Statement by the Staff Representative on Israel Executive Board Meeting, September 4, 2015

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.

This statement provides information that has become available since the issuance of the staff report (SM/15/192). The information does not alter the thrust of the staff appraisal.

  1. Initial estimates suggest growth slowed in Q2. Real GDP increased by 2.1 percent year-on-year, down from 2.9 percent in Q1.1 The slowdown was the result of weaker consumption growth and a sharper decline in exports, while gross investment accelerated. Growth continues to be driven by domestic demand, with consumption growing by 4.9 percent y/y and exports declining by 6.6 percent, the latter reflecting persistently weak world trade and a stronger shekel.

  2. These figures may be revised, however, as employment growth accelerated, and unemployment continued to decline. Employment growth rose to 2.8 percent year-on-year in the second quarter from 2.0 percent in the first quarter, and unemployment fell from 5.4 percent in the first quarter to 5.0 percent in the second. Taking this information into account, staff will likely revise down its 2015 growth estimate by around ½ percentage point from 3.0 to 2.5 percent.

  3. The central bank kept interest rates unchanged in August. Year-on-year CPI inflation has increased from -1.0 percent in February to -0.3 percent in July. Low CPI inflation is imported: the GDP deflator in the second quarter was 3.4 percent higher than a year earlier. Meanwhile, housing prices continue to increase by around 4 percent year-on-year.

  4. As expected, the Cabinet increased the fiscal deficit targets for 2015 and 2016 to nearly 3 percent of GDP (almost 4 percent of GDP on international accounting standards). In August the cabinet approved a draft budget for 2015 and 2016, raising the fiscal deficit targets for both years to 2.9 percent of GDP, compared with 2.5 and 2.0 percent of GDP previously. The debt ratio is expected to increase for the first time since 2009. Medium-term deficit targets will also decline more gradually, reaching 1½ percent of GDP in 2021, two years later than in the current Deficit Reduction Law. The draft budget needs to pass through three votes in Parliament by November 19 to be approved.

1

Quarter-on-quarter, real GDP expanded by an annualized 0.3 percent—below consensus forecast of 2.7 percent, and down from 2.0 percent in the first quarter. Quarterly growth rates in Israel are volatile, and are often revised subsequently.