Israel: Selected Issues
Author: International Monetary Fund. European Dept.
Publication Date:
16 Sep 2015
eISBN:
9781513594675
Language:
English
Keywords:
ISCR; CR; Israel; price; pay; productivity; income balance; ratio Israel; share of world; high-tech export; saving-investment perspective; Current account balance; Service exports; Exports; Income; Current account; Global
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Israel: Selected Issues

Abstract

Israel: Selected Issues

External Sector Assessment1

This chapter aims to explain why Israel’s current account surplus has improved in recent decades, assess whether the Israel’s current account balance and real exchange rate is in line with fundamental.

A. Introduction

1. Israel’s current account balance does not stand out compared with other advanced countries. Israel’s current account balance shows a moderate surplus (4.3 percent of GDP in 2014), slightly above the average for advanced countries.

2. Current account surpluses do stand out, however, compared to Israel’s economic history. Until the mid 1990s, Israel used to have large current account deficits. Between 1995 and 2006, Israel’s current account balance improved from a deficit of 5 percent to a surplus of 4 percent. Since 2007, the current account balance fluctuated around 2.5 percent of GDP.

A04ufig1

Current Account Balance

(Percent of GDP, 2014)

Citation: IMF Staff Country Reports 2015, 262; 10.5089/9781513594675.002.A004

Sources: IMF WEO Database.
A04ufig2

Israel: Current Account

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 262; 10.5089/9781513594675.002.A004

Sources: Bank of Israel, CBS and Haver Analytics.
Table 1.

Israel: Current Account Components, 1995–2014

(Percent of GDP)

article image
Source: Haver Analytics.

B. Current Account Developments: A Balance of Payments Perspective

3. Israel’s current account surplus is in large part the result of a surplus on “Other Business Services” (largely IT and communications)2 and transfers (part of “Other” in the chart to the right). The balance on goods is negative, as is the balance on services excluding other business services.

A04ufig3

Current Account Components

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 262; 10.5089/9781513594675.002.A004

Source: Haver Analytics.
A04ufig4

Israel Current Account Components

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 262; 10.5089/9781513594675.002.A004

Source: Haver Analytics.

4. The improvement in the current account balance since the mid-1990s has been the result of a reduction of the goods balance deficit and an increase of the service balances. Reduced investment income payments have also played a role.

Balance of Goods

5. From the late 1990s to the mid-2000s, Israel had a goods export boom, interrupted only by the dotcom bust. The export to GDP ratio increased from 19 to 29 percent. The export boom in the late 1990s was the result of rising high-tech exports (electronics, IT) and was associated with an increase in world market shares. After the dotcom bust, despite strong export growth, world market shares started to trend down; but the export to GDP ratio still increased. The depreciation of the exchange rate from 2001 until 2006/07 further fueled the boom. The exports to GDP ratio fell after 2007, as global demand weakened, but GDP growth held up relatively well.

A04ufig5

Growth of Real Exports & Imports of Goods

(Annual data)

Citation: IMF Staff Country Reports 2015, 262; 10.5089/9781513594675.002.A004

Source: Haver Analytics.
A04ufig6

Growth of Real Exports & Imports of Goods

(4 year moving average)

Citation: IMF Staff Country Reports 2015, 262; 10.5089/9781513594675.002.A004

Source: Haver Analytics.
A04ufig7

Israel’s Share of World Exports

(Merchandise export, percent)

Citation: IMF Staff Country Reports 2015, 262; 10.5089/9781513594675.002.A004

Sources: Haver Analytics; and IMF.
A04ufig8

Export to GDP Ratio Israel

(Goods exports as percent of GDP)

Citation: IMF Staff Country Reports 2015, 262; 10.5089/9781513594675.002.A004

Source: Haver Analytics.

Balance of Services

6. The services balance has been increasing steadily since 2001. This was mostly driven by other business services—which largely consist of IT and communications (see section below)—and tourism.3 Israel’s service export strength is shown by a substantial increase in the share of world services exports since 2007.

Other business services
A04ufig9

Israel’s Share of World Exports, 2006-14

(Percent of world services exports)

Citation: IMF Staff Country Reports 2015, 262; 10.5089/9781513594675.002.A004

Sources: World Trade Organization.

7. One important component of other business series is “services from startups,” which consists of both services provided by startups as well as the sale of startups, because it includes transfers of intangible services abroad4. When startups are sold to other countries—mainly to the US—this is recorded as service exports. Exports of services from startups are volatile, but on an increasing trend since 2001. At 0.8 percent of GDP in 2014, their (positive) net contribution is higher than that of tourism (0.5 percent).

A04ufig10

Export of Services (Start-Ups)

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 262; 10.5089/9781513594675.002.A004

Source: Bank of Israel.
Figure 1.
Figure 1.

Israel Services Trade

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 262; 10.5089/9781513594675.002.A004

Source: Haver Analytics.
Services other than other business services

8. Since 2000, the balance on services (excluding other business services) has improved by almost 1.5 percentage points to -0.5 percent in 2014, because of an improvement in the balance of transportation services and increasing exports of travel services.

9. Travel services is a sector that has keenly felt the impact of the security situation, although in recent years, the impact has tended to be short-lived. Tourism grew strongly in the second half of the 1990s, collapsed in the early 2000s because of the second intifada and a recession, and recovered from 2003 onwards. Since 2007, there have been a number of conflicts, but they have had only a short-lived influence, with the strongest impact always in the first quarter.

A04ufig11

Balance on Services ex. Other Business Services

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 262; 10.5089/9781513594675.002.A004

Source: Haver Analytics.
A04ufig12

Exports of Travel Services

(Billion USD)

Citation: IMF Staff Country Reports 2015, 262; 10.5089/9781513594675.002.A004

Source: Haver Analytics.

Balance of transfers and income

10. The balance on income and transfers has improved since the early 2000s and its components have changed. Transfers have declined, but so have investment income payments.

Transfers

11. Public transfers largely reflect US assistance. The US government committed itself to providing $30 billion assistance to the Israeli government for defense needs over 10 years (2009 to 2018)5, which is about $3 billion per year. 74 percent of the amount must be used for purchases in the US. In the current transfers account, receipts from “government” amounted to $5bn in 2013, $3bn thereof from the US. The impact of public transfers on the current account balance is however limited, as when transfers from the US increase, the goods deficit increases because the majority of purchases must be imported from the US.

A04ufig13

Income and Current Transfers

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 262; 10.5089/9781513594675.002.A004

Sources: Haver analytics.
A04ufig013

Israel: Current Transfers

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 262; 10.5089/9781513594675.002.A004

Source: Haver analytics.

12. Since 2004, private transfers have been higher than public transfers and consist of $8bn in 2014 including personal restitutions from Germany (transfers from the German state to individuals in Israel6, not the state) and remittances. Private transfers (denominated other non-govt in the chart) are expanding in dollar terms even though not in terms of GDP. Transfers to individuals make up approximately two thirds of transfer receipts, while restitutions from Germany and transfers to institutions account almost equally for the remaining share.7 According to the Central Bureau of Statistics, personal restitutions paid by the German state were $807 million in 2013.

Income balance

13. The improvement of the income balance is largely driven by the reduction in investment income payments, which is the result of the improvement of the international investment position.

A04ufig14

Israel Income Balance

(Percent of GDP, ex. compensation of employees)

Citation: IMF Staff Country Reports 2015, 262; 10.5089/9781513594675.002.A004

Source: Haver Analytics.
A04ufig15

International Investment Position

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 262; 10.5089/9781513594675.002.A004

Source: Haver Analytics.

C. Current account from a Saving-Investment Perspective

The improvement in the current account

14. From a saving-investment perspective, the improvement in the current account since the mid-1990s initially reflected a decline of investment, but later the impact of rising saving dominated. National saving as percent of GDP rose 2 percentage points from 1995 to 2014, while investment decreased -5.4 percentage points in this time period.

  • The decline in investment started in the mid-1990s. In the early 1990s, investment had been elevated after an immigration wave from the former Soviet Union. From the mid-1990s, investment declined, with some pickup from 2003 onwards. A high real interest rate (compared to the United Kingdom, United States, Netherlands, and Czech Republic for example) may also have subdued investment in the 1990s and early 2000s. Since 2009, however, the real interest rate in Israel is around the average of above mentioned peers.

  • The improvement in saving occurred from the early 2000s onwards and was largely driven by private saving. National saving increased from 18.9 percent of GDP in 2002 to 21.9 percent in 2014. During this time period, private saving improved from 20.4 percent to 22.5 percent of GDP, while public saving rose from -1.5 percent to -0.6 percent of GDP.

A04ufig16

Gross National Savings and Investment in Israel

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 262; 10.5089/9781513594675.002.A004

Sources: Bank of Israel and WEO Database.
A04ufig17

S-I Balance in Israel

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 262; 10.5089/9781513594675.002.A004

Sources: Bank of Israel and WEO Database.
A04ufig18

S-I Balance Change 2014 vs. 2000

(Percentage points)

Citation: IMF Staff Country Reports 2015, 262; 10.5089/9781513594675.002.A004

Sources: CBS, and WEO Database.

15. The increase in private saving may in large part be due to households,8 and was boosted by a change in the pension law that boosted saving. The large increase in long-term saving contributions occurred because of the enactment of the Mandatory Pension Law in 2008 that requests employers and workers to contribute a significant percentage of their income for pensions.9,10 Pension savings also have increased because the contribution rate rose. The total contribution rate from employer and employee is currently 17.5 percent in the private sector (5.5 percent employee, 12 percent employer) and 19.5 percent in the public sector (6.5 percent employee, 13 percent employer). In 2015, the contribution rate is going to be raised by one percent, further contributing to higher savings in Israel.

The Level of the Current Account

16. Compared with other advanced countries, Israel’s current account surplus is the result of higher saving and about average investment. Israel’s saving is relatively high, particularly because private saving is high compared to a selection of other advanced economies. Israel’s investment level (20 percent of GDP) has increased in the past years to a level above average, compared to 20 percent in the US, 15 percent in the UK, 18 percent in Germany, but 22 percent in France.

A04ufig19

S-I Balance Deviation 2014

(Percentage points, unweighted average)

Citation: IMF Staff Country Reports 2015, 262; 10.5089/9781513594675.002.A004

Sources: CBS, and WEO Database.
A04ufig20

Investment Ratio

(Percent of GDP, 2014)

Citation: IMF Staff Country Reports 2015, 262; 10.5089/9781513594675.002.A004

Source: WEO Database.
A04ufig21

Private Saving Ratio

(Percent of GDP, 2014)

Citation: IMF Staff Country Reports 2015, 262; 10.5089/9781513594675.002.A004

Source: WEO Database.

D. Current account movements: The role of the real exchange rate

17. Israel’s real exchange rate has seen sharp swings in the past decade and a half. The real exchange rate depreciated between 2001 and the 2008/09 crisis, and had—until August 2014—been on an upward trend since.

Real exchange rate and exports of goods

18. The real exchange rate has a clear impact on goods exports, but much less on exports of services.

A04ufig22

REER

(Index, 2010 Average=100)

Citation: IMF Staff Country Reports 2015, 262; 10.5089/9781513594675.002.A004

Source: IMF’s Information Notice System.

  • There is a close link between the REER and the ratio of goods exports to GDP. The more depreciated the exchange rate, the higher the ratio—although this in part reflects valuation effects.

  • For services, the link is much less clear-cut (see chart), because a change of the exchange rate has only a limited impact on exports of services, whereas goods exports are more reactive to exchange rate movements. Despite the REER fluctuations, Israel’s share of world services exports has been increasing in the past few years.

A04ufig23

Israel: REER and Exports of Goods

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 262; 10.5089/9781513594675.002.A004

Sources: Central Bureau of Statistics; and Haver Analytics.
A04ufig24

Israel: REER and Exports of Services

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 262; 10.5089/9781513594675.002.A004

Sources: Central Bureau of Statistics; and Haver Analytics.

19. Econometric estimates further confirm that exchange rate appreciation has a clear impact on exports. In an estimated model with Israel goods and services export growth as the dependent variable and REER (ULC) and foreign demand growth as dependent variables, a 10 percent appreciation lowers exports by 1 percent. When estimating a model with the current account balance as percent of GDP as a dependent variable, a 10 percent appreciation lowers the current account balance by 0.25 percent.

20. Low technology exports are particularly affected by an appreciating real exchange rate, while for medium or high-tech exports the impact is not as strong. An appreciating real exchange rate also decreases the profitability of the manufacturing sector (measured by return on assets).

21. Israel’s share of world exports differs between exports of goods and exports of services. Goods exports decreased continuously and only slightly recovered in 2013, while services are improving. Despite fairly stable global demand, both from OECD countries and worldwide, Israel’s exports have been falling since 2011 and fluctuating since the end of 2012. Export increases comparing 2014 to 2008 have been modest compared to other advanced economies.

A04ufig25

Israel: REER and Exports in Low-Tech Manufacturing

(2004=100)

Citation: IMF Staff Country Reports 2015, 262; 10.5089/9781513594675.002.A004

Sources: Haver Analytics; and IMF.
A04ufig26

ROAvs REER

(ULC)

Citation: IMF Staff Country Reports 2015, 262; 10.5089/9781513594675.002.A004

Source: IMF staff calulations.
A04ufig27

International Trade, 2008-2014

(Index, 2008Q2 = 100, SA)

Citation: IMF Staff Country Reports 2015, 262; 10.5089/9781513594675.002.A004

Sources: IMF INS, Haver Analytics, and OECD MEI
A04ufig28

Change in Exports of Goods and Services

(Percent, 2014 compared to 2008, const, prices)

Citation: IMF Staff Country Reports 2015, 262; 10.5089/9781513594675.002.A004

Source: WEO April 2015.

E. Is the REER over or undervalued?

22. As discussed in the previous sections, in the past, Israel used to have a current account deficit, but in the last ten years the current account balance has shown moderate surpluses. The improvement occurred in the 1995–2007 period; since 2007, the current account surplus has fluctuated, but now shown a clear further upward trend.

23. How should we assess the shift to a current account surplus—is it a sign that the real exchange rate is undervalued, or does it reflect a “new normal”? There are some arguments suggest that there has indeed been a structural change, and that the current account surplus does not reflect an undervalued exchange rate:

  • Government policies have contributed to a structural increase in household saving including in particular the introduction of the Mandatory Pension Law and the transition to a defined contribution pension scheme.

  • The outward opening of Israel’s capital account for institutional investors has further contributed to the current account surplus. Israeli savings are now partly invested abroad, rather than in Israel. Given the small size of the Israeli economy, and the difficult geo-political situation it is confronted with, such a diversification of household assets, does make sense.

24. Evidence from exchange rate models is mixed, but the average of three existing estimates suggests the shekel is at around its fundamental value:

  • 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).11 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 just above 2 percent of GDP, suggesting the shekel was undervalued by about 9 percent in May 2015.12

  • The EBA-like REER regression approach suggests 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-type REER model suggests an overvaluation in the medium term of 6.8 percent.

25. On balance, we therefore conclude that the real exchange rate is broadly in line with fundamentals.

1

Prepared by Marco Semmelmann.

2

Other business services include electronic components, electronic communications equipment, command and control equipment, scientific medical equipment, communications, computer services, research and development.

3

Israel is an innovative nation. The gross expenditure on R&D is 4.38 percent of GDP in 2011, which is the highest among all OECD countries. The same accounts for venture capital (0.36 percent in percent of GDP in 2012) which is three times as high as in the United States (0.12 percent), coming second in an OECD ranking. This environment helped to create an IT startup sector. According to OECD data, Israel’s information and communication technology sector accounts for about 20 percent of total industrial output and 9 percent of business sector employment.

4

CBS, Statistical Abstract of Israel 2012.

5

According to the 2011 BoI Annual report.

6

Compensation for injustice of the National Socialist regime.

7

Source: Bank of Israel.

8

There are no official statistics that break down private saving into household and corporate.

9

Capital outflows by institutional investors have become important. Net transactions by institutional investors (which include pension funds, profit sharing insurance companies, provident funds and advanced study funds) invest primarily in portfolio investment (in 2013, this accounted for 85 percent of resident investment abroad by institutional investors), followed by other investment (resident deposits, loans). Direct investment only makes up a small share. Also, total investment abroad, not limited to institutional investors, has increased between 1995 and now, despite fluctuations.

10

Additionally, from 2004 on there was a transition in the public sector to contribute to defined contribution pensions instead of defined benefit pensions.

11

The EBA assessment, done in March 2015 when the 2014 current account surplus was estimated at 3 percent of GDP, suggested an undervaluation of 14 percent. More recently, the 2014 current account surplus was revised up to 4.3 percent of GDP.

12

The modified EBA model takes the revisions to the current account balance into consideration.

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Cover IMF Staff Country Reports
Israel: Selected Issues
Author: International Monetary Fund. European Dept.
Volume/Issue:
Volume 2015: Issue 262
Publisher:
International Monetary Fund
ISBN:
9781513594675
ISSN:
1934-7685
Pages:
69
DOI:
https://doi.org/10.5089/9781513594675.002

Current Account Balance

(Percent of GDP, 2014)

Israel: Current Account

(Percent of GDP)

Current Account Components

(Percent of GDP)

Israel Current Account Components

(Percent of GDP)

Growth of Real Exports & Imports of Goods

(Annual data)

Growth of Real Exports & Imports of Goods

(4 year moving average)

Israel’s Share of World Exports

(Merchandise export, percent)

Export to GDP Ratio Israel

(Goods exports as percent of GDP)

Israel’s Share of World Exports, 2006-14

(Percent of world services exports)

Export of Services (Start-Ups)

(Percent of GDP)

Israel Services Trade

(Percent of GDP)

Balance on Services ex. Other Business Services

(Percent of GDP)

Exports of Travel Services

(Billion USD)

Income and Current Transfers

(Percent of GDP)

Israel: Current Transfers

(Percent of GDP)

Israel Income Balance

(Percent of GDP, ex. compensation of employees)

International Investment Position

(Percent of GDP)

Gross National Savings and Investment in Israel

(Percent of GDP)

S-I Balance in Israel

(Percent of GDP)

S-I Balance Change 2014 vs. 2000

(Percentage points)

S-I Balance Deviation 2014

(Percentage points, unweighted average)

Investment Ratio

(Percent of GDP, 2014)

Private Saving Ratio

(Percent of GDP, 2014)

REER

(Index, 2010 Average=100)

Israel: REER and Exports of Goods

(Percent of GDP)

Israel: REER and Exports of Services

(Percent of GDP)

Israel: REER and Exports in Low-Tech Manufacturing

(2004=100)

ROAvs REER

(ULC)

International Trade, 2008-2014

(Index, 2008Q2 = 100, SA)

Change in Exports of Goods and Services

(Percent, 2014 compared to 2008, const, prices)