IMF Executive Board Concludes 2015 Article IV Consultation with Israel

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.

On September 4, 2015, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation1 with Israel.

Israel’s economy has been doing well and near-term growth prospects are favorable. Following growth of 2.6 percent last year, the economy is expected to expand by around 2.5 percent this year and 3-3.3 percent each year in the medium term. Employment creation has been remarkable—growing by 3.5 percent annually—and unemployment is at multidecade lows. Inflation has been negative, but this reflects temporary external factors and not domestic weakness. Risks are balanced, and the real exchange rate is broadly in line with fundamentals.

The central government met the original deficit target of 2.8 percent of GDP in 2014. However, the government raised the deficit targets for 2015 and 2016 to 2.9 percent of GDP for both years (almost 4 percent of GDP based on international accounting standards), compared with 2.5 and 2.0 percent of GDP previously. Debt has declined to 67 percent of GDP from a peak of 94 percent of GDP in 2003 but is expected to increase for the first time since 2009, following the upward revisions to the deficit targets.

The central bank kept interest rates on hold in August, as inflation is expected to return to the target band next year. Housing prices continue to increase by around 4 percent year-on-year, owing largely to supply constraints. In response, the government has announced a variety of initiatives to boost housing supply. Macroprudential measures have been successful in containing the increase in household leverage and household credit to GDP has remained low at around 40 percent of GDP compared to other advanced economies.

Labor productivity growth and levels are low, weighing on growth prospects, and income inequality is among the highest in advanced countries. Acknowledging the challenges to medium-term growth and poverty, the new government has prioritized boosting competition in several sectors and better integrating the rapidly growing Israeli-Arab and Ultra-Orthodox Jewish (Haredi) populations into the labor force.

Executive Board Assessment2

Executive Directors welcomed Israel’s recent strong economic performance and the favorable near-term outlook. Directors agreed that the main policy challenges ahead relate to reinforcing the foundations for lasting and inclusive growth by bolstering fiscal buffers, mitigating housing market risks, increasing labor productivity, and reducing income inequality.

Directors emphasized the importance of strengthening the fiscal framework. Most Directors noted that sustained budgetary consolidation, consistent with the Deficit Reduction Law, is needed to place the debt-to-GDP ratio on a downward path and broaden fiscal space. At the same time, a number of Directors considered appropriate a path of fiscal adjustment not unduly frontloaded. To achieve the deficit targets, Directors encouraged the authorities to consider a mix of revenue and expenditure measures, emphasizing particularly the need for stronger commitment control of multi-year projects.

Directors noted that headline inflation is currently below the Bank of Israel’s target, but agreed that no monetary easing is needed at this point, as low inflation is largely imported and likely to be temporary.

Directors noted the social and financial risks arising from the continued rise in housing prices. They welcomed the government’s intention to boost supply through various measures, and encouraged continued use of macroprudential policies to contain household leverage. Close monitoring of the financial sector’s exposure to the housing market is also warranted. In this regard, Directors recommended the prompt establishment of the Financial Stability Council to help coordinate macroprudential policies across sectors. Timely adoption of the amendment to the Banking Ordinance to enhance the crisis resolution framework would also be important.

Directors concurred that increasing labor productivity growth remains a policy priority. In this context, they welcomed the authorities’ plans to boost competition in several sectors, although they highlighted that banking sector reforms should remain mindful of financial stability concerns. Directors also called for efforts to address infrastructure gaps, reform the product market, improve education, and ease business constraints.

Directors noted that reducing inequality will require concerted efforts from government agencies, stakeholders, and communities. They agreed that boosting labor force participation rates of the Haredi and Arab-Israeli populations is essential—both to reduce poverty rates and safeguard Israel’s long-run growth potential.

Israel: Selected Economics Indicator1

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

Incorporates updated data and projections compared to the staff report.

Percent of potential GDP.

National Accounts data.

1

Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.

2

At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country’s authorities. An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.