IMF Executive Board Concludes 2006 Article IV Consultation with Israel

Public Information Notice (PIN) No. 07/6
January 23, 2007

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. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2006 Article IV Consultation with the Israel is also available.

On January 19, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Israel.1


Strong macroeconomic conditions and sound domestic policies have significantly improved Israel's growth performance and prospects, notwithstanding political uncertainties and the hostilities in the north during the summer of 2006. Since 2004, the economy expanded in the 4−6 percent range annually, with real GDP growth reaching an estimated 5.0 percent in 2006. Key drivers of the expansion included improving internal security and productivity; buoyant external demand; exceptionally benign financial conditions, notably falling risk premia; and sound macroeconomic policies. Concurrently, the current account surplus continued to widen to an estimated 5 percent of GDP for 2006.

Inflationary pressures are subdued and monetary policy has been easing as of late. As spare capacity was reduced through mid 2006, inflationary pressure first built and the Bank of Israel (BoI) raised its policy rate to 5.5 percent for August 2006. However, since then an appreciation of the sheqel has been passing through swiftly to domestic prices and energy prices have fallen. As a result, Consumer Price Index inflation moved below the BoI's 1−3 percent target range and the Bank cut its policy rate in several steps to 4.5 percent.

Tight expenditure policy together with the recovery reduced the central government budget deficit to 0.9 percent of GDP in 2006, notwithstanding unexpected expenditure related to the hostilities in the north. For 2007, the central government budget deficit is expected to widen on account of higher expenditure related to these hostilities and moderating revenue growth but is targeted not to exceed 2.9 percent of GDP. The public debt-to-GDP ratio has been falling faster than expected but remains high at just under 90 percent of GDP.

Financial soundness indicators have been recovering although some weaknesses on bank balance sheets that relate mainly to previous boom-bust cycles remain. Financial markets performed well during 2006 and the improved economic outlook and enhanced fiscal policy and credibility continued to attract strong foreign capital inflows.

For 2007, real GDP growth is forecast around 4½ percent. The risks to growth lie on the downside and include a disruptive unwinding of global current account imbalances as well as geopolitical uncertainties. Inflation would remain below the Bol's 1−3 percent target range but return toward the midpoint during the second half of 2007, assuming unchanged exchange rates and energy prices.

Executive Board Assessment

Executive Directors commended the authorities on the strong performance of the economy and the notable improvements in macroeconomic policies. Executive Directors identified the need to further strengthen the economy's resilience to shocks, particularly through public debt reduction, as the key challenge facing policymakers.

Directors considered the foundation for continued rapid economic expansion in 2007 to be strong. However, downside risks, notably a disruptive unwinding of global imbalances, investor flight from risk, and geopolitical uncertainties are significant.

Directors supported the recent easing of monetary policy given falling inflationary pressure. They noted that amid buoyant activity inflation is forecast to return toward the mid-point of the central bank's target range later in 2007. Absent an increase in downside risks to prices, notably related to continued appreciation of the sheqel, a further significant addition of stimulus does not appear necessary.

Directors welcomed the increased transparency resulting from the publication of minutes of monetary policy discussions. This has contributed to keeping inflation expectations well anchored despite more volatile headline inflation. Directors generally viewed that the BoI should consider the regular publication of its inflation forecast, to further bolster transparency and stabilize expectations. In this regard, a few others urged caution, considering forecasting difficulties.

Directors praised the strengthening of fiscal policy and advised an appreciable overperformance relative to the proposed central government budget deficit ceiling for 2007. This would contribute to a rapid lowering of the high public debt ratio and thereby create more room for policies to respond to unexpected changes in economic and social conditions without risking adverse public debt dynamics. Directors stressed that fiscal policy should stay on a predictable and credible path toward a significantly lower debt-to-GDP ratio over the medium run. Real expenditure growth should be held at or below the 1.7 percent ceiling and debt reduction should be given priority over tax cuts. Together with some cuts in the many tax expenditure programs, this could bring the general government accounts close to balance in just over 5 years, rapidly lower the debt ratio, and create a buffer against shocks as well as room for more policy maneuver.

Directors advocated a more holistic and forward-looking approach to fiscal policy. In particular, budget documents should include a comprehensive analysis of medium-term fiscal policy challenges and risks. It was viewed that consideration could be given to the introduction of independent, nonpartisan fiscal governance mechanisms that could appraise policies in a forward-looking manner, building on existing institutions. This could foster the constituency for deficit and debt reduction.

Directors welcomed the accelerated financial deepening that is fostering the economy's integration with the rest of the world and adding to growth potential. However, they pointed out that this process calls for the resources and independence of financial supervisors to be buttressed commensurately. Accordingly, they highlighted several policy priorities, including quick passage of the BoI law; re-enforcing risk-based supervision through accelerated implementation of Basel II; improving the institutional framework for insurance supervision; and aligning prudential policies and practices across all sectors. Efforts to strengthen the anti-money laundering and terrorist financing regime should continue.

Directors welcomed advances in the areas of privatization and labor market policy, as well as the authorities' intention to place greater emphasis on combating poverty.

Directors observed that Israel meets the Special Data Dissemination Standard specifications for coverage, periodicity, and timeliness of the data, and that quality of the data is adequate for the purpose of surveillance.

Table 1. Israel: Selected Economic and Financial Indicators, 2001−07

  2001 2002 2003 2004 2005 2006 1/ 2007 2/

(Percent change unless otherwise indicated)

National accounts indicators (constant prices)

Domestic demand

1.7 -0.5 -2.0 2.6 4.5 3.6 4.4

Private consumption

2.6 0.8 0.9 5.5 3.4 4.6 4.0

Public consumption

3.8 5.0 -2.3 -2.3 2.7 3.2 3.0

Fixed capital formation

-3.5 -6.0 -5.5 0.3 2.9 6.1 6.0

Imports of goods and services

-5.1 -1.1 -1.4 12.1 3.4 2.0 5.0

Exports of goods and services

-11.2 -2.3 8.2 18.2 5.1 5.1 5.2

Real GDP

-0.6 -0.9 1.5 4.8 5.2 5.0 4.5

Labor market indicators


Unemployment rate (in percent)

9.3 10.3 10.8 10.3 9.0 8.6 8.2

Real wages 3/

-2.6 -6.0 -3.0 2.5 1.0 0.7 ...



CPI (end period)

1.4 6.5 -1.9 1.2 2.4 -0.1 2.0

CPI (period average)

1.1 5.7 0.7 -0.4 1.3 2.1 0.2

Interest rates (average, in percent) BOI policy rate 4/

6.8 6.8 7.5 4.2 3.7 5.1 4.5

Money and credit (period average)


Private sector credit 3/

14.3 11.7 -3.1 3.9 7.1 2.5 ...

Narrow money (M1) 5/

14.2 15.6 0.5 18.0 17.5 11.5 ...

Broad money (M3) 5/

15.5 6.1 2.2 4.6 7.9 6.7 ...

Public finance (percent of GDP)


Central government revenue

35.6 37.4 35.5 35.3 35.7 36.5 34.2

Central government expenditure

39.8 41.0 40.9 39.0 37.6 37.4 36.5

Central government balance 6/

-4.2 -3.6 -5.4 -3.7 -1.9 -0.9 -2.3

General government balance 7/

-4.9 -9.1 -5.3 -5.4 -4.6 -2.3 -4.0

General government debt

92.1 99.8 102.3 100.9 97.0 88.0 86.5

Balance of payments


Current account (percent of GDP)

-0.6 -0.5 1.6 2.6 2.9 5.2 4.8

Foreign direct investment (percent of GDP)

3.1 1.6 3.4 1.4 4.3 9.3 ...

Foreign currency reserves (e.o.p., in US$ billion)

23.5 24.2 26.5 27.0 27.9 28.7 ...

Exchange rate and terms of trade indices

NEER ( period average) 3/

1.0 -12.6 -3.7 -3.3 -0.8 5.8 ...

REER (period average) 3/

-0.9 -9.7 -5.3 -6.0 -2.1 3.9 ...

Terms of trade (2000=100; index level)

99.1 99.3 97.8 95.9 96.5 95.0 ...

Sources: Bank of Israel, Annual Report; Central Bureau of Statistics; IMF, International Financial Statistics; and IMF staff estimates and projections

1/ Preliminary estimates.

2/ IMF staff projections.

3/ As of October, 2006.

4/ The Bank of Israel set the policy rate at 4.5 percent for January, 2007.

5/ As of September, 2006.

6/ National definition, cash basis.

7/ International definition, accrual basis. On the difference between central and general government deficits during 2001-05: some 0.4 percent of GDP is accounted for by local governments' deficits and the remainder by the difference between accrual and cash bases accounting. On the latter, the key factor is the CPI indexation component that is paid on all NIS debt when it matures and is recorded below the line in the central government balance, but above the line in the general government balance when it accrues.

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. 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.


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