## 1. The Long View

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### Context and recent performance
- Growth performance (decade to 2015):
  - Growth averaged 3.9 percent (2 percent per capita).
  - Advanced-economies mean: 1.7 percent (1.1 percent per capita).
  - Employment surged 36 percent in this period.
  - Labor productivity growth averaged 0.8 percent.
- Population composition and poverty drivers:
  - Population: 8½ million.
  - Group shares: some 20 percent are Arab Israelis, 10 percent Haredi (ultra-orthodox Jews), and 65 percent other Jews.
  - Haredi and Arab household incomes reduced by low participation of Haredi men and Arab women and by lower average skills and wages.
- Political context and cost-of-living pressures:
  - Coalition government comprised of six parties with 66 seats in the 120-member Knesset; no administration has completed a full term since 1988.
  - Since 2011 protests, governments have cut various prices and VAT to lower living costs.
- IMF traction:
  - Fund recommendations from the 2012 FSSA, 2015 Article IV consultation, and 2015 technical assistance have seen implementation (Annex I).
  - BOI following up on 2016 technical assistance on banking supervision.

### Solid growth yet challenges ahead
- 2015–2016 developments and labor market:
  - 2015 growth: 2½ percent (held back by weak exports).
  - Preliminary 2016 real GDP growth: 4 percent.
  - Employment rose by 2.6 percent y/y in 2016.
  - Unemployment rate decline: 1 percentage point; Q4 2016 unemployment rate 4.4 percent.
  - Nominal wage growth in business sector: almost 3 percent y/y in second half of 2016 (from below 2 percent in 2014).
  - Real wage gains about 3½ percent in second half of 2016.
  - Monthly minimum wage increases: 8.6 percent in 2015 and 13.6 percent in January 2016.
- Prices, housing and household balance sheets:
  - Headline CPI modestly negative since second half of 2014, turned slightly positive in January 2017.
  - CPI excluding energy, fruit and vegetables, and government measures: 0.2 percent in 2016.
  - Dwelling prices: average pace of 7½ percent y/y in 2016.
  - Household debt: 74 percent of disposable income.
  - Mortgage interest rate (unindexed) rose 80 basis points since early 2015 to 3.1 percent.
  - Real housing prices nearly doubled since 2007.
  - Cross-country econometric analysis estimates a modest overvaluation of 9 percent as of Q3 2016, with wide uncertainty.
  - Mortgage volumes and housing sales slowed during 2016; price declines recorded in late 2016.
- Short-term outlook:
  - Output growth expected to settle around 3 percent.
  - Domestic demand growth expected to dip in 2017 given high 2016 base.
  - Exports expected to firm, supporting overall growth in 2017.
  - Output and employment gaps broadly closed; rise in CPI inflation likely though timing uncertain.
  - Potential medium-term growth near potential, estimated at some 3 percent.

### Macroeconomic indicators (Percent change y/y, unless noted)
- Real GDP: 2013 4.4; 2014 3.2; 2015 2.5; 2016 4.0; 2017 2.9; 2018 3.0; 2019 3.0
- Total domestic demand: 2013 3.0; 2014 4.0; 2015 3.8; 2016 5.6; 2017 2.7; 2018 2.9; 2019 2.9
- Exports: 2013 3.6; 2014 1.4; 2015 -4.3; 2016 3.9; 2017 3.5; 2018 4.0; 2019 4.0
- Imports: 2013 -0.3; 2014 3.8; 2015 -0.5; 2016 9.7; 2017 1.7; 2018 3.7; 2019 3.9
- Trading partner GDP: 2013 2.4; 2014 2.8; 2015 2.8; 2016 2.2; 2017 2.6; 2018 2.8; 2019 2.8
- Employment: 2013 2.6; 2014 3.0; 2015 2.5; 2016 2.7; 2017 2.5; 2018 2.5; 2019 2.5
- Unemployment rate (percent): 2013 6.3; 2014 5.9; 2015 5.3; 2016 4.8; 2017 4.8; 2018 4.8; 2019 4.8
- CPI (percent change, end of period): 2013 1.8; 2014 -0.2; 2015 -1.0; 2016 -0.2; 2017 1.1; 2018 1.8; 2019 2.0
- CPI (percent change, average): 2013 1.5; 2014 0.5; 2015 -0.6; 2016 -0.5; 2017 0.7; 2018 1.4; 2019 1.9
- Credit to households: 2013 8.4; 2014 7.1; 2015 8.3; 2016 8.2

### Long-term demographics and participation scenarios
- Demographic projections and participation effects:
  - Rising share of Haredi in working age population due to higher fertility; Israeli-Arab share also rising to a smaller extent.
  - If labor participation rates of each group remain at 2015 levels, total labor force participation rate projected to decline by almost 3 percentage points in a decade.
  - Lower average productivity of these groups would further lower potential growth and raise poverty.
- Labor force participation scenarios (based on Central Bureau of Statistics population projections):
  - Scenario 1: Participation rates of each cohort remain at 2015 levels.
  - Scenario 2 (Convergence): Participation rates of Haredi men and Arab women rise to level of Haredi women by 2059; participation rates of other cohorts remain at 2015 levels.

### Risks — wide-ranging, with significant downsides
- Domestic/regional risks:
  - Regional tensions that could hit tourism, damage confidence and investment.
  - Possible housing price weakening could impact construction and domestic demand.
  - Financial stability cushion: relatively low household debt and healthy banks.
- External risks:
  - Weak growth in main trading partners would weigh on exports and growth.
  - Potentially larger impacts given less-diverse exports and limited monetary policy space.
- Potential growth / inequality risks:
  - Limited progress in closing participation and productivity gaps for Haredi and Arab populations could slow growth and increase inequality.
  - Note: participation gaps have narrowed and progress may continue.

### Policy discussions — monetary, exchange rate, fiscal, and structural priorities
- Overarching policy objectives:
  - Support fiscal and structural reforms to promote sustained and inclusive growth.
  - Address supply-side bottlenecks in housing to moderate inequality and contain macrofinancial risks.
  - Promote participation and productivity of Haredi and Israeli-Arab populations while mitigating poverty without undermining work incentives.
A. Monetary and Exchange Rate Policies
- BOI policy rate held at 0.1 percent since February 2015.
- Shekel appreciated 5 percent in nominal effective terms in 2016.
- Monetary policy recommendation:
  - Monetary policy should remain accommodative pending a durable rise in inflation and inflation expectations.
  - Avoid premature monetary tightening before inflation is clearly heading back to target.
- Inflation expectations and exchange rate assessment:
  - Core CPI inflation remains below the 1–3 percent target range.
  - Israel’s real exchange rate appreciation: about 7 percent above historical average on a CPI basis, 17 percent higher on a unit labor cost basis.
  - Current account surplus: 3.6 percent of GDP in 2016.
  - Staff estimates of undervaluation range from 3 to 9.6 percent on favored approaches — not conclusive evidence of significant deviation from fundamentals (Appendix I).
- FX intervention and reserves:
  - BOI FX purchases: $6 billion in 2016 (down from $8.8 billion in 2015).
  - About one-third of 2016 purchases under pre-announced program; remainder aimed at moderating shekel overvaluation.
  - Foreign reserves: $102 billion at end-February 2017.
  - BOI’s estimated adequate reserves range: $70–$110 billion; reserves are within that range.
- BOI view:
  - BOI forecasts inflation to return to target range in 2017Q4 and sees upside and downside uncertainty.
  - BOI considers the shekel mildly overvalued, driven by global accommodative monetary policy and spillovers that reduced competitiveness and weighed on goods exports.

### Housing affordability, reforms, and macroprudential stance
- Affordability deterioration and distributional impacts:
  - The average cost of a home has risen to more than seven times the average household’s annual income, up from a ratio of about five in 2002–07.
  - Affordability is significantly worse than in a range of other countries.
  - In Tel Aviv the price-to-income ratio is almost twice the national average.
  - Elevated housing costs disproportionately impact young and low-income households; increases in rental expenditure as a share of consumption are largest among low-income households.
- Recent policy measures and assessment:
  - Fiscal measures: higher transaction taxes on second or subsequent homes until end 2020; recurrent property tax on owners of three or more houses; partial exemptions from capital gains tax on sales of residential properties until end 2017.
  - Buyer’s Price program: off-budget fiscal cost peaking at 0.2 percent of GDP in 2017–18; helps limited number of households and supplies mostly in the periphery.
  - Administrative steps: planning institutions consolidated under the Finance Ministry; planning process estimated expedited by 2–6 years.
- Recommended supply-side reforms:
  - Address municipal disincentives to approve residential projects and correct local fiscal incentives.
  - Accelerate land privatization, focusing on areas of high demand.
  - Expand urban renewal and improve public transportation.
  - Charge taxes on undeveloped privately held land to promote use.
  - Reduce construction times and costs by streamlining building regulations and widening entry to foreign builders.
- Rental market and tenant protection:
  - Rental market primarily small-scale landlords due partly to tax treatment; recent REIT amendments welcome to attract professional investment.
  - Protection for tenants is among the lowest in OECD countries; tenant protection reforms could aid rental market development.
- Macroprudential measures and financial stability:
  - BOI measures include quantitative limits, capital surcharges, LTV caps, DSTI caps, provisioning increases, and a requirement for banks to increase capital by 1 percent of outstanding mortgage lending by January 1, 2017.
  - Resulting developments: household debt-to-income ratios remain low; mortgages with LTVs exceeding 75 percent have been almost eliminated.
  - BOI allowed banks to raise credit supply to construction sector by recognizing transfer of credit risk to secondary insurers abroad.
  - Recommendation: BOI should continue to monitor property market and debt developments closely and remain vigilant to protect macrofinancial stability.

### Fiscal framework, tax expenditures, and public finance
- Medium-term fiscal framework progress and vulnerabilities:
  - Strengthened commitment controls and an agreed multi-year defense budget improve prospects for containing spending trends.
  - Medium-term budget framework remains susceptible to deviations from fiscal rules.
  - Recommended enhancements: include concrete measures to close deviations from fiscal rules in the budget document; set clear criteria limiting changes in spending and deficit ceilings; convert the Land Authority to a budgetary entity; report U.S. grants and related defense spending of ¾ percent of GDP annually on budget.
- Projected foregone revenue from tax benefits (Percent of GDP):
  - Total: 2017 5.0 / 2018 4.9
  - Direct taxes: 2017 4.1 / 2018 4.0
  - Pension: 2017 1.7 / 2018 1.7
  - Law for the encouragement of capital investments: 2017 0.5 / 2018 0.5
  - Education funds: 2017 0.4 / 2018 0.4
  - Exemption from betterment tax on apartments: 2017 0.4 / 2018 0.3
  - Credit to parents for children: 2017 0.2 / 2018 0.2
  - Exemption for the National Insurance allowances: 2017 0.2 / 2018 0.2
  - Others: 2017 0.7 / 2018 0.7
  - Indirect taxes: 2017 0.8 / 2018 0.8
  - VAT: 2017 0.4 / 2018 0.4
  - Customs and purchase tax: 2017 0.4 / 2018 0.4
  - Levies: 2017 0.1 / 2018 0.1
- Fiscal stance and authorities' views:
  - MOF highlighted deficits were below target in both 2015 and 2016 and supports tax rate cuts if revenues prove strong.
  - BOI did not support tax cuts at this time, citing one-off factors complicating revenue assessment and low civilian spending.
  - MOF cautious about setting criteria for adjusting fiscal targets.

### Structural reforms to raise productivity and inclusion
- Productivity and participation challenges:
  - Average labor productivity in Israel was 56 percent of U.S. levels in 2015 and 74 percent of EU levels.
  - Haredi male participation: 50.5 percent.
  - Participation of Arab women: 34.6 percent.
- Product market reform priorities:
  - Lower barriers to external competition: expand quota increases and tariff cuts, especially on food (half of dairy products and eggs face tariffs over 100 percent).
  - Shift agricultural support to less distortionary targeted subsidies.
  - Simplify import procedures, align standards with other advanced economies, and ease restrictions hindering foreign competition in services.
  - Reduce regulatory burdens: modernize regulation, implement “one-stop shop”, require regulatory impact assessments.
  - Reform state enterprises: improve SOE efficiency and implement electricity sector reforms.
- Inclusiveness, labor market and social policy:
  - ALMPs: 46 Career Centers targeting Israeli-Arabs, Haredi, and Ethiopian Israelis; only 0.2 percent of GDP spent on ALMP.
  - Earned Income Tax Credit (EITC):
    - Averages NIS 3,619 per household in 2015, equivalent to just 7 percent of the minimum wage.
    - Overall budgetary cost: 0.1 percent of GDP.
    - In 2015, 414,500 low income workers were eligible for the EITC; 70.2 percent used the credit.
  - Recommendations: substantially expand the EITC, lower the minimum earnings threshold, make payments more frequent and timely, and expand ALMP funding and coordination with employers.
  - MOF concern: significant EITC expansion could undermine work incentives for households near abatement thresholds.
  - BOI endorsement: expansion of ALMP and EITC, and support for small business development in Haredi and Israeli-Arab communities.

### Debt sustainability and stress tests (Appendix II)
- Recent debt dynamics:
  - Israel’s debt-to-GDP ratio fell from 94 percent in 2003 to 62 percent in 2016.
  - Debt structure: maturity averaging 7 years; nonresidents holding around 14 percent; high-yield non-tradable government bonds constitute 19 percent of general government debt.
- Baseline projections and financing needs:
  - Public debt-to-GDP ratio projected to gradually rise to 63½ percent of GDP by 2021.
  - Gross financing needs: 8½ percent of GDP in 2016; increase to 10 percent of GDP in 2017; remain around 10 percent of GDP throughout projection period.
- Baseline fiscal assumptions:
  - Real GDP projected to grow at around 3 percent annually on average.
  - CPI inflation projected to return to around 2 percent by 2019.
  - Central government deficit path: 2.1 percent of GDP in 2016; 2¾ percent in 2017 and 2018; 2.9 percent in 2019 and stay at that level thereafter.
  - Effective interest rate projected to increase from 5 percent in 2016 to 5⅔ percent in the medium term.
- Selected stress test outcomes:
  - Growth shock (lower real GDP growth by 1 standard deviation for 2 years starting in 2017): Debt-to-GDP about 65 percent by 2018 and 68¼ percent by 2022; financing needs increase to 12 percent of GDP by 2019 then decline to 11 percent.
  - Interest rate shock (borrowing costs rise by 200 basis points): Public debt increase to around 65½ percent of GDP by 2022; financing needs rise to around 11 percent of GDP by 2022.
  - Combined macro-fiscal shock: Debt-to-GDP 66 percent by 2018, rising to around 71½ percent by 2022; financing needs rise to 11 percent initially then around 11½–12½ percent.

### Staff appraisal — key policy recommendations
- Growth and outlook:
  - Growth of 4 percent in 2016; expected to settle around 3 percent in coming years.
  - Long-term risks: demographic trends could lower growth potential and raise poverty.
- Monetary policy:
  - BOI has maintained appropriately accommodative policy; avoid premature tightening given inflation uncertainty and weak short- to medium-term inflation expectations.
- Housing and supply-side measures:
  - Reforms to durably expand housing supply needed to improve affordability and lower macrofinancial risks.
  - Recommended steps include correcting municipal incentives, accelerating land privatization, expanding urban renewal, improving public transportation, reducing construction times and costs, and opening market to foreign competition.
- Financial stability and regulation:
  - Continue safeguarding financial stability during reforms.
  - Enact FSC legislation to improve regulator coordination and operationalize Solvency II for insurance.
  - Maintain operational independence of financial regulators and ensure adequate tools for new entrants.
- Fiscal policy:
  - Recommendation: reduce the central government deficit to around 2 percent of GDP in coming years while protecting buffers.
  - Prioritize additional spending on education and transport infrastructure.
  - Fund essential public investments while narrowing the deficit through additional savings from central government administration, improving public procurement, and reducing sizable tax benefits.
  - Reiterate importance of stronger political commitment to medium-term fiscal framework for effectiveness.

*Source: IMF staff report — "1. The Long View" (cr1775) from the IMF country report PDF content provided.*

### 1. The Long View  ________________________________________________________________________________ 24

### 1. The Long View

### Context and recent performance
- Growth performance (decade to 2015):
  - Growth averaged 3.9 percent (2 percent per capita).
  - Advanced-economies mean: 1.7 percent (1.1 percent per capita).
  - Employment surged 36 percent in this period.
  - Labor productivity growth averaged 0.8 percent.
- Population composition and poverty drivers:
  - Population: 8½ million.
  - Group shares: some 20 percent are Arab Israelis, 10 percent Haredi (ultra-orthodox Jews), and 65 percent other Jews.
  - Haredi and Arab household incomes reduced by low participation of Haredi men and Arab women and by lower average skills and wages.
- Political context and cost-of-living pressures:
  - Coalition government comprised of six parties with 66 seats in the 120-member Knesset; no administration has completed a full term since 1988.
  - Since 2011 protests, governments have cut various prices and VAT to lower living costs.
- IMF traction:
  - Fund recommendations from the 2012 FSSA, 2015 Article IV consultation, and 2015 technical assistance have seen implementation (Annex I).
  - BOI following up on 2016 technical assistance on banking supervision.

### Solid growth yet challenges ahead
- 2015–2016 developments:
  - 2015 growth: 2½ percent (held back by weak exports).
  - Preliminary 2016 real GDP growth: 4 percent.
  - Employment rose by 2.6 percent y/y in 2016.
  - Unemployment rate decline: 1 percentage point; Q4 2016 unemployment rate 4.4 percent.
  - Nominal wage growth in business sector: almost 3 percent y/y in second half of 2016 (from below 2 percent in 2014).
  - Real wage gains about 3½ percent in second half of 2016.
  - Monthly minimum wage increases: 8.6 percent in 2015 and 13.6 percent in January 2016.
- Inflation and prices:
  - Headline CPI modestly negative since second half of 2014, turned slightly positive in January 2017.
  - CPI excluding energy, fruit and vegetables, and government measures: 0.2 percent in 2016.
  - Dwelling prices: average pace of 7½ percent y/y in 2016.
  - Household debt: 74 percent of disposable income.
  - Mortgage interest rate (unindexed) rose 80 basis points since early 2015 to 3.1 percent.
- Housing market assessment:
  - Real housing prices nearly doubled since 2007.
  - Cross-country econometric analysis estimates a modest overvaluation of 9 percent as of Q3 2016, with wide uncertainty.
  - Mortgage volumes and housing sales slowed during 2016; price declines recorded in late 2016.
- Short-term outlook:
  - Output growth expected to settle around 3 percent.
  - Domestic demand growth expected to dip in 2017 given high 2016 base.
  - Exports expected to firm, supporting overall growth in 2017.
  - Output and employment gaps broadly closed; rise in CPI inflation likely though timing uncertain.
  - Potential medium-term growth near potential, estimated at some 3 percent.

### Macroeconomic indicators (Percent change y/y, unless noted)
- Real GDP: 2013 4.4; 2014 3.2; 2015 2.5; 2016 4.0; 2017 2.9; 2018 3.0; 2019 3.0
- Total domestic demand: 2013 3.0; 2014 4.0; 2015 3.8; 2016 5.6; 2017 2.7; 2018 2.9; 2019 2.9
- Exports: 2013 3.6; 2014 1.4; 2015 -4.3; 2016 3.9; 2017 3.5; 2018 4.0; 2019 4.0
- Imports: 2013 -0.3; 2014 3.8; 2015 -0.5; 2016 9.7; 2017 1.7; 2018 3.7; 2019 3.9
- Trading partner GDP: 2013 2.4; 2014 2.8; 2015 2.8; 2016 2.2; 2017 2.6; 2018 2.8; 2019 2.8
- Employment: 2013 2.6; 2014 3.0; 2015 2.5; 2016 2.7; 2017 2.5; 2018 2.5; 2019 2.5
- Unemployment rate (percent): 2013 6.3; 2014 5.9; 2015 5.3; 2016 4.8; 2017 4.8; 2018 4.8; 2019 4.8
- CPI (percent change, end of period): 2013 1.8; 2014 -0.2; 2015 -1.0; 2016 -0.2; 2017 1.1; 2018 1.8; 2019 2.0
- CPI (percent change, average): 2013 1.5; 2014 0.5; 2015 -0.6; 2016 -0.5; 2017 0.7; 2018 1.4; 2019 1.9
- Credit to households: 2013 8.4; 2014 7.1; 2015 8.3; 2016 8.2

### Long-term demographics and growth risks
- Demographic projections and participation effects:
  - Rising share of Haredi in working age population due to higher fertility; Israeli-Arab share also rising to a smaller extent.
  - If labor participation rates of each group remain at 2015 levels, total labor force participation rate projected to decline by almost 3 percentage points in a decade.
  - Lower average productivity of these groups would further lower potential growth and raise poverty.
- Labor force participation scenarios (based on Central Bureau of Statistics population projections):
  - Scenario 1: Participation rates of each cohort remain at 2015 levels.
  - Scenario 2 (Convergence): Participation rates of Haredi men and Arab women rise to level of Haredi women by 2059; participation rates of other cohorts remain at 2015 levels.

### Risks (Annex II) — wide-ranging, with significant downsides
- Domestic/regional risks:
  - Regional tensions that could hit tourism, damage confidence and investment.
  - Possible housing price weakening could impact construction and domestic demand.
  - Financial stability cushion: relatively low household debt and healthy banks.
- External risks:
  - Weak growth in main trading partners would weigh on exports and growth.
  - Potentially larger impacts given less-diverse exports and limited monetary policy space.
- Potential growth / inequality risks:
  - Limited progress in closing participation and productivity gaps for Haredi and Arab populations could slow growth and increase inequality.
  - Note: participation gaps have narrowed and progress may continue.

### Policy discussions — overview and monetary/exchange rate policy
- Policy objectives:
  - Support fiscal and structural reforms to promote sustained and inclusive growth.
  - Address supply-side bottlenecks in housing to moderate inequality and contain macrofinancial risks.
  - Promote participation and productivity of Haredi and Israeli-Arab populations while mitigating poverty without undermining work incentives.
A. Monetary and Exchange Rate Policies
- Current monetary stance and developments:
  - BOI policy rate held at 0.1 percent since February 2015.
  - Shekel appreciated 5 percent in nominal effective terms in 2016.
  - Average mortgage interest rate (unindexed) rose 80 basis points since early 2015 to 3.1 percent.
- Monetary policy recommendation:
  - Monetary policy should remain accommodative pending a durable rise in inflation and inflation expectations.
  - Avoid premature monetary tightening before inflation is clearly heading back to target.
- Inflation expectations:
  - Core CPI inflation remains below the 1–3 percent target range.
  - Significant decline in short- and medium-term expectations despite longer-term expectations anchored.
- Exchange rate assessment:
  - Israel’s real exchange rate appreciation: about 7 percent above historical average on a CPI basis, 17 percent higher on a unit labor cost basis.
  - Current account surplus: 3.6 percent of GDP in 2016.
  - Staff estimates of undervaluation range from 3 to 9.6 percent on favored approaches — not conclusive evidence of significant deviation from fundamentals (Appendix I).
- FX intervention and reserves:
  - BOI FX purchases: $6 billion in 2016 (down from $8.8 billion in 2015).
  - About one-third of 2016 purchases under pre-announced program (offset lower imports owing to natural gas production); remainder aimed at moderating shekel overvaluation.
  - Foreign reserves: $102 billion at end-February 2017.
  - BOI’s estimated adequate reserves range: $70–$110 billion; reserves are within that range.
- BOI views:
  - BOI forecasts inflation to return to target range in 2017Q4 and sees upside and downside uncertainty.
  - BOI considers the shekel mildly overvalued, driven by global accommodative monetary policy and spillovers that reduced competitiveness and weighed on goods exports.

*Source: IMF staff report — "1. The Long View" (cr1775) from the IMF country report PDF content provided.*

### 21. Housing affordability has deteriorated substantially. The average cost of a home has

### cr1775 - 21. Housing affordability has deteriorated substantially. The average cost of a home has

### Housing affordability: current state
- The average cost of a home has risen to more than seven times the average household’s annual income, up from a ratio of about five in 2002–07.
- Affordability is significantly worse than in a range of other countries.
- The situation is especially severe in Tel Aviv, where the price-to-income ratio is almost twice the national average.

### Distributional impacts
- Elevated housing costs have disproportionate impacts on young and low-income households.
- Lower-income families increasingly cannot afford the down payment, resulting in rising rents over the past decade.
- Increases in rental expenditure as a share of consumption are largest among low-income households.
- High-income households seeking investment returns increasingly own more than one dwelling.

### Recent housing market reforms (measures and assessment)
- Fiscal measures:
  - Higher transaction taxes on second or subsequent homes until end 2020.
  - Introduction of a recurrent property tax on owners of three or more houses.
  - Partial exemptions from capital gains tax on sales of residential properties until end 2017, with full exemptions on investing proceeds of sales in the capital markets.
  - Assessment: These tax changes may dampen price rises in the near term owing to investor sales, but focusing a recurrent property tax on investors could over time raise rental costs for low-income households, and the ceiling on monthly tax payments is regressive.
  - Buyer’s Price program: helps households purchase a first house, but benefits relatively few households that win a lottery, provides housing supply mostly in the periphery, and comes at an off-budget fiscal cost peaking at 0.2 percent of GDP in 2017–18 (Annex III).
- Administrative steps:
  - Government actions to reduce long construction planning times (previously estimated to average 13 years): Housing Cabinet established in 2014; Land Authority and Planning Administration consolidated under the Finance Ministry in 2015.
  - Estimates that the planning process has been expedited by 2–6 years.
  - Further gains possible by simplifying rules and decentralizing approval of smaller projects.

### Further supply-side reforms recommended
- Address municipal disincentives:
  - Local governments reluctant to approve residential projects because residential property taxes are well below those on commercial properties even as they require additional infrastructure and public services.
  - Authorities rely on “blanket agreements” with municipalities for major projects; correcting incentives would make supply more responsive to demand durably.
- Ensure adequate land supply for housing:
  - Majority of land in Israel is state owned.
  - Accelerating land privatization, focusing on areas of high demand, would help mitigate price pressures.
  - Recent efforts to reduce impediments to urban renewal are welcome and should be expanded dramatically as urban density in Tel Aviv is relatively low.
  - Improved public transportation would help relieve demand in major centers.
  - Municipalities could charge taxes on undeveloped privately held land to promote its use.
- Reduce construction times and costs:
  - Government recently approved six foreign companies to construct residential buildings in Israel to help raise productivity.
  - Recommendation to expand this initiative over time to allow broader entry of companies and help relieve shortages of skilled labor.
  - Construction costs and time to build should be reduced by streamlining building regulations.

### Rental market development
- Rental market primarily small-scale landlords, partly because rental income is taxable for companies but not for individuals.
- Recent amendments to laws and regulations for investment in Real Estate Investment Trusts (REIT) are welcome to attract professional investment and management into the rental sector, which could expand supply of rental property and moderate rents over time.
- Although over a quarter of the population lives in rental dwellings, protection for tenants is among the lowest in OECD countries; reforms to tenant protection could aid rental market development.

### Macroprudential stance and financial stability
- The Bank of Israel (BOI) has implemented a battery of macroprudential measures in the housing area, including quantitative limits and measures affecting banks’ cost of funding mortgages (Annex IV).
- Resulting developments:
  - Household debt-to-income ratios remain low in Israel.
  - Mortgages with LTVs exceeding 75 percent have been almost eliminated.
  - Requirement for banks to increase capital by 1 percent of outstanding mortgage lending by January 1, 2017 helps account for the rise in mortgage interest rates during 2016.
- BOI actions to avoid impeding housing supply:
  - Allowed banks to raise credit supply to the construction sector by recognizing transfer of credit risk to secondary insurers abroad.
- Recommendation: BOI should continue to monitor property market and debt developments closely and remain vigilant to protect macrofinancial stability.

### Authorities' perspective
- Authorities consider the combination of near- and longer-term measures to strike a reasonable balance and noted macroprudential policy would remain vigilant.
- MOF view: housing supply is the key issue; administrative planning reforms have made progress.
- Housing Cabinet has been effective on urban renewal and construction financing; current priorities include addressing skilled labor shortages.
- Political obstacles to changing municipal taxes were described as insurmountable, suggesting alternative approaches are required.
- Buyer’s Price program seen as providing younger households with affordable housing more quickly; contribution to supply would become significant in the medium term.
- MOF considered tax measure combination appropriate, noting some are temporary.
- BOI analysis indicates high risk loans are well controlled; bank capital buffers have increased recently and mortgage rates better incorporate lending risk, but BOI remains ready to act if needed.

*Italic: Source — IMF staff report text (cr1775), sections on housing affordability, reforms, rental market, and macroprudential policies.*

### 40. Important improvements in the medium-term fiscal framework have been made, but

### 40. Important improvements in the medium-term fiscal framework have been made, but

### Medium-term fiscal framework — progress and remaining vulnerabilities
- Following IMF Technical Assistance in 2015, the government implemented measures to strengthen the medium-term fiscal framework (Annex V).
- Strengthened commitment controls and an agreed multi-year defense budget, combined with enhanced transparency in implementation, will improve prospects for containing spending trends.
- The medium-term budget framework remains susceptible to deviations from fiscal rules based on long experience.
- Recommendations to enhance credibility and transparency:
  - Include concrete measures to close deviations from fiscal rules in the budget document.
  - Set clear criteria that limit changes in the spending and deficit ceilings to exceptional cases such as natural disasters.
  - Convert the Land Authority to a budgetary entity.
  - Report U.S. grants and related defense spending of ¾ percent of GDP annually on budget.

### Projected foregone revenue from tax benefits (Percent of GDP)
- 2017 / 2018
  - Direct taxes: 4.1 / 4.0
  - Pension: 1.7 / 1.7
  - Law for the encouragement of capital investments: 0.5 / 0.5
  - Education funds: 0.4 / 0.4
  - Exemption from betterment tax on apartments: 0.4 / 0.3
  - Credit to parents for children: 0.2 / 0.2
  - Exemption for the National Insurance allowances: 0.2 / 0.2
  - Others: 0.7 / 0.7
  - Indirect taxes: 0.8 / 0.8
  - VAT: 0.4 / 0.4
  - Customs and purchase tax: 0.4 / 0.4
  - Levies: 0.1 / 0.1
  - Total: 5.0 / 4.9
- Sources cited in the table: Israeli Ministry of Finance; WEO; and IMF staff calculations.

### Fiscal policy stances and authorities' views
- The MOF highlighted deficits were below target in both 2015 and 2016, seeing potential for recurrence and supporting tax rate cuts (e.g., VAT) if revenues prove strong to reduce the cost of living.
- The BOI did not support tax cuts at this time, citing one-off factors complicating revenue assessment and low civilian spending.
- The MOF was cautious about setting criteria for adjusting fiscal targets, fearing they could be a slippery slope.

### Structural reforms — productivity and participation challenges
- Two main opportunities to improve longer-term outlook:
  - Productivity is relatively low, especially in sheltered sectors: average labor productivity in Israel was 56 percent of U.S. levels in 2015 and 74 percent of EU levels. Labor productivity growth is higher in industries more exposed to international competition.
  - Labor participation of some groups remains very low:
    - Haredi male participation: 50.5 percent.
    - Participation of Haredi females has risen substantially over 15 years to approach other Jewish females.
    - Participation of Arab women: 34.6 percent.

### Product market reforms — areas for priority action
- Key characteristics to address: relatively low trade openness, complex burdensome regulation creating barriers to entry, and signs of inadequate competition in some sectors.
- Priority reform areas:
  - Lowering barriers to external competition:
    - Further lower trade barriers by expanding quota increases and tariff cuts, especially on food; half of dairy products and eggs face tariffs over 100 percent.
    - Shift support for agriculture to less distortionary targeted subsidies.
    - Simplify import procedures, align standards with other advanced economies, and ease restrictions hindering foreign competition in services.
  - Reducing regulatory burdens:
    - Review and modernize regulation to achieve public goals in a low-cost manner.
    - Implement simple and timely administration (e.g., a “one-stop shop”).
    - Require robust regulatory impact assessments for proposed new regulations.
    - Note: Israel’s Doing Business ranking dropped from 30th in 2008 to 52nd in 2016.
  - Reforming state enterprises:
    - Improve SOE efficiency, especially in network industries (electricity, ports, airports, postal services, water management).
    - Implement long-planned electricity sector reforms to make efficient use of natural gas resources.

### Inclusiveness, labor market, and social policy reforms
- Active labor market policies (ALMP):
  - Ministry of Labor and Social Affairs established 46 Career Centers targeting Israeli-Arabs, Haredi, and Ethiopian Israelis.
  - Only 0.2 percent of GDP is spent on ALMP, limiting impact.
  - Recommendation: Expand funding for programs with good results and coordinate closely with employers to ensure effectiveness.
- Environment for small businesses and infrastructure:
  - Need more jobs in or near Haredi and Israeli-Arab communities.
  - Increase investments in connecting towns to main roads and improve access to public transport.
  - Improve access to financing; Israeli-Arab communities may require government assistance to address land-as-collateral difficulties.
- Earned Income Tax Credit (EITC) and minimum wage:
  - Minimum wage increased significantly in recent years, to 51 percent of the average wage based on the increase planned for December 2017.
  - EITC specifics:
    - Averages NIS 3,619 per household in 2015, equivalent to just 7 percent of the minimum wage.
    - Overall budgetary cost: 0.1 percent of GDP.
    - In 2015, 414,500 low income workers were eligible for the EITC; 70.2 percent used the credit.
  - Recommendations for EITC:
    - Substantially expand the EITC to target low income workers with families.
    - Broaden impact by lowering the minimum earnings threshold to include more part-time workers.
    - Make payments more frequent and timely to increase take-up and strengthen employment incentives.
  - MOF concern: significant expansion of EITC could undermine work incentives for households near income levels subject to abatement of the credit.
  - BOI endorsement: expansion of ALMP and EITC, and support for small business development in Haredi and Israeli-Arab communities.

### Staff appraisal — macroeconomic assessment and policy recommendations
- Growth and outlook:
  - Growth of 4 percent in 2016, supported by robust domestic demand and an export rebound.
  - Growth expected to settle around 3 percent in coming years with moderated domestic demand and firmer exports.
  - Long-term risks: demographic trends, especially rising share of Haredi in working-age population, could lower growth potential and raise poverty.
- Monetary policy:
  - Inflation has been below the 1–3 percent target band in recent years.
  - BOI has maintained appropriately accommodative policy to keep long-term inflation expectations anchored.
  - A premature monetary tightening should be avoided given uncertainties around timing of inflation rise and weak short- to medium-term inflation expectations.
  - The shekel has appreciated despite accommodative policy and is not evidently significantly misaligned with fundamentals.
- Housing and supply-side measures:
  - Reforms to durably expand housing supply are needed to improve affordability and lower macrofinancial risks.
  - Measures taken: bringing relevant authorities under the MOF, Housing Cabinet actions to address financing and urban renewal impediments.
  - Issues: Buyer’s Price Program is costly and boosts supply mostly in the periphery.
  - Recommended steps:
    - Correct municipal incentives related to residential development.
    - Accelerate land privatization and expand urban renewal.
    - Improve public transportation to relieve demand in major centers.
    - Reduce construction times and costs by streamlining building regulations and opening market to foreign competition.
- Financial stability and regulation:
  - Continue safeguarding financial stability during reforms.
  - Regulatory enhancements: establishment of independent CMISA and a more risk-focused supervisory approach by the BOI.
  - Recommendation: Enact FSC legislation to improve regulator coordination and operationalize Solvency II for insurance.
  - Promote financial sector efficiency while maintaining stability: separation of two credit card companies from banks requires close supervision; lower bank entry barriers with adequate tools for deposit insurance and bank resolution.
  - Protect operational independence of financial regulators to give new entrants certainty about future arrangements.
- Fiscal policy recommendations:
  - Strong growth in 2016 lowered the fiscal deficit and continued the public debt downtrend.
  - Risk: Allowing deficits of up to 2.9 percent of GDP could result in a gradual rise in public debt.
  - Recommendation: Reduce the central government deficit to around 2 percent of GDP in coming years while protecting buffers.
  - Prioritize additional spending on education and transport infrastructure to sustain growth.
  - Fund essential public investments while narrowing the deficit through:
    - Additional savings from central government administration.
    - Improving public procurement.
    - Reducing sizable tax benefits.
  - Reiterate: Important improvements in the medium-term fiscal framework have been made, especially enhanced commitment controls, but greater political commitment is key to effectiveness.

*Source: IMF staff report (excerpt).*

### 56. It is proposed that the next Article IV consultation with Israel take place on the

### It is proposed that the next Article IV consultation with Israel take place on the standard 12-month cycle.

### Economic overview and long-term trends
- Fiscal deficits have been declining since the global financial crisis.
- Growth has relied on domestic demand rather than exports since 2012.
- The current account has been in surplus for the past decade.
- Contributing factors noted:
  - Decline in investment rates in the mid-2000s and high saving rates.
  - Down trend in government debt and helping raise the net IIP over time.

### Recent economic developments (high-frequency and cyclical)
- After a period of weakness in 2015, growth picked up in 2016.
- Consumption contributed strongly, partly boosted by a temporary surge in car purchases in 2016 ahead of tax hikes.
- Employment gaps closing; unemployment fell to historic lows along with rising vacancy rates.
- Fixed investment growth supported by Intel’s fabrication plant upgrade.
- High-frequency data suggest strong growth to continue.

### Inflation and monetary policy
- Headline inflation is below the target band.
- Nominal wage growth has been rising gradually and nontradable inflation is within the band.
- External factors, such as energy prices and exchange rates, have influenced inflation.
- The BOI has kept the policy rate (no specific rate value provided in the text).
- Long-term inflation expectations remain well anchored.
- Notes and definitions preserved:
  - Excluding fruit and vegetables, and estimated impact of government measures.
  - Crude Oil (petroleum), simple average of three spot prices; Dated Brent, West Texas Intermediate, and the Dubai Fateh, US$ per barrel.
  - A negative change indicates appreciation of the shekel.
  - Real policy rate is calculated as the difference between nominal policy rate and one-year ahead inflation expectations.

### Exchange rate, external sector, and balance of payments
- The shekel has appreciated against major currencies.
- The exchange rate is broadly in line with the PPP.
- Services have led the current account surplus; service exports are led by other businesses (includes medical services, communications, R&D, and IT services).
- Official and private transfers make substantial contributions to the current account.
- Selected BOP figures (preserved exactly as presented):
  - Current account balance (US$ billions): 2013: 10.3; 2014: 12.2; 2015: 13.0; 2016: 11.6; 2017: 11.7; 2018: 11.8; 2019: 12.2; 2020: 12.6; 2021: 12.9; 2022: 13.3.
  - Current account balance (percent of GDP): 3.5; 4.0; 4.3; 3.6; 3.4; 3.4; 3.3; 3.3; 3.2; 3.2.
  - Gross external debt (percent of GDP): 34.5; 31.1; 29.9; 28.6; 27.9; 27.8; 29.1; 33.1; 33.5; 35.8.
  - Foreign reserves (US$ billions): 81.8; 86.1; 90.6; 98.4; 105.0; 109.1; 113.9; 118.6; 123.4; 128.3.
  - GDP (US$ billions): 293.3; 308.8; 299.4; 318.3; 339.6; 352.9; 368.1; 383.5; 399.1; 414.9.

### Housing market and affordability
- House prices and mortgage credit have been rising at 7-8 percent y/y in recent years, fueled by growing incomes and low interest rates.
- Housing supply has not kept pace with population growth, contributing to prices rising faster than incomes.
- High house prices have greatly reduced housing affordability since 2007, with affordability in Tel Aviv low by international standards.
- Housing investment returns have held up as long-term bond yields have declined, pushing some households out of home ownership, particularly young families.
- Housing demand dynamics: strong growth in purchases for investment purposes by high-income households.

### Financial sector and banking system
- Lending operations have remained fully funded by deposits.
- Bank credit has flowed largely to households.
- Profitability has risen as efficiency has gradually improved; banks’ capital has continued to rise.
- Interbank spreads have hovered near zero.
- Sovereign bond yields have tracked US yields closely; sovereign CDS spreads have been stable.
- Default probabilities have fallen aside from a temporary increase for one bank.
- Selected banking indicators (preserved exactly):
  - Regulatory capital to risk-weighted assets (2010–2016 Q3): 14.1; 14.0; 14.9; 14.8; 14.3; 14.0; 14.6.
  - Regulatory Tier I capital to risk-weighted assets (2010–2016 Q3): 8.5; 8.4; 9.2; 9.8; 9.7; 9.9; 10.7.
  - Nonperforming loans to total gross loans (2010–2016 Q3): ...; 3.4; 3.5; 2.9; 2.2; 1.8; 1.6.
  - Return on average assets (before tax) (2010–2016 Q3): 0.9; 1.2; 0.8; 0.9; 0.8; 1.0; 1.1.
  - Return on average equity (before tax) (2010–2016 Q3): 13.8; 12.3; 12.1; 13.3; 11.8; 14.4; 15.5.

### Corporate and household sectors
- Corporate leverage ratios have declined further; profitability has trended down in recent years.
- Business sector borrowing has picked up; market indicators for corporate default probability have increased.
- Household net worth has remained around four times their disposable income, and household debt remains low.
- Selected borrowing statistics (percent of GDP, preserved exactly):
  - Total business sector borrowing (2008–2016): 93.3; 87.2; 84.3; 83.4; 79.8; 73.7; 71.7; 69.9; 68.6.
  - Total household sector borrowing (2008–2016): 37.7; 38.8; 39.5; 39.6; 39.5; 39.7; 40.3; 40.8; 41.2.
  - Mortgage (percent of GDP, 2008–2016): 24.5; 25.1; 26.2; 26.6; 26.8; 27.0; 27.2; 27.5; 27.5.

### Fiscal position and public finance (selected figures)
- Fiscal deficits and public debt trajectory (selected exact values):
  - Central government overall balance (percent of GDP, 2013–22): -3.3; -2.7; -2.1; -2.1; -2.7; -2.7; -2.9; -2.9; -2.9; -2.9.
  - General Government overall balance (percent of GDP, 2013–22): -4.2; -3.4; -2.7; -2.5; -3.3; -3.5; -3.7; -3.7; -3.7; -3.7.
  - General Government debt (percent of GDP, 2013–22): 67.0; 66.0; 64.1; 62.2; 62.6; 63.0; 63.2; 63.3; 63.5; 63.7.
  - Central government revenues and grants (percent of GDP, 2013–22): 25.5; 25.7; 25.8; 26.3; 25.6; 25.7; 25.6; 25.6; 25.6; 25.6.
  - Central government total expenditure (percent of GDP, 2013–22): 28.8; 28.4; 27.9; 28.4; 28.3; 28.4; 28.4; 28.4; 28.4; 28.4.
  - Public debt to GDP (Table 4, 2010–18 selected): 70.7; 68.8; 68.3; 67.0; 66.0; 64.1; 62.2; 62.6; 63.0.

### Key projections and model outputs (table highlights)
- Real GDP (percent change, Table 1, 2013–22): 4.4; 3.2; 2.5; 4.0; 2.9; 3.0; 3.0; 3.0; 3.0; 3.0.
- Unemployment rate (percent, Table 1, 2013–22): 6.3; 5.9; 5.3; 4.8; 4.8; 4.8; 4.8; 4.8; 4.8; 4.8.
- Overall CPI (percent change, end of period, Table 1, 2013–22): 1.8; -0.2; -1.0; -0.2; 1.1; 1.8; 2.0; 2.0; 2.0; 2.0.
- Gross national saving (percent of GDP, Table 1, 2013–22): 23.5; 24.1; 24.3; 23.9; 23.1; 23.0; 22.9; 22.8; 22.8; 22.8.

*INTERNATIONAL MONETARY FUND*

### Annex I. Status of Key Recommendations from

### Annex I. Status of Key Recommendations from

### Status of key 2015 recommendations — fiscal consolidation and frameworks
- Reduce fiscal deficits to put debt on a firmly downward path and build fiscal space.
  - Central government deficits for 2015 and 2016 came in below the budget targets, but deficit targets for 2017 and 2018 have been revised up.
  - Debt is not projected to decline in the medium term.
- Establish a stronger medium-term fiscal framework, with an explicit revenue and expenditure plan consistent with the deficit target.
  - The government has:
    - started publishing a medium-term fiscal framework since the 2015–16 budget (noted to have gaps that need to be closed to meet the deficit targets);
    - introduced a mechanism to strengthen transparency and ability to control future commitments;
    - for the Defense Ministry, agreed on a medium-term budget framework and specified conditions to deviate from it;
    - established a Spending Review Committee, which published the procedure for a spending review in 2017.
  - The recommendation to clearly define the criteria for revisions to the deficit targets was not implemented.
- Monetary policy.
  - The BOI has maintained the policy rate since February 2015.
- Housing supply and local incentives.
  - The government moved the Land Authority and the Planning Commission under the MoF, but it is not yet clear if procedures have been accelerated.
  - There has been no change in the local property tax framework to incentivize local governments to facilitate more residential development.
- Macroprudential and financial sector oversight.
  - Macroprudential measures are unchanged since September 2014; BOI analysis indicates the share of high risk loans remains low and stable.
  - A governmental decision has been made to establish a Financial Stability Committee (FSC) with a clear focus on macroprudential policies in normal times and with the BOI in the lead; required legislative changes are yet to be concluded.
  - Legislation to establish emergency liquidity assistance for banks and nonbanks, including eligibility requirements and collateral policies, is currently being drafted.
- Structural reforms and inclusion.
  - Government implemented various product and labor market reforms, including:
    - effective September 2016, lowering import barriers for pasta, breakfast cereals, cookies, crackers, rice, and beans to allow independent traders to enter;
    - amendments to the Poultry Council Law and Antitrust Law to eliminate the cartel in the poultry sector;
    - decision to establish a Consolidated Electricity Authority aiming to improve competition in the electricity market.
  - Social inclusion measures:
    - The 2017–18 budget aims to improve the quality of Israeli-Arab education and build roads to minority communities.
    - Legislation requiring Haredi schools to teach a core curriculum (of English, mathematics, and science) was repealed.

### Risk Assessment Matrix (as of March 3, 2017) — sources, likelihoods, and impacts
- External risks
  - Weaker-than-expected global growth, including lower medium-term growth in key advanced and emerging economies
    - Relative Likelihood: Medium/High
    - Impact if realized: Medium — would hurt recovery of exports and lower output; rise in inflation likely delayed.
    - Policy response: BOI could signal continued accommodative stance and lean against excessive shekel volatility; fiscal policy allow automatic stabilizers and, if prolonged, moderate growth in spending over the medium term.
  - Tighter and more volatile global financial conditions
    - Relative Likelihood: Medium/High
    - Impact if realized: Low/Medium — investor flight to safety would impact Israel’s risk premia modestly; modest support to exports if it relieves shekel appreciation pressures.
    - Policy response: Protect confidence through sound fiscal policy and financial sector supervision; FX intervention could be used to smooth excessive exchange rate volatility.
  - Heightened regional security/geopolitical tensions
    - Relative Likelihood: High
    - Impact if realized: Medium/High — would hit tourism receipts—equivalent to about 5 percent of exports in 2015—and could damage business confidence and investment; likely depreciation would cushion overall impact.
    - Policy response: Fiscal policy should allow automatic stabilizers to operate fully; for more severe shock, proactive measures to contain unemployment rises and protect low incomes.
- Domestic risks
  - A significant reversal in housing prices
    - Relative Likelihood: Medium
    - Impact if realized: Medium/High — household debt service impacts likely contained by macroprudential policies; bank losses moderated by full recourse and relatively low LTV ratios; domestic demand growth, especially construction, could fall significantly affecting corporate loan quality.
    - Policy response: Maintain current macroprudential policies and tighten through targeted measures if needed; if house prices fall sharply, ease monetary policy as feasible, allow automatic fiscal stabilizers to operate, and ensure weak credit supply does not aggravate adjustment (including by adjusting macroprudential policies if needed).

### Annex III — Fiscal implications of the “Buyer’s Price” program
- Overview of measures since 2015 with fiscal implications:
  - Temporarily raising transaction taxes for investors by eliminating the two low rates for investors (2015–2021) — implying additional revenue of NIS 0.3–0.4 billion per year.
  - Introduction of a new recurrent property tax on owners of three or more residential dwellings — generating additional revenue of NIS 0.9 billion per year.
  - Introduction of a “Buyer’s Price” program (2015–18) — with a total fiscal cost of NIS 7 billion.
  - Relocation of the military bases from the Tel Aviv region to free up land for constructing about 60,000 housing units — total fiscal cost of NIS 5.3 billion for 2015–2027.
  - Provision of “blanket agreements” with local authorities to cover expenses associated with residential construction projects.
- Design and targeting of the “Buyer’s Price” program
  - Temporary measure for 2015–18 to lower cost of purchasing a home for eligible people winning a lottery.
  - Focuses on high-density construction, mainly outside areas of high demand; no tenders in areas where home prices exceed a certain amount — expected minimal impact on housing prices in Tel Aviv or Jerusalem.
  - Eligible population: all couples that do not own a home and all unmarried individuals over the age of 35, with allocation by lottery; program distinguishes between eligible buyers and local eligible buyers and allocates dwellings separately.
  - Program channels to lower housing costs: (i) privatizing state-owned land at discounted prices, (ii) providing grants to purchasers, (iii) providing subsidy for development costs.
  - Discount on price of land sold by the Land Authority is up to NIS 120,000 per housing unit; combined with grants and subsidies, total fiscal cost about NIS 120,000 per unit in total.
  - Grant condition: buyer must hold the apartment for at least five years from the occupancy date (buyer allowed to rent it out).
- Parameters of “Buyers’ Price” tenders (Table 1)
  - Price of land per unit before development cost (NIS) -> Discount on the price of land / Grant to purchasers (NIS) / Subsidy to development costs (NIS):
    - Up to 50,000 -> 80% / 60,000 / 40,000
    - 50,000–100,000 -> 80% / 40,000 / 40,000
    - 100,000–150,000 -> 80% / 0 / 0
    - Above 150,000 -> NIS 120,000 / 0 / 0
- Estimated fiscal cost and transactions (Table 2)
  - Authorities expect about 15,000 annual transactions of housing would go through the program with a fiscal cost of NIS 2.5 billion (0.2 percent of GDP) per year in 2017–18 and NIS 7 billion in total.
  - The estimated fiscal cost—off budget—peaks at 0.2 percent of GDP annually in 2017–18.
  - Table 2 (selected totals as reported):
    - Grant and subsidy (Millions of NIS): 2015: 0; 2016: 60; 2017: 658; 2018: 664; 2019: 377; 2020: 501; Total: 1,809.
    - In percent of GDP: (0.0), (0.0), (0.1), (0.1), (0.0), (0.0), (0.1).
    - Foregone income (Millions of NIS): 2015: 34; 2016: 1,300; 2017: 1,800; 2018: 1,800; 2019: 0; 2020: 0; Total: 5,241.
    - In percent of GDP: (0.0), (0.1), (0.1), (0.1), (0.0), (0.0), (0.4).
    - Total (Millions of NIS): 2015: 34; 2016: 1,360; 2017: 2,458; 2018: 2,464; 2019: 377; 2020: 507; Total: 7,050.
    - In percent of GDP: (0.0), (0.1), (0.2), (0.2), (0.0), (0.0), (0.6).
  - Note: Because the Land Authority is not a budgetary entity, both proceeds from land sales and its expenditure are excluded from budget, although remain included in the general government presentation on a Government Finance Statistics basis.

### Annex IV — Macroprudential policy measures for housing markets (measures and targets)
- Capital surcharges
  - Group loans: 100 percent capital surcharge on groups of borrowers who buy newly-built residential properties collectively, and/or who engage with third parties to construct and develop residential projects (March 2010).
  - Debt-service-to-income (DSTI): Capital surcharge on mortgages with DSTI ratios between 40–50 percent (August 2013).
  - Mortgage lending: Banks must increase Common Equity by 1 percent of the outstanding mortgage lending gradually by January 1, 2017 (September 2014).
- Risk weights
  - Group loans: classify loans extended to “purchasing groups” as “construction and real estate” credit, with higher risk weight (March 2010).
  - Larger mortgages with higher risk: raise the risk weight for mortgages with a floating component of over 25 percent, an LTV of at least 60 percent, and a mortgage value higher than NIS 800,000 from 35 to 100 percent (October 2010).
  - High LTV loans: raise the risk weight for loans with an LTV between 45 and 60 percent from 35 percent to 50 percent; and for loans with an LTV above 60 percent to 75 percent (March 2013).
- Provisioning
  - High LTV loans: require additional provisions of 0.75 percent for all outstanding mortgages with an LTV ratio exceeding 60 percent (July 2010).
  - Total mortgage loans: raise the allowance for credit losses from mortgage loans—such that the ratio between the allowance and the outstanding of mortgage loans is at least 0.35 percent (March 2013).
- Mortgage lending ratios
  - Loan-to-value (LTV) caps: limit LTVs on mortgage loans up to 70 percent (75 percent for first-time buyers); and up to 50 percent on mortgage loans for purchasing properties for investment purposes (November 2012).
  - DSTI caps: limit DSTI of new loans at 50 percent (August 2013).
  - Floating interest component caps:
    - Limit the variable-interest-rate component of mortgages with variable-interest rates that change within 5 years at 1/3 of the total mortgage loans (May 2011).
    - Limit the overall variable-interest component of mortgages at 2/3 of the total mortgage loans (August 2013).
- Mortgage maturity
  - Maximum mortgage maturity: limit the maximum repayment period to 30 years (August 2013).
- Other
  - Reporting requirement: require detailed reporting on residential mortgage loans (May 2011).

### Annex V — Recent steps to enhance medium-term fiscal management
- Background on fiscal anchors
  - Since 1991, fiscal policy regulated by multi-year deficit ceilings aiming to lower debt; expenditure rule introduced in 2005 to reduce spending fluctuations.
  - Fiscal targets have not served as an effective fiscal anchor as they are not binding and have been revised in practice.
- MTFF and MTBF
  - Government started publishing a medium-term fiscal framework (MTFF) in the 2015–16 budget and a medium-term budget framework (MTBF) in the 2017–18 budget.
  - MTFF sets aggregate fiscal objectives (anchors); MTBF presents a more detailed spending framework consistent with macro-fiscal objectives and priorities.
  - Because commitments exceed expenditure ceilings and are inconsistent with deficit ceilings, the MTFF shows the “adjustments required to converge with the deficit ceiling” for each year.
- Measures to strengthen control of commitments and defense spending
  - “Numerator” mechanism (2016): restricts ability to make new expenditure commitments outside the budget approval process unless offsetting resources are found; controls only new commitments for the future while near-term expenditure remains governed by legacy commitments made before 2016.
  - Multi-year defense budget for 2016–2020: MoF and Ministry of Defense agreed on an MTBF that disaggregates human resource-related budget and core military objective; agreement on specific conditions under which budget could be changed.
    - According to the MTBF, the real growth rate of defense spending is expected to decline to 1.3 percent year for 2018–2020, from 1.5 percent per year for 2007–2017, reducing defense spending by 0.3 percentage points of GDP between 2017 and 2020.
  - Spending Reviews: Spending Review Central Committee initiated Spending Reviews in 2016 to improve budget composition and enhance spending efficiency while reducing deficits.
    - Procedure targeted cutting 0.2 percent of the overall budget to be implemented by 2019.
    - The Committee approved several streamlining plans in 2016 with implementation deferred to 2019 for ministries with approved plans; budgets for ministries without approved plans were cut already in the 2017–18 budget.

*International Monetary Fund — Annexes I–V, selected excerpts (from the provided content).*

### Appendix I. External Sector Assessment

### Appendix I. External Sector Assessment

### Overview
- The shekel has appreciated substantially in real effective terms over the last decade and is now above its long-term average even as the current account remains in modest surplus.
- There is no clear evidence of the shekel being misaligned with fundamentals from an economy-wide perspective, but the real appreciation appears to have had a significant impact on merchandise exports.

### Model-Based Current Account and Exchange Rate Valuations
- Israel’s real exchange rate (REER) experienced large swings in recent decades and it is currently above its historical average.
- As of end-2016:
  - The shekel had appreciated by about 13 percent in CPI-based real effective terms relative to its average level in 2009.
  - The CPI-based REER was 7 percent above its two-decade average.
  - The ULC-based REER appreciated by about 26 percent and was 17 percent above its historical average as of 2016Q3.
- Drivers cited for the appreciation include easy monetary conditions in major advanced economies, promising prospects for natural gas production, and strong FDI inflows including foreign purchases of high-tech start-ups.

### Israel’s External Position and Recent Trends
- Current account (CA) developments:
  - CA balance declined from 4.3 percent of GDP in 2015 to 3.6 percent of GDP in 2016 as imports rose partly owing to a surge in vehicle purchases.
  - The positive CA largely reflects resilient service exports and consistently high official and private transfer net inflows of about 3 percent of GDP.
  - The CA balance is expected to stabilize around 3 percent in the medium-term.
- Net international investment position (NIIP):
  - NIIP rose 10 percentage points to about 33 percent of GDP as of end 2016.
  - Part of this increase reflected an increase in foreign reserves owing to FX intervention by the Bank of Israel of about $6 billion (or about 2 percent of GDP) in 2016.

### External Balance Assessment (EBA) Methodologies and Results
- EBA CA analysis (standard) results:
  - Suggests the REER is undervalued by 15.6 percent, given a 2016 CA balance some 3.9 percentage points above its estimated norm of slightly below zero.
- Modified CA analysis incorporating pension contributions:
  - Implies a higher CA norm for Israel; estimated CA gap narrows to 2.4 percent of GDP, indicating the shekel is moderately undervalued by 9.6 percent.
- Additional considerations:
  - The standard EBA CA analysis does not take into account actual pension contributions (important given the Mandatory Pension Law in 2008) and does not include indicators of net official and private transfers.
  - The EBA-Lite REER index analysis—which does consider aid and remittances—indicates the REER is broadly in line with fundamentals and desirable policies and yields a REER gap of 3.0 percent.
- Staff judgment:
  - Staff considers the modified CA analysis (approach (2)) and the EBA-Lite REER index analysis (approach (4)) to be most likely reliable for Israel, which show modest undervaluation of 9.6 percent and 3 percent respectively.
  - Taking into account that two measures of the REER have appreciated significantly in recent years to be above their historical averages, staff do not see adequate evidence to conclude that the shekel deviates significantly from fundamentals.

### Recent Export Performance and the Impact of the Exchange Rate Appreciation
- Diverging outcomes for merchandise and services exports:
  - After a severe slump in the early 2000s, Israel’s overall export share in global trade has gradually recovered, driven by a steady rise in the share of services exports.
  - IT-related services rose 78 percent since 2011 to some 4.1 percent of GDP in 2016.
  - Merchandise exports (excluding aircraft, ships and diamonds) started to lose market share from 2011, suggesting factors beyond subdued external demand.
- Sectoral and firm-level factors:
  - Several major sectors lost global market share since 2011; some declines reflect idiosyncratic shocks to major companies (Israel Chemicals Ltd.; Intel; Teva Pharmaceutical Industries Ltd.), contributing to the dip in exports in 2015.
  - The slowdown in exports became broadly spread across other exporting sectors beyond those idiosyncratic cases.

### Drivers of Merchandise Export Weakness
- Accumulation of real appreciation:
  - The large cumulative real appreciation, especially on a PPI basis, has coincided with a notable decline in the share of manufacturing exports relative to GDP in the last decade (partly a valuation effect).
  - Within manufacturing, exports of lower technology goods declined notably more than higher technology goods, suggesting less differentiated products with narrower margins and greater sensitivity to exchange rate appreciation.
- Slowdown in productivity growth:
  - After trending upwards strongly in the 2000s, labor productivity in manufacturing appears to have been broadly flat since 2010.
  - The absence of growth in trend labor productivity falls short of the productivity growth seen in the United States and is below the Euro area average.
- Low diversification:
  - Israel’s exports are concentrated, with four industries (pharmaceutical, chemical, diamonds, electronics) accounting for two-thirds of total goods exports in 2015.
  - A few major enterprises have a large share of the exports in each industry, and the export diversification index points to a less diversified profile for Israel compared with countries at the same income level, implying higher risk of periods of weak export performance.

*Source: IMF staff calculations and analysis (Appendix I. External Sector Assessment).*

### Appendix II. Debt Sustainability Analysis 2017

### Appendix II. Debt Sustainability Analysis 2017

### Overview
- Israel’s debt-to-GDP ratio fell from 94 percent in 2003 to 62 percent in 2016.
- Debt structure:
  - Maturity averaging 7 years.
  - Nonresidents holding only around 14 percent of the total.
  - High-yield non-tradable government bonds that guarantee a stable return of approximately 4 percent in real terms currently constitute 19 percent of general government debt.
- Vulnerabilities noted: relatively high interest payments and elevated gross financing needs; debt outlook most sensitive to growth shocks.
- The DSA covers debt of the general government.

### Baseline Projections and Key Outcomes
- Public debt-to-GDP ratio is projected to gradually rise to 63½ percent of GDP by 2021.
- Gross financing needs:
  - 8½ percent of GDP in 2016.
  - Increase to 10 percent of GDP in 2017.
  - Remain around 10 percent of GDP throughout the projection period.

### Baseline Assumptions
- Real GDP is projected to grow at around 3 percent annually on average.
- CPI inflation is projected to return to around 2 percent—the mid-point of the target range—by 2019 and remain at around 2 percent throughout the projection period.
- Central government deficit path:
  - 2.1 percent of GDP in 2016.
  - 2¾ percent of GDP in 2017 and 2018.
  - 2.9 percent of GDP in 2019 and stay at that level thereafter.
- General government deficit is assumed to be larger than the budget deficit by:
  - 0.5 percentage points of GDP in 2016,
  - 0.6 points in 2017,
  - 0.8 points annually from 2019 through 2022.
- Non-debt creating financing: ½ percent of GDP annually.
- Primary expenditure: projected to increase from 37 percent of GDP in 2016 to around 37⅔ percent of GDP.
- Effective interest rate: projected to increase gradually from 5 percent in 2016 to 5⅔ percent in the medium term, reflecting normalization of monetary policy.
- Borrowing conditions assumed favorable, supported by sovereign ratings (A+ and A1) and the U.S. debt guarantee program (about 3 percent of GDP).

### Shocks and Stress Tests — Results and Sensitivities
- Overall: A range of stress tests indicate debt sustainability is reasonably resilient to growth, interest rate, and combined macro-fiscal shocks.

- Growth shock (lower real GDP growth by 1 standard deviation for 2 years starting in 2017):
  - Debt-to-GDP ratio: about 65 percent by 2018 and 68¼ percent by 2022.
  - Financing needs: increase to 12 percent of GDP by 2019 and then decline to 11 percent of GDP.

- Interest rate shock (borrowing costs rise by 200 basis points):
  - Public debt: increase moderately to around 65½ percent of GDP by 2022.
  - Financing needs: moderate increase to around 11 percent of GDP by 2022.

- Combined macro-fiscal shock (exchange rate depreciation, expansion of the primary deficit, and decline in real GDP):
  - Debt-to-GDP ratio: 66 percent by 2018, increasing to around 71½ percent by 2022.
  - Financing needs: rise to 11 percent of GDP initially, then stay around 11½–12½ percent of GDP.

### Composition of Public Debt and Alternative Scenarios (selected indicators)
- Gross nominal public debt (projection path shown): baseline, historical, and constant primary balance scenarios illustrated (figures referenced in source).
- Public gross financing needs (projection path shown) — baseline around 10 percent of GDP through projection horizon.
- By maturity: share of medium and long-term versus short-term debt shown historically and in projection.
- By currency: local currency–denominated versus foreign currency–denominated debt shares shown historically and in projection.

### Relevant Quantitative Series and Notes (selected exact figures from DSA tables and charts)
- Nominal gross public debt: 71.2 (2015), 64.1 (2016), 62.2 (2017), 62.6 (2018), 63.0 (2019), 63.2 (2020), 63.3 (2021), 63.5 (2022), 63.7 (2022) — (table labels and years as presented).
- Public gross financing needs: 10.8 (2015), 6.9 (2016), 8.8 (2017), 10.2 (2018), 9.8 (2019), 10.1 (2020), 10.1 (2021), 10.2 (2022), 10.3 (2022) — (values as presented).
- Real GDP growth (in percent): 4.1 (2015), 2.5 (2016), 4.0 (2017), 2.9 (2018), 3.0 (2019), 3.0 (2020), 3.0 (2021), 3.0 (2022) — (table labels and years as presented).
- Inflation (GDP deflator, in percent): 2.1 (2015), 2.8 (2016), 1.0 (2017), 0.7 (2018), 1.3 (2019), 2.0 (2020), 2.0 (2021), 2.0 (2022).
- Effective interest rate (in percent): 6.6 (2015), 5.4 (2016), 5.1 (2017), 5.4 (2018), 5.6 (2019), 5.7 (2020), 5.7 (2021), 5.7 (2022).
- Change in gross public sector debt (cumulative): -2.5 (2015), -1.9 (2016), -1.9 (2017), 0.4 (2018), 0.4 (2019), 0.2 (2020), 0.2 (2021), 0.2 (2022), 1.4 (cumulative).
- Identified debt-creating flows (cumulative projection): -1.1 (2015), -0.2 (2016), -0.1 (2017), 1.8 (2018), 1.7 (2019), 1.4 (2020), 1.4 (2021), 1.4 (2022), 9.0 (cumulative).
- Primary (noninterest) revenue and grants: 37.3 (2015), 36.2 (2016), 36.8 (2017), 36.7 (2018), 36.8 (2019), 36.8 (2020), 36.8 (2021), 36.8 (2022), 20.1 (cumulative).
- Primary (noninterest) expenditure: 36.8 (2015), 36.2 (2016), 36.9 (2017), 37.6 (2018), 37.8 (2019), 37.7 (2020), 37.7 (2021), 37.7 (2022), 26.2 (cumulative).
- Automatic debt dynamics and real interest rate / growth contributions are reported in the DSA using the DSA formulae and projections (see staff tables and figure labels).

### Policy Implications Highlighted in Analysis
- Debt outlook is sensitive to growth performance; maintaining growth near baseline assumptions is central to debt sustainability.
- The projection assumes normalization of monetary policy raising effective interest rates gradually; this contributes to debt dynamics.
- Favorable borrowing conditions and sovereign ratings help contain financing costs; the U.S. debt guarantee program (about 3 percent of GDP) supports borrowing conditions.
- Continued prudence in fiscal management (adherence to medium-term fiscal framework and control of primary expenditure and deficit paths) is important to stabilize or lower debt ratios over time.

*Source: IMF staff.*

### 30.1 percent over the same period. Mortgages with leverage ratio higher than 75 percent have

### The Labor Market, Productivity and the Demographic Challenge

### Labor market strength and productivity
- The labor market is strong. Unemployment rate is at a multi-decade low and the participation rate is at a record high.
- Improvement supported by protracted measures for over a decade aimed at incentivizing employment (e.g. through earned income tax credit) and disincentivizing unemployment and labor market detachment (e.g. by stricter eligibility criteria for unemployment benefits and reducing child allowances).
- The improvement in the labor market is accompanied by sluggish productivity growth, at least partly driven by increased labor market attachment of workers with weaker labor market skills.
- Demographic composition of these workers (largely associated with the Haredi (ultra-orthodox Jews) and Arab populations) poses one of the greatest long-term macroeconomic challenges to the Israeli economy, as these groups are expected to become a majority in Israeli society within a few decades.
- Strengthening labor market skills and continuing to improve labor market attachment in these groups will also address inequality and poverty challenges as emphasized by Staff.

### Participation trends and demographic projections
- Increasing labor force participation is probably one of the most effective mechanisms for improving growth inclusiveness.
- Haredi society and Arab women have traditionally had the lowest participation rates in the Israeli labor market, but participation has increased markedly over the past decade.
- Participation statistics (main working-age 25–64):
  - Haredi population: 2001–05 average participation rate 46.4 percent; in 2015 it reached 63.7 percent (most improvement driven by entry of Haredi women).
  - Arab women: participation rate increased from 25.1 percent to 34.6 percent over the same period and age group.
  - For comparison, the participation rate of the non-Haredi non-Arab population improved from 79.8 percent to 87.4 percent.
- New workers from Haredi and Arab groups typically have weaker labor market skills, reducing average labor productivity.
- The challenge: keep increasing participation while equipping these workers with stronger labor market skills to boost labor productivity and support more inclusive growth.
- Demographic importance:
  - Fertility rates of Haredi and Arab groups, although declining, are higher than that of the rest of the population.
  - Israeli Central Bureau of Statistics projection: within 40 years the Haredi and Arab communities combined will account for about 50 percent of the total population, compared to 32 percent in 2015.
  - In 2015 Haredi and Arab children aged 0–9 accounted for 43 percent of that age group, compared to a share of 26 percent of these communities in the main working age population (25–64).

### Programs and policies to improve integration and skills
- Authorities have embarked on numerous programs for promoting labor market attachment and improving productivity, in addition to providing better incentives through the tax system and social benefits.
- Many programs specifically target the Haredi and Arab communities; examples listed:
  - “One-Stop Career Centers” aim to enhance employment in the Haredi, Arab and Ethiopian immigrant communities, and target people with disabilities; centers provide vocational training, help developing soft skills, provide guidance and assist with job placement.
  - Government assistance to integrate Arabs in the high-tech industry: assists students and academics with job placement and subsidizes employee salaries through an "employment track" program for interns.
  - Haredi students of high-tech professions at the Vocational Training System are entitled to scholarships.
  - Small and Medium Businesses Agency programs support and guide entrepreneurship initiatives in both Arab and Haredi communities.
  - Micro-finance loans are available to Arab women entrepreneurs.
  - Special daycare subsidies also target Arab women.
- The substantial rise in labor force participation over the past decade occurred on the back of such programs and other incentives.
- Staff note high poverty rate and inequality in Israel compared to other OECD countries, but these are on a persistent declining path, albeit a moderate one, since 2006 alongside improvement in labor market attachment.
- Authorities concur that pressing ahead with reforms to improve skills and increase labor market participation is the right way forward and crucial for the long-term outlook.

### Conclusion: macroeconomic outlook and key structural challenges
- Macroeconomic performance is strong:
  - Growth has accelerated in 2016.
  - Labor force participation is at an all-time high.
  - Unemployment rate at its lowest level in decades.
  - Inflation is under check.
  - Debt-GDP ratio is on a declining path for over a decade.
  - The financial system is strong.
- Main challenges are structural:
  - High house prices driven by supply-side shortages are most pressing.
  - Demographic dynamics weigh on long-term labor productivity.
- Authorities recognize these challenges and are taking actions; substantial progress exists on both fronts but plenty remains to be done.

*Source: IMF staff report excerpt (cr1775).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2017/cr1775.pdf_