Public Information Notice: IMF Concludes Article IV Consultation with Israel

March 23, 1999

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

On March 12, 1999, the Executive Board concluded the Article IV consultation with Israel1.


Economic growth has slowed sharply since 1996, after averaging an impressive 6 percent per annum during the first half of the 1990s. In 1998, real GDP grew by 2 percent and unemployment rose to about 8½ percent of the labor force. The slowdown reflected, in part, the effects of setbacks to the peace process and the fading impetus to growth provided by the large immigration from the former Soviet Union earlier in the decade. In addition, macroeconomic policies turned restrictive in order to redress overheating, especially pressures on prices and the external accounts, that had emerged following excessive fiscal laxity in the mid-1990s, which had a restraining effect on domestic demand. More recently, exports also weakened, reflecting depressed foreign demand. With a better balance between fiscal and monetary policies starting in 1997, consumer price inflation declined, falling to 3.2 percent during the 12 months to August 1998, well below the lower end of the official target range of 7–10 percent.

In the wake of the international currency turmoil sparked by the Russian crisis, market participants reassessed their risk exposures and the shekel depreciated rapidly in August and October 1998, while remaining within the exchange rate band. Price increases accelerated sharply after the depreciation, prompting a sharp increase in official interest rates (by 400 basis points) in October–November. The tightening of monetary policy contributed subsequently to some firming of the exchange rate and a rapid abatement of inflation and inflation expectations; indeed in January and February 1999 consumer prices actually fell. In response, the Bank of Israel lowered official interest rates by 50 basis points (to 13 percent), effective in March 1999. The external current account deficit—-which ballooned from about 1 percent in 1991 to 6.9 percent of GDP in 1996—narrowed to 2.3 percent of GDP in 1998, reflecting mainly a significant improvement in the terms of trade, growth of exports, and the weakness of domestic demand.

In line with the authorities’ medium-term fiscal consolidation plan, the central government operational deficit (defined so as to exclude from government spending, and hence the deficit, the inflation component of interest payments on domestic government debt) was lowered from 2.8 percent of GDP in 1997 to 2.4 percent of GDP in 1998. Fiscal discipline at the local level, however, deteriorated ahead of municipal elections, and the general government operational budget deficit widened, reaching 2.6 percent of GDP. The public debt also increased to 111 percent of GDP in 1998, reflecting mainly the effect of the depreciation of the shekel on foreign currency denominated debt. The 1999 Budget, which was recently approved by the Knesset, targets a further reduction in the central government deficit to 2.0 percent of GDP.

During 1998, the Israeli authorities continued to make progress in implementing structural reforms, notably in the areas of privatization—especially in regard to the banks—and the liberalization of capital account transactions.

In 1999, real GDP growth is projected to accelerate somewhat to 2¼ percent. This projection assumes that the improvement in competitiveness stemming from the recent shekel depreciation will be largely maintained, without compromising the inflation target. It is also assumed that fiscal policy will remain on track, that monetary policy will continue to bring about a gradual reduction of inflation, thereby providing room for a gradual easing of monetary conditions, and that the peace process will move forward. The rate of inflation is expected to be broadly consistent with the authorities’ 4 percent target, while the current account deficit is projected to narrow further to around 2 percent of GDP.

Executive Board Assessment

Executive Directors noted that while growth had remained sluggish and unemployment had risen in 1998, significant progress had been made in reducing macroeconomic imbalances and implementing structural reforms. Most notably, the external current account deficit had narrowed sharply and inflationary pressures had abated, notwithstanding the large price level effects of the recent depreciation of the shekel. In addition, the financial position of the central government had strengthened, and several welcome steps had been taken to reduce the size of the public sector and address other structural weaknesses in the economy. Directors stressed that, if sustained, these developments, including the recent improvement in the external competitive position of the economy, would provide a solid basis for the resumption of strong output and employment performance in the years ahead.

Directors emphasized that consolidation of the authorities’ achievements in fostering stable macroeconomic conditions required—along with the removal of any doubts about theGovernment’s commitment to sustained disinflation—continued efforts to rein in the budget deficit. Directors noted that the fiscal deficit remained large, especially when measured, as is conventional, on a nominal basis, and that Israel’s public debt was high. Deficits in the pension and health funds were also large, underscoring the need for continued consolidation of public finances. Directors observed that, over the last two years, the authorities had made progress in strengthening central government finances, notwithstanding the weakness of economic activity. Directors urged the authorities to stand ready to take additional measures to ensure close adherence to the budget targets for 1999, to prepare more ambitious plans for strengthening the public finances further over the medium term, and to improve the structure of tax revenues and of expenditure. They also stressed the need to take action to restore fiscal discipline at lower levels of government. Regarding pension reform, Directors welcomed the introduction of a contributory pension scheme for new public employees.

Directors noted that the sharp depreciation of the shekel late in 1998 reflected mainly a major reassessment of exchange rate risk by domestic and foreign investors, induced by international currency turbulence. Directors commended the authorities’ firm policy response, observing that it had been successful in containing negative contagion effects, and in quelling the initial inevitable rise in inflationary expectations, with inflation having subsequently returned to very low levels. The authorities’ strategy also appeared to have dampened wage and price pressures, increasing the likelihood that the depreciation will be translated into a lasting improvement in external competitiveness. Directors commended the authorities for the decision not to intervene in the foreign exchange markets, and to rely instead on active interest rate policy to contain the effects of the depreciation.

Looking forward, Directors suggested that monetary policy should balance the need to sustain the disinflationary process and—as long as that process was not compromised—to support activity, at a time when the economy was weak and fiscal policy needed to be restrictive. In this context, most Directors supported the maintenance of the official inflation target for end-1999, stressing that a revision of the target could undermine the credibility of the authorities’ commitment to low inflation, and adversely affect ongoing wage negotiations. They also welcomed the authorities’ recent decision to lower official interest rates, which was appropriate in light of the growing evidence of receding inflationary pressures. Given the recent declines in inflation, Directors saw room for a further easing of interest rates in the period ahead, although they noted that the possibilities in this regard would increase if there was clear evidence that the inflation target would be met, and that progress was being made toward sound public finances and in structural reforms.

Concerning the monetary policy framework, most, but not all, Directors supported extending the horizon for the setting of inflation targets to two to three years. Moreover, Directors urged that the operational autonomy of the Bank of Israel, as well as the primacy of the objective of price stability, be reaffirmed in the envisaged amendment of the central bank legislation recommended by the Levin Committee. Directors welcomed recent steps to enhance the transparency and accountability of monetary policy, and encouraged the Bank of Israel to increase the frequency and information content of its inflation reports.

Directors observed that Israel had already scored some notable achievements in promoting structural reform. These included the opening to competition of segments of the telecommunications and financial services sectors, the privatization of various public sector entities, and the implementation of an orderly liberalization of capital movements. However, in many other areas the pace of change needed to be stepped up. In particular, Directors stressed the need for early action to implement plans to reform the tax system and to eliminate a range of restrictive practices in the economy. In regard to the labor market, Directors welcomed the increased attention to the upgrading of the skill qualifications of the work force, but expressed concern that recent large increases in the minimum wage may have contributed to job losses. Several Directors argued that it would be desirable to phase out wage and price indexation.

Directors welcomed the accelerated privatization of banks in recent years, and the recent decision to raise the minimum capital adequacy ratios of commercial banks. They urged the authorities to take further action to increase competition—including foreign entry in the financial system—and to ensure the effective coordination of the activities of the supervisory agencies of various segments of the financial sector.

Israel: Selected Economic Indicators

1994 1995 1996 1997 1998 1

(Percentage change, unless otherwise indicated)
National accounts (constant prices)
Real GDP 6.9 6.8 4.7 2.7 2.0
Private consumption 9.5 7.2 5.0 4.1 3.3
Public consumption -0.2 0.3 5.7 1.9 2.3
Gross capital formation 8.4 10.5 6.7 -6.1 -7.6
Exports of goods and services 12.8 10.7 6.8 7.6 6.0
Imports of goods and services 10.9 8.5 8.1 2.8 2.1

Labor market indicators

Israeli civilian labor force 4.3 3.5 2.2 2.5 2.8
Overall employment 6.9 5.2 2.4 1.4 1.8
Unemployment rate (in percent) 7.8 6.9 6.7 7.7 8.6

Prices (end period)

Overall CPI 14.5 8.1 10.6 7.0 8.6
Underlying CPI (excluding housing, fruits and vegetables) 9.7 8.8 10.1 6.7 8.5

Money and credit (period average)

Narrow money (M1) 20.6 8.4 14.9 14.3 12.2
Broad money (M3) 26.3 25.5 24.0 25.3 ...
Net domestic credit 28.1 26.2 21.6 18.2 ...

Interest rates (average, in percent)

Discount rate 12.6 14.4 15.1 13.6 11.8
Nondirected credit in new sheqalim 17.4 20.2 20.7 18.7 16.1

Public finance (percent of GDP)

Central government balance2 -2.4 -4.2 -3.9 -2.8 -2.4
General government balance2 -1.1 -2.7 -4.1 -2.3 -2.6
Public debt 116.0 110.0 108.0 106.0 111.0

Balance of payments

Trade balance (percent of GDP) -8.7 -10.6 -10.0 -7.6 -5.4
Current account (percent of GDP) -5.4 -7.4 -6.9 -5.0 -2.3
Foreign reserves (average, in US$ billions) 6.3 8.6 9.9 17.2 21.8

Exchange rate and terms of trade indices

Nominal effective exchange rate (1990=100) -7.6 -6.1 -2.7 0.2 -6.6
Real effective exchange rate (1990=100) 1.1 0.8 5.9 7.0 -3.1
Terms of trade (1990=100; index level) 106.7 103.1 103.6 107.3 111.5

Sources: Data provided by the Israeli authorities; and IMF, International Financial Statistics.

1Staff preliminary estimates.
2Measured by the operational deficit which is defined to exclude from government spending (and hence the deficit) the inflation component of interest payments on domestic government debt.

1Under 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. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of directors, and this summary is transmitted to the country's authorities. In this PIN, the main features of the Board's discussion are described.


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