## cr18111 - 2.5 percent of GDP is preferable to gradually reduce debt in normal times. Ensuring the Buyer’s

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### Fiscal policy, debt target, and Buyer’s Price program
- Recommendation: Limit the deficit of the general government to 3 percent of GDP by 2019 to allow a gradual reduction of debt in normal times.
- Preferred pace of debt reduction: 2.5 percent of GDP is preferable to gradually reduce debt in normal times.
- Ensure the Buyer’s Price program is temporary to support fiscal health because subsidies via heavily discounted land sales reduce receipts from the Land Authority.
- If public investment is increased:
  - Any rise in the public debt ratio should be modest and temporary.
  - Liabilities from PPPs should be managed carefully and reported in line with international best practices.
- Revenues should be the main source of non-debt financing, focusing on reducing tax benefits (which total about five percent of GDP) to limit the drag on growth.
- Fiscal rule details:
  - The expenditure ceiling sets the real increase in government expenditures in accordance with population growth in the past three years plus the ratio of 50 to debt-to-GDP in the last year; converted to nominal terms using average CPI inflation in the past three years.
  - Fiscal assumptions: deficit target assumes nominal GDP growth averaging five percent and an annual stock-flow adjustment of around ½ percent of GDP.

### Public investment, infrastructure strategy, and management
- Development of an integrated long-term national infrastructure strategy through 2030 (“Infrastructure 2030”) is under way and welcome.
- Immediate priority: ensure existing infrastructure is efficiently utilized through demand management tools (ride sharing, car-pooling, “Going Green” pilot, consider charging for road use at peak hours coupled with flexible working hours).
- Managing and scaling public investment:
  - Under a scenario with public investment raised by 1.5 percent of GDP for 15 years, staff estimate a cumulative output gain ranging from four to six percent depending on investment efficiency.
  - Recommended institutional and procedural steps:
    - Establish a body with clear accountability and sufficient powers for upgrading Israel’s infrastructure, supported by technical staff.
    - Make project evaluation and selection more rigorous and transparent; streamline zoning and permitting; improve coordination between ministries and between central and local governments.
    - Broaden coverage of the medium term fiscal framework to the general government since local governments implement around three-quarters of public investment.
    - Phase scaling up of investment judiciously; use PPPs only where private sector know-how improves efficiency; maintain transparency around investment levels and composition.
  - Preserve adequate fiscal buffers if public investment is raised; a significant buffer relative to the 85 percent debt threshold usually applied to advanced economies is appropriate.

### Macroeconomic outlook, monetary policy, and external position
- Growth and inflation outlook:
  - Growth in 2017: 3.4 percent.
  - Near-term prospects: growth to remain around 3½ percent; 2019–20 growth projected at 3¼–3½ percent aided by completion of major investment projects.
  - Absent such drivers, on current policies growth projected to return to around three percent.
  - CPI: inflation remained below the 1–3 percent target range; core CPI inflation was 0.7 percent y/y in February 2018.
- Labor market and housing:
  - Unemployment fell below four percent in early 2018; unemployment was 3¾ percent in January–February 2018.
  - Robust wage rises averaging 3¼ percent in 2017.
  - House price increases slowed to below two percent y/y in 2017; residential investment began to decline in mid-2017 with a 16 percent y/y fall in starts in H2’2017.
- Monetary and exchange rate policy:
  - Policy rate has remained at 0.1 percent since February 2015; BoI committed to remain accommodative pending a durable rise in inflation.
  - Israel’s REER has been on an upward trend for a decade, standing some 26 percent above historical averages on a ULC basis in January (REER-based analyses vary).
  - FX intervention in 2017 amounted to US$6.6 billion; reserves rose to US$113 billion by end 2017 (32 percent of GDP).
  - Policy guidance: exchange rate flexibility should continue as the first line of defense; FX intervention limited to addressing disorderly market conditions and significant deviations from fundamentals.

### Medium-term risks and demographics
- Regional/security risk: Israel is highly exposed to regional geopolitical risks including developments in the West Bank; these could impact growth via tourism and domestic demand.
- Housing risk: moderate decline in housing prices would improve affordability; risks of a sharp price decline appear modest given low household debt and healthy banks, but growth could be significantly affected.
- External risk: weak growth in main trading partners would weigh on exports; shekel depreciation and automatic fiscal stabilizers could cushion impact but monetary policy space is reduced.
- Demographics and labor market challenge:
  - Currently just over one-quarter of the working age population is Haredi or Israeli-Arab; these groups on average have poor market skills and low labor participation.
  - This share will rise greatly as these groups constitute almost half of school age children, potentially slowing labor supply gains and productivity, weakening potential growth.
  - Slower revenue growth and rising social support demands could increase deficits and debt.

### Financial sector soundness, competition, and fintech
- Banking soundness indicators (end-period, in percent) — 2014 / 2015 / 2016 / 2017 Q3:
  - Regulatory capital to risk-weighted assets 1/ : 14.3 / 14.0 / 14.7 / 14.5
  - Regulatory Tier I capital to risk-weighted assets 1/ : 9.7 / 9.9 / 10.9 / 11.1
  - NPL to total gross loans: 2.2 / 1.8 / 1.6 / 1.4
  - NPL net of loan-loss provisions to capital: 6.1 / 3.4 / 2.2 / 1.1
  - Return on average assets (before tax): 0.8 / 1.0 / 1.0 / 1.0
  - Return on average equity (before tax): 11.8 / 14.4 / 13.9 / 13.7
  - Customer deposits as a percent of total (non-interbank) loans: 115.8 / 117.8 / 121.6 / 120.1
- Household and business debt:
  - Household debt ratio has been rising for a decade but remains low at just over 40 percent of GDP.
  - Consumer credit is almost two-fifths of total household debt.
  - Business sector debt declined to below 70 percent of GDP; corporate bonds fell to 19 percent of GDP by 2017 (9 percent of GDP less than their former ratio).
- Competition and regulatory recommendations:
  - Establish the Financial Stability Committee (FSC) comprising the BoI (chair); MoF; CMISA; and Israel Securities Authority.
  - Approve entry by new banks with appropriate deposit insurance and resolution arrangements.
  - Continue operationalizing a risk-focused approach to supervision; harmonize regulations across financial regulators.
  - CMISA adopted the Solvency II framework in 2017 aiming for full compliance by end-2024.
- Fintech and cybersecurity:
  - In 2017 there were 474 Fintech companies in Israel, up from around 300 in 2014.
  - BoI and authorities support innovation while stepping up monitoring; a Banking Cyber Center was established in 2017.

### Housing market and supply-side reforms
- Authorities estimate 45–50 thousand new housing units needed annually during 2015–2020, rising to 60 thousand annually by 2026–35.
- Completions appear sufficient in 2016–2017, but shortfalls could return given falls in housing starts.
- Recommended supply-side reforms:
  - Increase land auctions; streamline building regulations; expand foreign construction company access.
  - Raise residential property taxes (while avoiding work disincentives); provide predictable central government support to municipalities for up-front infrastructure and public service costs.
  - Develop public transportation; establish metropolitan authorities; increase urban renewal and fast-track approvals of mixed use development.
- In March 2018, BoI announced a reduction in risk weights on mortgage loans to first-time homebuyers with an LTV of 60–75 percent.

### Tax policy, fiscal space, and redistribution
- Authorities consider further cuts in personal and corporate income taxes; high-tech firms already enjoy 6 or 12 percent rates.
- Little room for tax cuts given low civilian spending and rising needs in infrastructure, education and training, and active labor market policies.
- Recommendation: finance initiatives in a growth-friendly manner, such as by scaling back tax benefits which total about five percent of GDP.
- Redistributive measures:
  - Substantially expand the EITC and implement it more effectively.
    - EITC fiscal cost is 0.16 percent of GDP annually.
    - Doubling the EITC ceiling would bring spending into the 0.4–0.5 percent of GDP range, reducing indicators of poverty by about 0.5 percentage points.
    - Implement more frequent and timely payments (currently claimable only at year-end) and streamline administration to improve take-up.
  - Make transfers more targeted by modifying non-income-tested child allowances; use resources released to expand the EITC and fund transfers conditional on education and training.
  - Review modest levels of welfare support for the most vulnerable while protecting labor force participation.

### Inclusiveness, labor market, and education
- Labor market gaps and potential gains:
  - Hourly wages: non-Haredi Jewish women are about one-fifth lower than non-Haredi Jewish men; Haredi (both men and women) are about one-third lower; Israeli-Arabs are about half.
  - Employment rates: Haredi men 47 percent; Arab women 35 percent.
  - Closing gaps in employment and labor productivity by half would raise potential output by 14 percent.
  - An increase in full-time workers sufficient to reduce monthly-wage gaps by half would raise potential output by 22 percent; an estimated two-thirds of these gains are attributable to narrowing gaps between men and women.
- Education and active labor market policies:
  - Increase effectiveness of schools: higher standards for teachers; covering core subjects at all grades in Haredi schools; improving Hebrew teaching in Arab schools; extending the short school day.
  - Enhance vocational training and expand active labor market policies; Total ALMP spending is only 0.2 percent of GDP and should be raised.
  - Career centers should guide job seekers; consider conditional transfers for training completion.
  - Employment policy to 2030: expand childcare support (especially for younger children); continue increases in the female retirement age toward equalization with men without new incentives for early retirement; enhance public transportation and enable workplaces near communities.

### Business environment, regulation, and judicial reform
- Israel’s Doing Business performance is below the average of advanced economies; small-business experience may differ from large firms surveyed.
- Key frictions (selected metrics):
  - Property registration: 81 days required in Israel versus a 25 day advanced economy average; procedures cost 8.3 percent of property value versus 4.7 percent.
  - Contract enforcement: average time 975 days in Israel versus 567 days in advanced economies.
  - Getting electricity: 102 days to obtain electricity.
- Recommendations:
  - Dramatically simplify and speed up regulation administration (e.g., “one-stop shop”).
  - Subject all proposals for new regulations to robust regulatory impact assessments.
  - Make court procedures more efficient; establish a specialized court for complex antitrust cases.

### Debt sustainability, baseline projections, and stress tests
- Debt and financing context:
  - Debt-to-GDP ratio fell from 94 percent in 2003 to 61 percent in 2017.
  - Under staff baseline, government debt-to-GDP projected to remain around 61 percent of GDP.
  - Gross financing needs: 8¼ percent of GDP in 2017; projected above 10 percent in 2018; then around 10 percent throughout projection period.
  - Baseline assumes no fiscal consolidation measures would be taken.
- Baseline DSA selected figures (percent of GDP or percent as stated):
  - Nominal gross public debt: 2016 = 69.4; 2017 = 62.3; 2018 = 60.9; 2019 = 61.5; 2020 = 61.4; 2021 = 61.3; 2022 = 61.1; 2023 = 61.0.
  - Public gross financing needs: 2016 = 10.4; 2017 = 6.5; 2018 = 8.2; 2019 = 10.0; 2020 = 9.5; 2021 = 9.7; 2022 = 9.8; 2023 = 9.8.
  - Real GDP growth (percent): 2016 = 3.8; 2017 = 4.0; 2018 = 3.4; 2019 = 3.4; 2020 = 3.4; 2021 = 3.3; 2022 = 3.0; 2023 = 3.0.
  - Effective interest rate (percent): 2016 = 6.3; 2017 = 4.8; 2018 = 5.1; 2019 = 5.2; 2020 = 5.2; 2021 = 5.3; 2022 = 5.3; 2023 = 5.5.
- Stress-test results:
  - Growth shock (one standard deviation lower real GDP growth for two years starting in 2019): debt-to-GDP would rise to about 64¾ percent by 2020 and stay around that level through 2023; financing needs increase to 11¼ percent of GDP by 2020 then decline to around 10½ percent.
  - Interest rate shock (borrowing costs increase by 200 basis points): government debt would rise to around 62½ percent of GDP by 2023, 1½ percentage point above baseline; financing needs rise to around 10½ percent.
  - Combined macro-fiscal shock (exchange rate depreciation, expansion of primary deficit, decline in real GDP): debt would rise to around 66 percent of GDP by 2020; financing needs rise to 11½ percent of GDP by 2020; debt projected to keep rising to around 67 percent by 2023 with financing needs around 11½ percent.

### Key statistics and projections (selected)
- Real GDP growth: 2014: 3.5; 2015: 2.6; 2016: 4.0; 2017: 3.4; 2018: 3.4 (Prel.); 2019: 3.4 (Projections); 2020: 3.3 (Projections).
- Domestic demand (percent change): 2014: 4.2; 2015: 3.4; 2016: 6.0; 2017: 3.5; 2018: 3.4; 2019: 3.5; 2020: 3.0.
- Private consumption (percent change): 2014: 4.5; 2015: 3.9; 2016: 6.1; 2017: 3.3; 2018: 3.4; 2019: 2.9; 2020: 3.0.
- Gross fixed investment (percent change): 2014: 0.8; 2015: -0.8; 2016: 11.9; 2017: 2.8; 2018: 3.4; 2019: 5.6; 2020: 3.0.
- Potential GDP (percent change): 2014: 3.7; 2015: 3.4; 2016: 3.4; 2017: 3.3; 2018: 3.3; 2019: 3.4; 2020: 3.3.
- Unemployment rate (percent): 2014: 5.9; 2015: 5.3; 2016: 4.8; 2017: 4.2; 2018: 4.2; 2019: 4.2; 2020: 4.2.
- Overall CPI (end of period percent change): 2014: -0.2; 2015: -1.0; 2016: -0.2; 2017: 0.4; 2018: 1.0; 2019: 1.5; 2020: 2.0.
- Gross national saving (percent of GDP): 2014: 24.2; 2015: 24.7; 2016: 24.0; 2017: 23.7; 2018: 23.7; 2019: 24.0; 2020: 24.3.
- Current account balance (percent of GDP): 2014: 4.0; 2015: 4.9; 2016: 3.5; 2017: 3.0; 2018: 2.8; 2019: 2.7; 2020: 3.1.
- Central government revenues and grants (percent of GDP): 2014: 25.7; 2015: 25.8; 2016: 26.4; 2017: 26.9; 2018: 25.9; 2019: 25.7; 2020: 25.7.
- Central government total expenditure (percent of GDP): 2014: 28.4; 2015: 27.9; 2016: 28.5; 2017: 28.9; 2018: 28.8; 2019: 28.6; 2020: 28.6.
- Central government overall balance (percent of GDP): 2014: -2.7; 2015: -2.1; 2016: -2.1; 2017: -2.0; 2018: -2.9; 2019: -2.9; 2020: -2.9.
- General government debt (percent of GDP): 2014: 66.1; 2015: 64.2; 2016: 62.3; 2017: 60.9; 2018: 61.5; 2019: 61.4; 2020: 61.3.
- Foreign reserves (eop, US$ billions): 2014: 86.1; 2015: 90.6; 2016: 98.4; 2017: 113.0; 2018: 120.6; 2019: 125.8; 2020: 132.7.
- Oil imports (billions of U.S. dollars): 2014: 12.8; 2015: 7.4; 2016: 5.8; 2017: 7.4; 2018: 9.1; 2019: 8.8; 2020: 8.6.

*Source: ISRAEL STAFF REPORT FOR THE 2018 ARTICLE IV CONSULTATION.*

### 2.5 percent of GDP is preferable to gradually reduce debt in normal times. Ensuring the Buyer’s

### cr18111 - 2.5 percent of GDP is preferable to gradually reduce debt in normal times. Ensuring the Buyer’s

### Fiscal policy, debt target, and the Buyer’s Price program
- Recommendation: Limit the deficit of the general government to 3 percent of GDP by 2019 to allow a gradual reduction of debt in normal times.
- Preferred pace of debt reduction: 2.5 percent of GDP is preferable to gradually reduce debt in normal times.
- Buyer’s Price program: Ensuring the Buyer’s Price program is temporary would support Israel’s fiscal health.
- If public investment is increased, any rise in the public debt ratio should be modest and temporary; liabilities from PPPs should be managed carefully and reported in line with international best practices.
- Revenues should be the main source of non-debt financing, focusing on reducing tax benefits to limit the drag on growth.

### Infrastructure investment and management
- Development of an integrated long-term national infrastructure strategy through 2030 is welcome.
- Immediate priority: ensure existing infrastructure is efficiently utilized through demand management tools.
- Strengthen the framework for managing infrastructure investment to ensure investments are high-quality and timely.
- If public investment is raised:
  - Preserve adequate fiscal buffers.
  - Manage PPP liabilities carefully and report them in line with international best practices.

### Business environment, regulation, and competition
- Fundamental upgrades of the business environment are critical, especially reducing bureaucratic bottlenecks.
- Progress on electricity sector and other reforms is welcome; reforms should continue, including replacing trade barriers on agricultural products with targeted subsidies.
- Numerous regulations and high compliance costs remain major impediments to competition and investment.
  - Recommendation: simple and timely administration of regulations, such as a “one-stop shop” that would assess all regulatory requirements within a reasonable period.
  - All proposals for new regulations should be subject to robust regulatory impact assessments.
- Judicial/contract enforcement reforms:
  - Lengthy contract enforcement processes indicate a need to make court procedures more efficient.
  - Establishment of a specialized court for complex antitrust cases would support competitive markets.

### Education, labor market, and social policy (inclusiveness)
- Deep reforms of education and training are needed to reduce gaps in labor productivity and participation while enhancing redistribution carefully.
  - Increase effectiveness of schools: higher standards for teachers; covering core subjects at all grades in Haredi schools; improving Hebrew teaching in Arab schools; extending the short school day.
  - Enhance vocational training and expand active labor market policies to reduce skills gaps and aid employability.
- Raise labor participation and work hours of women:
  - Expand childcare support, especially for younger children.
  - Continue increases in the female retirement age without introducing new incentives for early retirement.
  - Enhance public transportation and enable workplaces to locate near communities to promote labor participation.
- Inequality and poverty:
  - Substantially expand the EITC and implement it more effectively to reduce inequality while supporting participation.
  - Contain fiscal costs by making transfers more targeted.

### Macroeconomic policy and outlook
- Monetary policy: remain accommodative pending clear signs of a durable rise in inflation, while prepared to tighten more rapidly if needed.
- Growth and inflation outlook:
  - Growth in 2017: 3.4 percent.
  - Prospects: growth to remain around 3½ percent in the near term; 2019–20 growth projected at 3¼–3½ percent aided by completion of major investment projects.
  - Absent such drivers, on current policies growth projected to return to around three percent.
  - CPI: inflation remained below the 1–3 percent target range; core CPI inflation was 0.7 percent y/y in February 2018.
- Labor market:
  - Unemployment fell below four percent in early 2018; unemployment was 3¾ percent in January–February 2018.
  - Robust wage rises averaging 3¼ percent in 2017.
- Housing market:
  - House price increases slowed to below two percent y/y in 2017.
  - Residential investment began to decline in mid-2017; a 16 percent y/y fall in starts in H2’2017 suggests further falls to come.
  - Investor activity likely affected by the proposed tax on owners of more than two apartments and first-time buyers waiting to see the Buyer’s Price program impact.

### Key statistics and projections (selected)
- Real GDP growth: 2014: 3.5; 2015: 2.6; 2016: 4.0; 2017: 3.4; 2018: 3.4 (Prel.); 2019: 3.4 (Projections); 2020: 3.3 (Projections).
- Domestic demand (percent change): 2014: 4.2; 2015: 3.4; 2016: 6.0; 2017: 3.5; 2018: 3.4; 2019: 3.5; 2020: 3.0.
- Private consumption (percent change): 2014: 4.5; 2015: 3.9; 2016: 6.1; 2017: 3.3; 2018: 3.4; 2019: 2.9; 2020: 3.0.
- Gross fixed investment (percent change): 2014: 0.8; 2015: -0.8; 2016: 11.9; 2017: 2.8; 2018: 3.4; 2019: 5.6; 2020: 3.0.
- Potential GDP (percent change): 2014: 3.7; 2015: 3.4; 2016: 3.4; 2017: 3.3; 2018: 3.3; 2019: 3.4; 2020: 3.3.
- Unemployment rate (percent): 2014: 5.9; 2015: 5.3; 2016: 4.8; 2017: 4.2; 2018: 4.2; 2019: 4.2; 2020: 4.2.
- Overall CPI (end of period percent change): 2014: -0.2; 2015: -1.0; 2016: -0.2; 2017: 0.4; 2018: 1.0; 2019: 1.5; 2020: 2.0.
- Gross national saving (percent of GDP): 2014: 24.2; 2015: 24.7; 2016: 24.0; 2017: 23.7; 2018: 23.7; 2019: 24.0; 2020: 24.3.
- Current account balance (percent of GDP): 2014: 4.0; 2015: 4.9; 2016: 3.5; 2017: 3.0; 2018: 2.8; 2019: 2.7; 2020: 3.1.
- Central government revenues and grants (percent of GDP): 2014: 25.7; 2015: 25.8; 2016: 26.4; 2017: 26.9; 2018: 25.9; 2019: 25.7; 2020: 25.7.
- Central government total expenditure (percent of GDP): 2014: 28.4; 2015: 27.9; 2016: 28.5; 2017: 28.9; 2018: 28.8; 2019: 28.6; 2020: 28.6.
- Central government overall balance (percent of GDP): 2014: -2.7; 2015: -2.1; 2016: -2.1; 2017: -2.0; 2018: -2.9; 2019: -2.9; 2020: -2.9.
- General government debt (percent of GDP): 2014: 66.1; 2015: 64.2; 2016: 62.3; 2017: 60.9; 2018: 61.5; 2019: 61.4; 2020: 61.3.
- Foreign reserves (eop, US$ billions): 2014: 86.1; 2015: 90.6; 2016: 98.4; 2017: 113.0; 2018: 120.6; 2019: 125.8; 2020: 132.7.
- Oil imports (billions of U.S. dollars): 2014: 12.8; 2015: 7.4; 2016: 5.8; 2017: 7.4; 2018: 9.1; 2019: 8.8; 2020: 8.6.

*Source: ISRAEL STAFF REPORT FOR THE 2018 ARTICLE IV CONSULTATION.*

### 9. Medium-term risks are wide ranging, but growth vulnerabilities are contained by

### 9. Medium-term risks are wide ranging, but growth vulnerabilities are contained by well-developed policy frameworks, shekel flexibility, and healthy balance sheets

### Medium-term risks
- Regional/security
  - Israel is highly exposed to regional geopolitical risks including developments in the West Bank, with the potential to impact growth through tourism and domestic demand.
- Housing
  - A moderate decline in housing prices would be welcome to improve affordability and reduce inequality.
  - Risks of a sharp price decline appear modest, and financial stability is protected by low household debt and healthy banks, but growth could be significantly affected.
- External
  - Weak growth in Israel’s main trading partners would weigh on Israeli exports and growth.
  - Shekel depreciation and the operation of automatic fiscal stabilizers could help cushion the impact on growth, yet monetary policy currently has reduced space.

### Long-term challenges and demographic risks
- Demographics and labor market
  - Currently just over one-quarter of the working age population is Haredi or Israeli-Arab, groups that on average have poor market skills and low labor participation.
  - This share will rise greatly over time as these groups constitute almost half of school age children.
  - Together with infrastructure gaps (most evident in high traffic congestion), these factors could slow labor supply gains and be a drag on productivity, weakening potential growth notably in coming decades.
  - Slower revenue growth would come as demands for social support increase, with rising deficits and debt threatening stability.

### Key statistics (Percent change y/y, unless noted)
- Real GDP: 2014 3.5; 2015 2.6; 2016 4.0; 2017 3.4; 2018 3.4; 2019 3.4; 2020 3.3
- Total domestic demand: 2014 4.2; 2015 3.4; 2016 6.0; 2017 3.5; 2018 3.4; 2019 3.5; 2020 3.0
- Exports: 2014 1.9; 2015 -2.7; 2016 2.5; 2017 3.7; 2018 4.3; 2019 4.5; 2020 4.5
- Imports: 2014 4.0; 2015 -0.3; 2016 9.4; 2017 4.3; 2018 4.4; 2019 5.0; 2020 3.6
- Trading partner GDP: 2014 3.0; 2015 3.0; 2016 2.3; 2017 3.2; 2018 3.2; 2019 3.1; 2020 2.7
- CA balance (percent of GDP): 2014 4.0; 2015 4.9; 2016 3.5; 2017 3.0; 2018 2.8; 2019 2.7; 2020 3.1
- Terms of trade: 2014 -3.9; 2015 10.6; 2016 1.4; 2017 -3.0; 2018 -2.2; 2019 0.5; 2020 0.6
- Employment: 2014 3.0; 2015 2.6; 2016 2.7; 2017 2.4; 2018 2.5; 2019 2.2; 2020 2.2
- Unemployment rate (percent): 2014 5.9; 2015 5.3; 2016 4.8; 2017 4.2; 2018 4.2; 2019 4.2; 2020 4.2
- CPI (percent change, end of period): 2014 -0.2; 2015 -1.0; 2016 -0.2; 2017 0.4; 2018 1.0; 2019 1.5; 2020 2.0

### Monetary and exchange rate policies
- Recent stance and outlook
  - Accommodative monetary conditions continued in 2017. The policy rate has remained at 0.1 percent since February 2015.
  - The shekel’s effective exchange rate appreciated notably until Spring 2017, but has since been broadly stable.
  - Mortgage rates (unindexed) have declined moderately, reflecting cooling housing activity.
  - The BoI is committed to maintaining an accommodative policy as long as necessary to entrench inflation within the target range.
- Policy recommendations
  - Monetary policy should remain accommodative pending a durable rise in inflation and inflation expectations.
  - Avoid a premature monetary tightening before inflation is clearly heading back to target.
  - The pace of eventual interest rate hikes will need to be data driven given the possibility inflation could rise relatively quickly due to the tight labor market.
- Exchange rate and external balance
  - Israel’s REER has been on an upward trend for a decade, to stand some 26 percent above historical averages on a ULC basis in January.
  - Appreciation likely contributed to the significant decline in the global market share of Israeli goods exports; services exports continued to rise.
  - The current account surplus narrowed from 4.9 percent of GDP in 2015 to 2.7 percent of GDP in 2017 (excluding one-off vehicle imports).
  - External position: current account gap of 3½ percent of GDP (EBA-based norm deficit of one percent of GDP), implying an undervaluation of about 15 percent, though this may overstate undervaluation for stated reasons.
  - REER-based analyses: shekel broadly consistent with fundamentals on an REER-CPI basis (EBA-Lite Analysis) and 17 percent overvalued using the EBA REER Level Analysis; REER-ULC appreciation suggests greater overvaluation in ULC terms.
- FX intervention and reserves
  - Intervention in 2017 amounted to US$6.6 billion, compared with US$6.0 billion in 2016.
  - Reserves rose to US$113 billion by end 2017 (32 percent of GDP), with over half of the increase due to revaluation gains.
  - Reserves exceed standard adequacy metrics but are not deemed excessive given geopolitical risks and low export diversification.
  - Policy stance: exchange rate flexibility should continue as the first line of defense; FX intervention limited to addressing disorderly market conditions and significant deviations from fundamentals.
- BoI views
  - The BoI finds the shekel to be overvalued (on REER models) and considers its FX intervention appropriate.
  - The BoI forecasts inflation to return to the target range by end 2018 but notes inflation is currently well below target and not entrenched.
  - Currency intervention is viewed as part of the monetary policy toolkit preferred over negative interest rates or QE.

### Financial sector and housing policies
- Banking system soundness
  - Capitalization, loan quality, and profitability continued to improve in 2017.
  - The leverage ratio rose to 7.5 percent, exceeding that in most advanced economies.
  - All five of the largest banks met the capital requirement, enabling them to resume or raise dividend payouts in 2017.
  - Banking Soundness Indicators (end-period, in percent) — 2014 / 2015 / 2016 / 2017 Q3:
    - Regulatory capital to risk-weighted assets 1/ : 14.3 / 14.0 / 14.7 / 14.5
    - Regulatory Tier I capital to risk-weighted assets 1/ : 9.7 / 9.9 / 10.9 / 11.1
    - NPL to total gross loans: 2.2 / 1.8 / 1.6 / 1.4
    - NPL net of loan-loss provisions to capital: 6.1 / 3.4 / 2.2 / 1.1
    - Return on average assets (before tax): 0.8 / 1.0 / 1.0 / 1.0
    - Return on average equity (before tax): 11.8 / 14.4 / 13.9 / 13.7
    - Customer deposits as a percent of total (non-interbank) loans: 115.8 / 117.8 / 121.6 / 120.1
- Household and business debt
  - Household debt ratio has been rising for a decade but remains low at just over 40 percent of GDP.
  - Consumer credit is almost two-fifths of total household debt and calls for close monitoring.
  - Business sector debt has declined to below 70 percent of GDP; corporate bonds fell to 19 percent of GDP by 2017 (9 percent of GDP less than their former ratio).
- Housing market and supply-side reforms
  - Authorities estimate 45–50 thousand new housing units needed annually during 2015–2020, rising to 60 thousand annually by 2026–35.
  - Completions appear sufficient in 2016–2017, but shortfalls could return given recent falls in housing starts.
  - Recommended reforms:
    - Land supply, competition, and regulation: increase land auctions; streamline building regulations; expand foreign construction company access.
    - Municipal incentives: raise residential property taxes (while avoiding work disincentives); provide predictable central government support to municipalities for up-front infrastructure and public service costs.
    - Expand commutable areas and increase urban density: develop public transportation; establish metropolitan authorities; increase urban renewal and fast-track approvals of mixed use development.
  - In March 2018, the BoI announced a reduction in risk weights on mortgage loans to first-time homebuyers with an LTV of 60–75 percent (to prevent financing part of the equity through consumer credit).
- Competition and regulation
  - Banking sector concentration: five locally-owned banking groups account for 95 percent of banking sector assets; two largest groups account for over 60 percent of assets.
  - Establishing the Financial Stability Committee (FSC) is critical to complement competition-enhancing measures and avoid oversight gaps; FSC comprises the BoI (chair); MoF; CMISA; and Israel Securities Authority.
  - Approve entry by new banks with appropriate deposit insurance and resolution arrangements to contain fiscal costs from potential failure.
  - Continue operationalizing a more risk-focused approach to supervision to lower compliance costs while maintaining high standards.
  - CMISA adopted the Solvency II framework in 2017 aiming for full compliance by end-2024.
  - Harmonize regulations across financial regulators to avert regulatory arbitrage; safeguard operational independence of regulators.
- Fintech and cyber security
  - In 2017 there were 474 Fintech companies in Israel, up from around 300 in 2014.
  - BoI supports innovation (digital banks, cloud technology, IT sharing) while stepping up monitoring of emerging risks from Fintech.
  - BoI, National Cyber Authority, MoF, and banks established a Banking Cyber Center in 2017 to facilitate inter-agency intelligence sharing and incident management.

### Fiscal policy and infrastructure
- Recent fiscal outcomes and budget timing
  - In 2017, the central government deficit excluding one-off items came in at 2.9 percent of GDP, in line with the budget target; general government debt declined to 61 percent of GDP.
  - The headline budget deficit was two percent of GDP in 2017, benefitting from one-off revenues (sales of Mobileye, Keter Plastics, Tamar Petroleum) and an exceptional dividend tax collection.
  - The reserve fund of 0.3 percent of GDP was allocated to social spending (disability benefits, subsidies for after school childcare, old-age benefits).
  - The Knesset approved the 2019 budget in mid-March 2018; the target for 2019 was raised to 2.9 percent of GDP from 2.5 percent and the 2019 budget breaches the expenditure ceiling.
- Policy advice on consolidation and fiscal sustainability
  - A modest consolidation in 2018–19 would have been preferable in this favorable economic environment.
  - Adhering to the former target of reducing the central government deficit to 2.5 percent of GDP by 2019 would entail little drag on growth and imply a general government deficit of around three percent of GDP, sufficient if subsequently maintained to gradually reduce debt in normal times.
  - Ensuring the Buyer’s Price program is temporary would support Israel’s fiscal health as subsidies via heavily discounted land sales reduce receipts from the Land Authority.
  - The expenditure ceiling formula and historical notes: the ceiling sets the real increase in government expenditures in accordance with population growth in the past three years plus the ratio of 50 to debt-to-GDP in the last year; the ceiling is converted to nominal terms using average CPI inflation in the past three years.
  - Fiscal assumptions: deficit target assumes nominal GDP growth averaging five percent and an annual stock-flow adjustment of around ½ percent of GDP.
  - Note: the general government GFS deficit tends to be larger than the central government deficit; five-year average for 2012–16 was 0.5 percent of GDP.

### Authorities' views and coordination
- Macroeconomic outlook
  - The Israeli authorities assessed underlying growth in 2017—excluding the unwinding of one-offs—was above 3½ percent, benefitting from exports strengthening.
  - Their medium-term projections for growth and inflation were similar to staff and they remained alert to risks.
  - The authorities fully agreed on long-term challenges owing to the shifting demographic composition.
- Regulatory coordination
  - Authorities emphasized urgency of approving legislation to establish the FSC.
  - BoI will continue enhancing a more risk-focused supervision approach; BoI and CMISA plan to intensify coordination and information sharing, including to supplement the Central Credit Register.
  - On entry of new banks, authorities are developing views, weighing potential support arrangements against fiscal costs and stability risks.

*Source: cr18111 - 9. Medium-term risks are wide ranging, but growth vulnerabilities are contained by*

### 27. There is little room for tax cuts with civilian spending already low. Following recent U.S.

### 27. There is little room for tax cuts with civilian spending already low

### Tax policy and fiscal space
- Authorities are considering further cuts in personal and corporate income taxes following recent U.S. tax cuts and with elections approaching in 2019.
- High-tech firms already enjoy 6 or 12 percent rates.
- The adoption of the new tax on owners of more than two apartments remains uncertain.
- Israel’s low civilian spending and rising needs in infrastructure, education and training, and active labor market policies indicate tax cuts would be difficult to finance through offsetting expenditure cuts.
- Recommendation: finance initiatives in a growth-friendly manner, such as by scaling back tax benefits, which total about five percent of GDP.

### Infrastructure needs and priorities
- Cross-country benchmarks suggest an infrastructure gap on the order of 20 percent of GDP, broadly confirmed by sectoral analysis; high traffic congestion is the most prominent issue.
- A government committee is developing an integrated long-term national infrastructure strategy through 2030 (“Infrastructure 2030”) and preparing a list of additional projects for implementation for the next five years.
- Priority: ensure current and prospective infrastructure is efficiently utilized through demand management before committing to large new projects.
  - Near-term, low-cost demand-side tools: ride sharing, car-pooling; ramp up the “Going Green” pilot.
  - Consider charging for road use at peak hours, coupled with flexible working hours.
  - If bottlenecks remain after demand management, focus additional public investment on clearly identified areas.

### Managing and scaling public investment
- Growth benefits of higher public investment depend on quality and timeliness of spending.
  - Under a scenario with public investment raised by 1.5 percent of GDP for 15 years, staff estimate a cumulative output gain ranging from four to six percent depending on investment efficiency.
- Recommended steps to enhance public investment management:
  - Establish a body with clear accountability and sufficient powers for upgrading Israel’s infrastructure, supported by staff with necessary technical expertise.
  - Make project evaluation and selection more rigorous and transparent, ensuring consistency with the long-term infrastructure strategy.
  - Streamline zoning and permitting processes and address other bureaucratic impediments to timely project implementation.
  - Improve coordination between ministries and between the central and local governments.
    - Broadening coverage of the medium term fiscal framework to the general government could improve coordination and planning as local governments implement around three-quarters of public investment.
  - Phase any scaling up of public investment judiciously to avoid waste.
  - Use public-private partnerships (PPP) only where private sector know-how improves efficiency; design and monitor PPPs carefully to protect the public interest.
  - Maintain a high level of transparency around the level and composition of investment.

### Fiscal buffers and debt management
- If public investment is increased, adequate fiscal buffers must be preserved.
  - Infrastructure enhances potential GDP and revenue over a long horizon; there is a case for smoothing taxes and financing a portion with debt or PPPs.
  - Israel has some fiscal space but faces wider uncertainties than most advanced economies; a significant buffer relative to the 85 percent debt threshold usually applied to advanced economies is appropriate.
  - Any increase in the public debt ratio should be modest and temporary.
  - Liabilities from PPPs should be managed carefully and reported in line with international best practices.
  - Within revenues, focus on sources with the least drag on potential growth, especially reducing tax benefits which total five percent of GDP.

### Expenditure rule refinements
- Given the low level of civilian spending, refine the current expenditure rule to provide flexibility to accommodate new initiatives if financed.
  - Key step: include revenue measures within the rule as a basis for higher spending, making the expenditure rule consistent with recently adopted commitment controls (the Numerator rule).
  - Consider replacing the current adjustor for deviations of the public debt ratio from 50 percent with one based on deviations in the balance from the medium-term deficit target, so the spending rule supports steady progress toward that target.

### Authorities’ views
- Authorities broadly concurred with staff’s assessment and recommendations.
  - They agree on keeping public debt on a declining path in normal times given Israel’s exposure to geopolitical risks.
  - The MoF noted relatively high deficit targets could limit space to cushion shocks but saw scope for deficits to come in below target as in recent years.
  - The MoF is cautious about temporary increases in deficit or debt given political difficulty of ensuring additional space is used for productive spending.
  - The BoI supports a review of the expenditure rule to accommodate social and investment spending without increasing deficits; the MoF is cautious about modifying rules too frequently.
  - The authorities are digesting implications of the U.S. tax reforms; the Finance Minister is considering tax cuts to remain competitive.
  - On PPPs, authorities recognize advantages in pre-committing infrastructure spending but stress careful management.

### Inclusive growth, labor market, and education (context for fiscal choices)
- Long-term growth and stability hinge on closing participation and productivity gaps among large population groups and genders.
  - Hourly wages: non-Haredi Jewish women are about one-fifth lower than non-Haredi Jewish men; Haredi (both men and women) are about one-third lower; Israeli-Arabs are about half.
  - Employment rates: Haredi men 47 percent; Arab women 35 percent.
  - Haredi women are approaching employment rates of non-Haredi Jewish women; women tend to work shorter hours, reducing monthly wages and impeding career progression.
  - Closing gaps in employment and labor productivity by half would raise potential output by 14 percent.
  - An increase in full-time workers sufficient to reduce monthly-wage gaps by half would raise potential output by 22 percent.
  - An estimated two-thirds of these gains are attributable to narrowing gaps between men and women.
- Education system reforms are essential:
  - Education spending has been raised recently, primarily through increases in teachers’ pay, but academic qualifications expected of teachers remain low and the teaching day is unusually short.
  - Many Haredi men lack education in math, science, English, and other market-oriented disciplines.
  - Arab schools show signs of quality improvement but large gaps remain, including in Hebrew skills.
  - Recommendations: increase effectiveness of schools via higher standards for teachers, core subjects at all grades in Haredi schools, improve Hebrew teaching in Arab schools, and extend the short school day.
- Vocational training and ALMPs:
  - Vocational training reforms should ensure courses meet business needs, involve business community experts, and facilitate participation by Haredi and Arab communities.
  - Career centers should guide job seekers to suitable training, including business-oriented Hebrew.
  - Low wage workers should receive support for training costs; consider a transfer program conditional on completing eligible classes or job training.
  - Additional resources would increase ALMP impact: Total ALMP spending is only 0.2 percent of GDP and should be raised.
  - Employment Circles program paid for itself after seven months in external analysis; subsidizing mobility to jobs outside home towns shows preliminary effectiveness.
- Targets and measures to raise employment to 2030:
  - Authorities, led by the Ministry of Labor, are updating targets and developing policies.
  - To raise female participation and work hours: expand childcare support (especially for younger children); continue increases in retirement age for women toward equalization with men without new incentives for early retirement.
  - For minority groups: enhance public transportation and enable workplaces to locate within or close to communities (e.g., for Arab women).

### Business environment and redistribution
- Business environment:
  - Government has progressed on electricity sector reform and liberalizing personal imports.
  - Domestic business environment remains unfavorable with numerous regulations and high compliance costs impeding competition and investment.
  - Recommended: dramatic change toward simple and timely administration of regulations (e.g., a “one-stop shop”), robust regulatory impact assessments for new regulations, make court procedures more efficient, and establish a specialized court for complex antitrust cases.
- Redistributive measures to contain poverty:
  - Priority actions:
    - Further expand the amount and coverage of the Earned Income Tax Credit (EITC).
      - EITC fiscal cost is 0.16 percent of GDP annually.
      - Doubling the EITC ceiling would bring spending into the 0.4–0.5 percent of GDP range, reducing indicators of poverty by about 0.5 percentage points.
      - Expanding the EITC increases take-up and can have larger practical impacts.
    - Implement the EITC more effectively: allow more frequent and timely payments (currently claimable only at year-end), streamline administration to improve take-up.
    - Make transfers more targeted: current transfer system provides similar shekel amounts to all households largely due to non-income-tested child allowances; modifying transfers to better target low income households can reduce poverty at less fiscal cost.
      - Use resources released to expand the EITC and fund transfers conditional on education and training to reinforce incentives to work and upgrade skills.
    - Review modest levels of welfare support for the most vulnerable while protecting labor force participation.

### Staff appraisal (key macro findings)
- Israel’s macro conditions:
  - Growth of almost 3½ percent in 2017 helped bring unemployment below four percent.
  - Core inflation remains below the 1–3 percent target range.
  - Growth is expected to remain at about 3½ percent in the next few years before moderating to around three percent.
  - In the longer term, a rise in population share of groups with lower labor productivity and participation combined with sizable infrastructure needs could weigh on Israel’s growth potential and raise poverty.
- Monetary and external policy:
  - Monetary policy should remain accommodative pending a durable rise in inflation and inflation expectations.
  - Exchange rate flexibility should remain the first line of defense in the event of external shocks; foreign exchange intervention should be limited to addressing disorderly market conditions.
- Financial stability and competition:
  - Reinforcing the financial stability framework is critical to complement progress on enhancing competition.
  - Urgent need to approve legislation to establish the FSC to avoid oversight gaps.
  - Entry by new banks would be welcome with appropriate deposit insurance and resolution arrangements.
  - Banking supervision should continue operationalizing a risk-focused approach; adoption of Solvency II by the CMISA is welcome.
  - Regulators should harmonize regulations in overlapping activity areas to avert regulatory arbitrage and safeguard operational independence.
- Housing:
  - Slowing housing construction despite still high housing prices calls for continued reforms to make supply more responsive and improve housing affordability.

*International Monetary Fund — staff assessment from the cited chapter.*

### 44. Fiscal policy should support Israel’s growth potential while building buffers. In 2018

### 44. Fiscal policy should support Israel’s growth potential while building buffers. In 2018

### Fiscal policy, social spending, and buffers
- In 2018 fiscal reserves are allocated to welcome subsidies for after-school childcare.
- An expansion of disability benefits should be coupled with a reform of eligibility requirements and testing for new entrants to:
  - protect labor participation, and
  - contain fiscal costs.
- The 2019 budget supports technical training in schools and expands the EITC, but adhering to the former deficit target of 2.5 percent of GDP is preferable to gradually reduce debt in normal times.
- Ensuring the Buyer’s Price program is temporary would also support Israel’s fiscal health.

### Public investment management and fiscal buffers
- Stronger public investment management would help address infrastructure needs and adequate fiscal buffers must be preserved.
- Development of an integrated long-term national infrastructure strategy through 2030 is welcome.
- Immediate priority: ensure existing infrastructure is efficiently utilized through demand management tools.
- The framework for managing infrastructure investment needs to be strengthened to ensure investments are high-quality and timely.
- If public investment is increased:
  - any rise in the public debt ratio should be modest and temporary, and
  - liabilities from PPPs should be managed carefully and reported in line with international best practices.
- Given the low level of Israel’s civilian spending and reform needs in education, training, and active labor market policies:
  - revenues should be the main source of non-debt financing, focusing on reducing tax benefits to limit the drag on growth.

### Business environment and regulatory reform
- Fundamental upgrades of the business environment are critical, especially reducing bureaucratic bottlenecks.
- Progress on electricity sector and other reforms is welcome and reforms should continue, including replacing trade barriers on agricultural products with targeted subsidies.
- Numerous regulations and high compliance costs remain major impediments to competition and investment, calling for:
  - simple and timely administration of regulations, such as a “one-stop shop” that would assess all regulatory requirements within a reasonable period, and
  - subjecting all proposals for new regulations to robust regulatory impact assessments.
- The lengthy process of contract enforcement indicates a need to make court procedures more efficient.
- The establishment of a specialized court for complex antitrust cases would support competitive markets.

### Education, training, labor participation, and redistribution
- The government should undertake deep reforms of education and training to reduce gaps in labor productivity and participation while enhancing redistribution carefully.
- Measures to increase effectiveness of schools include:
  - higher standards for teachers,
  - covering core subjects at all grades in Haredi schools,
  - improving Hebrew teaching in Arab schools, and
  - extending the short school day.
- Enhanced vocational training can play a large role in reducing skills gaps, with expanded active labor market policies further aiding employability.
- To raise labor participation and work hours of women:
  - childcare support needs to be further expanded, especially for younger children, and
  - increases in the female retirement age should continue without introducing new incentives for early retirement.
- Alongside enhancing public transportation, enabling workplaces to locate near communities would promote labor participation.
- Inequality and poverty can be reduced while supporting participation by substantially expanding the EITC and implementing it more effectively, with fiscal costs contained by making transfers more targeted.

### Israel’s infrastructure needs (Box 1)
- Public investment declined over the past two decades, from around three percent of GDP in the second half of the 1990s to around two percent in 2017, so Israel’s stock of public capital is now substantially below that in peers.
- The reduction in public investment was part of the fiscal consolidation process, but the amount and quality of infrastructure development was also affected by:
  - issues with public investment management (especially at local levels),
  - the lack of land registries in the Arab towns, and
  - the regulation of network industries.
- A more granular sectoral analysis by the Israeli authorities, supported McKinsey & Company, finds a range of infrastructure needs.
- Public transport infrastructure in major cities is vastly inadequate given Israel’s income level.
  - For example, traffic congestion was causing an average loss of 60 minutes per road-user per day in 2012, with signs of deterioration over time, dragging on productivity growth.
  - The share of train travel in total motorized travel in Israel is substantially below the average in advanced economies.
  - A lack of competition for managing ports and airports has also lowered efficiency.

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

*cr18111 - 44. Fiscal policy should support Israel’s growth potential while building buffers. In 2018*

### Box 2. Some Headaches of Doing Business in Israel

### Box 2. Some Headaches of Doing Business in Israel

### Overall comparison with advanced economies
- According to the World Bank’s Doing Business, Israel's overall performance is below the average of advanced economies.
- The Israeli Chambers of Commerce noted that the Doing Business data is primarily based on information from relatively few large businesses, who may not have the same experience as the many small businesses in Israel.

### Property registration
- 81 days are required in Israel compared to a 25 day advanced economy average.
- Procedures cost 8.3 percent of property value in Israel versus 4.7 percent in advanced economies.
- One drag on the registration process is the roughly 68 days required to file a transaction report and obtain tax clearance from municipalities.

### Contract enforcement
- The average time for completing judicial processes is 975 days in Israel, versus 567 days on average in advanced economies.
- Key factors behind the long time to complete judicial processes include the lack of a dedicated commercial court, the maximum number of adjournments, and electronic filing system.

### Paying taxes
- Tax rates in Israel are comparatively low, but:
  - The time required to comply with tax procedures is unduly long.
  - The time required to obtain VAT refunds is unduly long.

### Getting electricity
- The cost of electricity in Israel is close to the frontier.
- The number of procedures and the time involved to obtain electricity is high: 102 days.

*IMF staff compilation from Box 2, "Some Headaches of Doing Business in Israel".*

### Annex I. Status of Key Recommendations from the 2017 Article IV

### Annex I. Status of Key Recommendations from the 2017 Article IV Consultation and 2016 Technical Assistance on Bank Supervision

### Fiscal policy and public investment
- Recommendation: Reduce general government fiscal deficits to around three percent of GDP over the business cycle, with temporary flexibility to facilitate structural reforms.
  - Excluding one-off revenues, the central government deficit for 2017 was in line with 2.9 percent of GDP budget target.
  - The deficit ceiling for 2019 has been raised to 2.9 percent of GDP, from 2.5 percent of GDP. The implied deficit for the general government is 3.4 percent of GDP.
  - The 2.5 percent target for the central government is deferred until 2020, but the track record of past adjustments indicates it will be revised up.
- Recommendation: Increase public investments in human and physical capital while protecting fiscal space.
  - Several public transport projects are underway, including a high-speed rail between Jerusalem and Tel Aviv and light rail systems in the largest three cities (4.9 percent of GDP).
  - In 2017, the government created a committee on scaling up public infrastructure investments (‘Infrastructure 2030’).

### Housing and rental markets
- Recommendation: Boost the supply of housing by addressing municipal disincentives, ensuring adequate land supply for housing, reducing construction times and costs. Enhance also rental markets.
  - Buyers’ Price tenders took place in 2017; 40,000 apartments were successfully sold by end-2017.
  - A new tax on owners of more than two properties aiming to promote a release of apartments by investors was overturned by the Supreme Court.
  - An Arnona equalization fund was created in 2017 aiming to redistribute property tax fairly across municipalities.
  - A Fair Rental Law was passed in 2017.

### Financial stability and supervision
- Recommendation: Establish a Financial Stability Council (FSC). Further strengthen the financial stability framework to fully realize the benefits of greater competition. For the insurance sector, adopt Solvency II.
  - A bill to establish the FSC was discussed by the Knesset Finance committee in May 2017, but it remains to be approved.
  - An inter-governmental working group comprising the BoI, MoF, and Ministry of Justice was formed in 2017 to discuss (i) creation of a framework to provide temporary deposit security to new bank entrants and (ii) the bank resolution framework.
  - The CMISA adopted a Solvency II framework in 2017, aiming to achieve full compliance with the solvency capital requirements by end-2024.
- Recommendation: Enhance risk-focused and forward-looking bank supervision strategy.
  - In 2017, the BSD streamlined cases that require its prior approval from every new initiative to only major cases.
  - The BSD is modifying risk cards to better capture a forward-looking dimension.

### Competition, productivity, and inclusion
- Recommendation: Raise productivity by boosting competition.
  - Government implemented product and labor market reforms, including:
    - Opening up the power production market and transferring system management and planning away from Israel Electric Corp (IEC).
    - Removing import barriers for communications products and streamlining personal imports.
    - Simplifying import procedures for non-sensitive food, cosmetic products, and home appliances.
    - Substantially easing the entry of high-tech foreign workers.
- Recommendation: Reduce poverty by addressing structural problems hindering inclusion of Haredi and Israeli-Arab populations.
  - Government actions included:
    - Creating the Employment 2030 committee to form measures to enhance labor participation.
    - Deciding to reform the technological education system to enhance quality.
    - Raising the amount and expanding the coverage of the EITC.
    - Starting to provide subsidies for after-school extra curriculum programs.

---

### Annex II. Risk Assessment Matrix — key risks and policy responses

### External risks (relative likelihood / impact if realized)
- Weaker-than-expected global growth
  - Relative likelihood: High/Medium
  - Impact if realized: Medium — would hamper the emerging recovery of exports, reduce foreign investments, and lead to lower growth in Israel; a rise in inflation would likely be delayed.
  - Policy response: Monetary policy should remain accommodative. Fiscal policy should allow automatic stabilizers to operate fully, but if the shock is prolonged, there would be a need to moderate spending growth over the medium term.
- Tighter global financial conditions owing to repricing of risk across asset classes
  - Relative likelihood: High
  - Impact if realized: Low/Medium — investor flight to safety would modestly impact Israel’s risk premia; if it relieved appreciation pressures on the shekel this would be supportive for exports.
  - Policy response: Protect confidence through sound medium-term fiscal policy and strong financial sector supervision. Prolong accommodative monetary stance if the global growth outlook weakens notably. FX intervention could be used if needed to smooth excessive exchange rate volatility.
- Heightened regional security/geopolitical tensions
  - Relative likelihood: High
  - Impact if realized: Medium/High — lower tourism receipts, damaged business confidence and investment, increased defense spending could breach the multi-year defense budget and lead to fiscal slippages; likely shekel depreciation would partly cushion the impact.
  - Policy response: Fiscal policy should allow automatic stabilizers to operate fully. Deviations from the medium-term defense budget should be temporary and corrected once the situation improves.

### Domestic risks
- Sharp decline in housing prices (after price rises slowed to 2.0 percent y/y in November 2017 from 6.7 percent a year earlier)
  - Relative likelihood: Low
  - Impact if realized: Medium — macroprudential policies have contained household debt risks (including relatively low LTV ratios) and banks are further protected by capital buffers; but domestic demand, especially construction activity, could fall significantly, impacting growth and potentially corporate loan quality.
  - Policy response: Ease monetary policy as feasible and allow automatic fiscal stabilizers to operate. If price levels reach significantly lower levels, some easing of macroprudential policies could be considered.
- Fiscal pressures running up to the 2019 election
  - Relative likelihood: Medium
  - Impact if realized: Medium — early adoption of the 2019 budget has reduced the risk of election-related spending overruns, yet risks of tax cuts remain; a weakened fiscal position would reduce room for fiscal structural reforms.
  - Policy response: Adhere to the rule requiring new commitments to be financed. Maintain commitment to the multi-year deficit targets consistent with debt sustainability and preserving adequate fiscal buffers.

---

### Annex III. Steps to Promote Competition in the Financial Sector — actions and implementation status

- Instituting a bureau for banking computer services
  - The government plans to create a new central computer office that any banks can use, aiming to reduce entry cost for new banks.
  - The MoF has allocated NIS 200 million in the 2019 budget.
- Creating an information sharing platform
  - An online platform based on Application Program Interface (API) between banks and third parties acting on behalf of a customer will be created, allowing a customer to compare prices of personalized banking services.
  - Banks will be obliged to share the customer's information, with his consent and in a secured manner.
- Introducing “one-click” mobility between bank accounts
  - Administrative requirements for switching an account between banks will be eliminated.
  - The new framework employs a “follow-on” technological mechanism that links the customer’s old bank account to new account and automatically transfers all the standing orders.
- Operationalizing the Central Credit Register
  - The credit register will narrow information gaps between banks and customers, and is expected to be available to both parties in early 2019.
- Separating two credit card companies from banks
  - The BoI recently invited potential buyers from Israel and abroad to examine the opportunity to purchase these companies by January 2020.
- Lowering minimum capital requirements for banks
  - The government has reduced the minimum capital requirement for banks from NIS 400 million to NIS 50 million.
- Lowering minimum capital requirements for insurance companies
  - The CMISA cut the capital requirement for insurance in early 2018 with a view to enhancing competition in the insurance market.
  - In response, two on line insurance companies are expected to start business in 2018.

---

### Appendix I. External Sector Assessment — key findings and metrics

### Net international investment position (NIIP) and balance-sheet structure
- NIIP in 2017: 41 percent of GDP (up from 34 percent of GDP in 2016).
- Gross assets: rose from 119 to 123 percent of GDP in 2017.
- Liabilities: small decrease in gross liabilities in 2017.
- Portfolio investments: reached 33 percent of total assets in 2017.
- Liabilities composition: direct investment 44 percent of liabilities; portfolio investment 39 percent.

### Current account and drivers
- Israel’s current account:
  - Turned to surplus from 2003 and averaged three percent of GDP in the decade to 2017.
  - 2017 CA balance: 3.0 (percent of GDP) as reported in the EBA table.
  - A one-off factor: vehicle imports were bought forward into 2016, raising the 2017 balance by about ⅓ percent of GDP; underlying 2017 CA balance is given as 2.6 (percent of GDP) in EBA calculations.
- Services: Rising exports of high-tech services were a key contributor to the current account surplus.
- Terms of trade:
  - Since 2012, terms of trade have risen by around 18 percent.
  - Improvement mostly driven by weakening goods import prices, especially for fuels.
  - Absent declines in goods import prices, the goods balance would be roughly three percent of GDP lower in 2017.

### Saving and investment trends
- Increase in savings driven by private sector, partly due to mandatory private pension saving introduced in 2008.
- Israel’s private net lending averaged 7.4 percent of GDP in 2008–15 (compared with 3.7 percent and 5.1 percent in OECD and the euro-area, respectively).
- Investment has declined since the early 1990s; general government investment fell by two percentage points of GDP from 1995–99 to 2011–15, exceeding the 1¼ percentage point deficit cut in that period.

### Real exchange rate (REER) and competitiveness
- REER developments:
  - REER has appreciated for a decade and is well above historical average.
  - ULC-based REER recently stood at its historical high, some 25 percent above its historical average.
  - CPI-based REER is almost 10 percent above historical average.
- Impact on exports:
  - Goods exports have declined since the early 2000s; global market share fell from 0.55 percent to below 0.40 percent.
  - Exports of high-tech goods have stalled in recent years, indicating competitiveness effects beyond a shift to higher-technology production.
- Growth context:
  - Real per capita growth in 2007–2017 was 1.7 percent, above advanced economies (0.8 percent) and advanced Europe (1.0 percent).

### Exchange rate misalignment and EBA results (table figures preserved)
- EBA Current Account Analysis (percent of GDP unless otherwise indicated):
  - Current Account (actual): 3.0
  - (-) Cyclical Contributions (from model): 0.1
  - (-) Adjustments to the CA (temporary factors): 0.3
  - (=) Cyclically-adjusted Underlying CA: 2.6
  - (-) Cyclically-adjusted Current Account Norm: -1.1
  - (=) Current Account Gap: 3.7
  - o/w Policy Gaps: 2.2
  - Elasticity (percent of GDP / percent change in REER): -0.25
  - REER Gap (percent): -14.8
- EBA External Sustainability Approach:
  - Adjusted Medium-term CA/GDP: 3.3
  - (-) CA/GDP Stabilizing NFA at Benchmark: 1.7
  - (=) Current Account Gap: 1.7
  - Elasticity (percent of GDP / percent change in REER): -0.25
  - REER Gap (percent): -6.8
- EBA REER Level Analysis:
  - REER Gap (percent): 16.9
  - o/w Policy Gaps: -4.0
- EBA-Lite Index REER Analysis:
  - REER Gap (percent): 0.8

- Interpretation and uncertainty:
  - Focusing on the external balance indicates significant undervaluation: EBA CA analysis suggests the underlying 2017 CA balance is above the level warranted by fundamentals and appropriate policies by 3⅔ percentage points of GDP, translating into an REER undervaluation of 15 percent.
  - However, real exchange rate analyses vary: the EBA-Lite REER index indicates the CPI-REER is broadly in line with fundamentals (overvaluation of 0.8 percent), while REER Level Analysis finds a significant overvaluation (17 percent).
  - The REER-ULC appreciation has been substantially larger than the REER-CPI appreciation, suggesting the shekel might be more overvalued on ULC terms than REER models indicate.
  - The EBA CA analysis does not factor in net official and private transfers (which remained high for Israel, at two percent of GDP in 2017), adding to uncertainty.

*IMF staff summary based on Annex I, Annex II, Annex III, and Appendix I of the provided document.*

### 9. Israel generally maintains small net financial outflows, where net outflows of across a

### 9. Israel generally maintains small net financial outflows, where net outflows of across a range of assets are partially offset by net direct and portfolio investment inflows

### Financial flows and capital mobility
- Israel maintains a regime with free capital mobility, with only a few sectoral restrictions on direct investment.
- Net outflows across a range of assets are partially offset by net direct and portfolio investment inflows.
- FDI in Israel surged in 2017, increasing from 3.7 to 5.4 percent of GDP, owing to the acquisition of Israeli companies (i.e., Mobileye, Keter Plastics, and Tamar Petroleum) by foreign companies.
- The financial account would remain in deficit as long as current and capital account surplus continues.

### FX intervention and international reserves
- Since August 2009, the Bank of Israel (BoI)’s policy provides for FX intervention in the event of shekel movements inconsistent with underlying economic conditions or when the foreign exchange market is disorderly.
- In 2013, the BoI started pre-announced interventions to offset lower imports owing to natural gas production.
- Intervention in 2017 amounted to US$6.6 billion, compared with US$6.0 billion in 2016.
- Reserves rose to US$113 billion by end 2017 (32 percent of GDP), with over half of the increase due to revaluation gains.

### Indicators of reserve adequacy (end-2017 estimates, as presented)
- Reserves coverage metrics (comparators listed in figures): CZE, THA, MYS, ISR, PER, CHN, KOR, POL, HUN, ZAF.
- Indicators shown include coverage relative to: 100% of Short-term Debt; 20% of Broad Money; 3 Months of Imports; ARA EM Metric.
- Comparator countries have similar tolerance for external risks based on indicators for economic flexibility, market maturity and market access.

### Debt sustainability overview
- Israel’s debt-to-GDP ratio fell from 94 percent in 2003 to 61 percent in 2017.
- Debt structure: maturity averaging 7.8 years and nonresidents holding around 13⅓ percent of the total, aiding resilience to shocks.
- Relatively high interest payments and elevated gross financing needs remain a source of vulnerability.
- Most indicators are below their early warning benchmarks, but Israel’s debt outlook appears most sensitive to growth shocks.
- Around a third of debt held by nonresidents is guaranteed by the U.S. government.

### Baseline DSA projections and assumptions
- Under staff’s baseline scenario, the government debt-to-GDP ratio is projected to remain around 61 percent of GDP.
- The DSA covers debt of the general government.
- Gross financing needs:
  - 8¼ percent of GDP in 2017;
  - projected to increase to above 10 percent in 2018;
  - then remain around 10 percent throughout the projection period.
- Baseline assumes no fiscal consolidation measures would be taken.
- Key macroeconomic and fiscal assumptions:
  - Real GDP growth is projected to remain near 3½ percent in the next few years, then return to around three percent in the medium term.
  - CPI inflation is projected to rise to around two percent—the mid-point of the target range—by 2020 and stay at around two percent throughout the projection period.
  - The central government deficit is expected to increase from 2.0 percent of GDP in 2017 to 2.9 percent of GDP in 2018 and stay at the level thereafter.
  - The general government deficit is assumed to be larger than the budget deficit by 0.3 percentage points of GDP in 2018, 0.4 points in 2019, and 0.5 points annually from 2020 through 2023.
  - Non-debt creating financing is assumed to be ½ percent of GDP annually.
  - Primary expenditure is projected to decline slightly to below 37 percent of GDP in 2018 and remains around that level throughout the projection period.
  - The effective interest rate is projected to rise from 5.1 percent in 2017 to 5½ percent in the medium term, reflecting gradual normalization of monetary policy.
- Borrowing conditions assumptions:
  - Facilitated by solid sovereign ratings (A+) and the U.S. debt guarantee program (untapped amount of US$ 3.8 billion or one percent of GDP), borrowing conditions are assumed to remain favorable.
- Notes on analytical scope:
  - The analysis is for the general government, including both tradable and non-tradable debt.
  - The difference between general and central government deficits was 0.5 percent of GDP annually during the past five years, but was close to zero in recent years.
  - The high interest rates reflect a long-standing arrangement guaranteeing a stable return of approximately four percent in real terms to benefit contributors to mandatory private pension schemes. About 30 percent of domestic debt falls into this category and is held by institutional investors (mostly pension and insurance funds) as non-tradable bonds.

### Shocks and stress tests
- Israel’s debt outlook is noted to be most sensitive to growth shocks (no further details provided in the excerpt).

*International Monetary Fund — Chapter excerpt*

### 2. A range of stress tests indicate that debt sustainability is reasonably resilient to

### 2. A range of stress tests indicate that debt sustainability is reasonably resilient to growth, interest rate, and combined macro-fiscal shocks

### Growth shock
- Shock description: Lower real GDP growth rates (by one standard deviation for two years starting in 2019).
- Mechanism: Revenues fall while expenditure remains unchanged in nominal terms, leading to a larger deficit.
- Debt-to-GDP outcome: Debt-to-GDP ratio would rise to about 64¾ percent by 2020 and would stay around that level through 2023.
- Financing needs: Increase to 11¼ percent of GDP by 2020 and then decline to around 10½ percent of GDP.

### Interest rate shock
- Shock description: Borrowing costs increase by 200 basis points (e.g., from a geopolitical shock or tighter global financial conditions).
- Debt outcome: Government debt would rise moderately to around 62½ percent of GDP by 2023, only 1½ percentage point above the baseline.
- Financing needs: Moderate increase to around 10½ percent of GDP over the same period.

### Combined macro-fiscal shock
- Shock description: Combined exchange rate depreciation, expansion of the primary deficit, and decline in real GDP.
- Debt outcome: Debt would rise to around 66 percent of GDP by 2020.
- Financing needs: Rise to 11½ percent of GDP by 2020, with debt projected to keep rising to around 67 percent by 2023 and financing needs to remain around 11½ percent of GDP.

### Baseline scenario highlights (selected projections and indicators)
- Nominal gross public debt: 2016 = 69.4; 2017 = 62.3; 2018 = 60.9; 2019 = 61.5; 2020 = 61.4; 2021 = 61.3; 2022 = 61.1; 2023 = 61.0 (in percent of GDP).
- Public gross financing needs: 2016 = 10.4; 2017 = 6.5; 2018 = 8.2; 2019 = 10.0; 2020 = 9.5; 2021 = 9.7; 2022 = 9.8; 2023 = 9.8 (in percent of GDP).
- Real GDP growth (percent): 2016 = 3.8; 2017 = 4.0; 2018 = 3.4; 2019 = 3.4; 2020 = 3.4; 2021 = 3.3; 2022 = 3.0; 2023 = 3.0.
- Inflation (GDP deflator, percent): 2016 = 2.2; 2017 = 1.0; 2018 = 0.1; 2019 = 0.2; 2020 = 1.5; 2021 = 1.9; 2022 = 2.1; 2023 = 2.1.
- Nominal GDP growth (percent): 2016 = 6.0; 2017 = 5.0; 2018 = 3.5; 2019 = 3.6; 2020 = 4.9; 2021 = 5.2; 2022 = 5.2; 2023 = 5.1.
- Effective interest rate (percent): 2016 = 6.3; 2017 = 4.8; 2018 = 5.1; 2019 = 5.2; 2020 = 5.2; 2021 = 5.3; 2022 = 5.3; 2023 = 5.5.
- Change in gross public sector debt (percent of GDP): 2016 = -1.8; 2017 = -1.9; 2018 = -1.4; 2019 = 0.5; 2020 = -0.1; 2021 = -0.2; 2022 = -0.1; 2023 = -0.1; cumulative = 0.0.
- Identified debt-creating flows (percent of GDP): 2016 = -0.7; 2017 = -0.9; 2018 = -0.6; 2019 = 1.3; 2020 = 0.7; 2021 = 0.6; 2022 = 0.6; 2023 = 0.6; cumulative = 4.5.
- Primary deficit (percent of GDP): 2016 = -0.2; 2017 = -0.5; 2018 = -0.6; 2019 = 0.4; 2020 = 0.6; 2021 = 0.6; 2022 = 0.5; 2023 = 0.5; cumulative = 3.2.
- Primary (noninterest) revenue and grants (percent of GDP): 2016 = 36.7; 2017 = 36.4; 2018 = 37.7; 2019 = 36.4; 2020 = 36.2; 2021 = 36.2; 2022 = 36.2; 2023 = 36.2; cumulative = 217.4.
- Primary (noninterest) expenditure (percent of GDP): 2016 = 36.5; 2017 = 35.9; 2018 = 37.2; 2019 = 36.8; 2020 = 36.8; 2021 = 36.8; 2022 = 36.7; 2023 = 36.7; cumulative = 220.6.
- Automatic debt dynamics (percent of GDP): 2016 = 0.0; 2017 = -0.2; 2018 = 0.1; 2019 = 0.9; 2020 = 0.2; 2021 = 0.0; 2022 = 0.1; 2023 = 0.2; cumulative = 1.6.
- Interest rate/growth differential (percent of GDP): 2016 = 0.2; 2017 = -0.1; 2018 = 0.9; 2019 = 0.9; 2020 = 0.2; 2021 = 0.0; 2022 = 0.1; 2023 = 0.2; cumulative = 1.6.
  - Of which: real interest rate (percent): 2007–2015 actual = 2.7; 2016 = 2.3; 2017 = 3.0; 2018 = 2.9; 2019 = 2.2; 2020 = 1.9; 2021 = 1.9; 2022 = 1.9; 2023 = 1.9; cumulative = 12.7.
  - Of which: real GDP growth (percent): 2007–2015 actual = -2.5; 2016 = -2.4; 2017 = -2.0; 2018 = -2.0; 2019 = -2.0; 2020 = -1.9; 2021 = -1.7; 2022 = -1.7; 2023 = -1.7; cumulative = -11.1.
- Exchange rate depreciation contribution (percent of GDP): 2016 = -0.2; 2017 = -0.1; 2018 = -0.8.
- Other identified debt-creating flows (percent of GDP): 2016 = -0.5; 2017 = -0.2; 2018 = -0.2; 2019 = -0.1; 2020 = -0.1; 2021 = -0.1; 2022 = -0.1; 2023 = -0.1; cumulative = -0.4.
- Privatization (negative, percent of GDP): 2016 = -0.5; 2017 = -0.2; 2018 = -0.2; 2019 = -0.1; 2020 = -0.1; 2021 = -0.1; 2022 = -0.1; 2023 = -0.1; cumulative = -0.4.
- Contingent liabilities (percent of GDP): 2016 = 0.0; 2017 = 0.0; 2018 = 0.0; projected 2019–2023 = 0.0; cumulative = 0.0.
- Residual, including asset changes (percent of GDP): 2016 = -1.1; 2017 = -0.9; 2018 = -0.8; 2019 = -0.7; 2020 = -0.7; 2021 = -0.7; 2022 = -0.7; 2023 = -0.7; cumulative = -4.4.

### Alternative scenarios and additional stress-test features
- Alternative scenarios shown include Historical Scenario and Constant Primary Balance Scenario with underlying assumptions explicitly listed for Real GDP growth, Inflation, Primary Balance, and Effective interest rate for 2018–2023.
- Stress-test variants presented: Primary Balance Shock, Real GDP Growth Shock, Real Interest Rate Shock, Real Exchange Rate Shock, Combined Shock, and Combined Macro-Fiscal Shock.
- Example scenario details (Combined Shock, selected years):
  - Real GDP growth: 2018 = 3.4; 2019 = 2.1; 2020 = 2.0; 2021 = 3.0; 2022 = 3.0; 2023 = 3.0.
  - Inflation: 2018 = 0.2; 2019 = 1.2; 2020 = 1.6; 2021 = 2.1; 2022 = 2.1; 2023 = 2.1.
  - Primary balance: 2018 = -0.4; 2019 = -1.1; 2020 = -1.8; 2021 = -0.6; 2022 = -0.5; 2023 = -0.5.
  - Effective interest rate: 2018 = 5.2; 2019 = 5.4; 2020 = 5.6; 2021 = 6.0; 2022 = 6.3; 2023 = 6.5.
- Stress-test visualization metrics include gross nominal public debt (percent of GDP and percent of revenue) and public gross financing needs (percent of GDP) across 2018–2023 under baseline and shocks.

*Source: IMF staff.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18111.pdf_