial sector has increased. The Bachar reform that began in mid-2005 forced banks to divest most noncommercial banking activities such as insurance, pension, and provident funds. Partly as a result, the nonbank financial sector has grown rapidly; its assets now comprise about half of all financial sector assets.

  • An active market in corporate bonds has developed. The outstanding stock of corporate bonds grew from 5 percent of GDP in 2004 to 27 percent in 2013.

Figure 8.
Figure 8.

Israel: Performance of the Israeli Banking System, 2005–14

(Percent, unless otherwise indicated)

Citation: IMF Staff Country Reports 2015, 261; 10.5089/9781513536057.002.A001

Sources: Bank of Israel;and IMF’s Financial Soundness Indicator Database.
Figure 9.
Figure 9.

Israel: Performance of Non-Bank Financial Sector, 2006–14

Citation: IMF Staff Country Reports 2015, 261; 10.5089/9781513536057.002.A001

Sources: Bank of Israel; Haver Analytics; and IsraeliMinistry of Finance Capital Markets, Insurance, and Savings Department; and IMF staff calculations.
Figure 10.
Figure 10.

Israel: Corporate and Household Sector, 2006–14

Citation: IMF Staff Country Reports 2015, 261; 10.5089/9781513536057.002.A001

Sources: Bank of Israel; Israel Central Bureau of Statistics; Haver Analytics; and IMF staff calculations.
Table 6.

Israel: Financial System Structure, 2005–13

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Sources: Bank of Israel, Ministry of Finance, and Israel Securities Authority.
Table 7.

Israel: Financial Soundness Indicators: Banks, 2008–14

(End-period, in percentage points)

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Sources: Bank of Israel, and IMF Financial Soundness Indicators Database.

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

Prior to 2010, data do not include off-balance sheet data and "borrowers with activity abroad" are not classified separately. From 2011 onward, data include off-balance sheet data.