## 1. Roadmap of Fiscal Actions ## Source details **Canonical URL:** [1. Roadmap of Fiscal Actions](https://www.imf.org/-/media/files/publications/cr/2021/english/1isrea2021001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2021/english/1isrea2021001.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2021/english/1isrea2021001.pdf.json) --- ### Context - Pre-pandemic growth and structure - Real annual GDP growth averaged about 3.5 percent in 2000–19. - ICT sector accounts for 19 percent of value added and is a major contributor to growth. - Labor productivity outside ICT is low; overall labor productivity is well below that of other small open advanced economies. - Precrisis fiscal and financial buffers - Household debt at end-2019: about 42 percent of GDP (about two-thirds high-quality mortgage loans). - Corporate debt: 68 percent of GDP (largely domestic). - Net international investment position: 40 percent of GDP at end-2019. - Gross external debt: 27 percent of GDP. - Social and political context - Relative poverty concentrated among Israeli-Arab and Haredi groups. - Fragile coalition with political uncertainty; a two-year budget was envisaged but deadline extended. - Geopolitical tensions exist; peace accords with the UAE and Bahrain are a positive development. ### Recent Economic Developments - Pandemic impact and containment - Early containment measures, reopening in mid-April, resurgence in June, second nationwide lockdown in mid-September. - Macroeconomic outcomes through 2020 - Real output collapsed by 3 percent yoy in January–September 2020. - Private consumption fell by 10 percent yoy (largest contribution to output plunge). - Severely affected sectors: accommodation and food services, transportation, wholesale and retail trade (heavily affected sectors ~15 percent of gross value added). - Revenues in accommodation and transportation were 41 and 21 percent below pre-COVID levels as of September. - Monetary policy and financial stability measures (Bank of Israel actions) - Policy interest rate reduced by 15 basis points to 0.1 percent. - Asset purchase programs with a total ceiling of about 6½ percent of GDP (NIS 85 billion); about 3.4 percent of GDP utilized as of end-November. - Corporate bond purchase program ceiling: NIS 15 billion (around NIS 3.5 billion purchased by end-November). - Term funding to banks (two tranches, 3-year and 4-year) for on-lending to SMEs. - Macroprudential easing: reduced regulatory capital by 1 percentage point, eliminated additional Tier-1 capital charge on housing loans, reduced leverage ratio requirements in November, raised loan-to-value cap on residence-backed loans from 50 to 70 percent, and other targeted measures. - Fiscal policy response - Planned fiscal stimulus in 2020: NIS 138 billion (about 10¼ percent of GDP), including: expanded health funding; benefits for unemployed and furloughed workers and grants for the self-employed; guaranteed loans, temporary property tax exemptions, tax and payment deferrals; infrastructure and investment support. - Execution rate expected to exceed 86 percent by year end. - 2020 deficit outturn expected to be about 13 percent of GDP. - Additional funding of NIS 72½ billion approved for 2021 (including to extend benefits for unemployed and furloughed workers). - Labor market and prices - 1.8 million workers (31 percent of labor force) were furloughed at peak. - More than 80 percent of furloughed workers recouped jobs before the second lockdown. - Seasonally adjusted unemployment rate: 4.7 percent in October 2020 (compared with 3.6 percent at beginning of 2020). - Real wages increased by 7 percent in the first eight months of 2020. - Headline CPI: declined by 1.6 percent yoy in May and remained suppressed; core inflation also negative. - 5- and 10-year inflation expectations remain anchored within the 1–3 percent target band. - External sector - Imports down 10 percent yoy in January–September, driven by a 40 percent drop in transportation equipment and fuel imports. - Exports increased by 0.3 percent, supported by ICT exports (high-tech: about 50 percent of goods exports and over 50 percent of service exports). - Net international reserves: $166.9 billion in November 2020 (18 months of imports), up from $126 billion at end-2019; $19 billion of the increase due to sovereign bond issuances. ### Outlook and Risks - Near-term outlook (staff baseline) - 2020: Real GDP decline projected at 4.0 percent. - 2020 inflation projections: headline –0.5 percent (average), core –0.4 percent (average). - Output gap in 2020: negative 5.2 percent of potential GDP. - Unemployment projected to rise to over 5 percent by end-2020. - 2021: Real GDP projected to increase by 4.1 percent; real GDP projected to remain 5.7 percent below its pre-COVID level in early 2021. - Medium-term scarring - Real GDP and potential output projected about 1 percent below the 2025 pre-COVID trend (Annex II). - Scarring projected to be relatively limited compared to other advanced economies, partly due to ICT share of value added (19 percent vs OECD average 11 percent). - Negative output gap not projected to close until 2025; inflation below BoI’s target well into the medium term. - Risks: unprecedented and multidimensional - Upside: early widespread vaccine distribution could boost confidence and speed recovery (Israeli contracts with major vaccine producers for early delivery and vaccination commencing in December cited as a plausible upside). - Downside: reescalation of the pandemic with tighter or prolonged lockdowns, higher fiscal support needs that could exhaust fiscal space and jeopardize fiscal sustainability; tightening of global financing conditions; adverse regional geopolitical developments; deglobalization and reshoring risks. - Macroeconomic projection highlights (selected rows, in percent / percent of GDP) - Real GDP growth: 2019 3.4, 2020 -4.0, 2021 4.1, 2022 5.0, 2023 4.6, 2024 4.1, 2025 3.6 - Unemployment: 2019 3.8, 2020 4.5, 2021 5.9, 2022 4.9, 2023 4.5, 2024 4.2, 2025 4.0 - Inflation (eop): 2019 0.6, 2020 -0.7, 2021 0.5, 2022 0.5, 2023 0.8, 2024 0.8, 2025 0.8 - Fiscal balance (percent of GDP): 2019 -3.9, 2020 -13.3, 2021 -9.7, 2022 -6.8, 2023 -4.9, 2024 -4.5, 2025 -4.3 - Current account balance (percent of GDP): 2019 3.4, 2020 4.0, 2021 3.7, 2022 3.5, 2023 3.3, 2024 3.1, 2025 2.9 ### Policy Discussions: Navigating Reopening and Recovery - Overarching policy guidance - Near term: fiscal policy should become more targeted to maximize impact of available fiscal space; monetary policy should remain accommodative. - Structural policies should mitigate labor market vulnerabilities, strengthen economic resilience, and foster a more inclusive recovery. - Medium term: resume fiscal consolidation in a growth-friendly way to restore pre-COVID fiscal buffers; gradually withdraw exceptional monetary easing. - Fiscal policy assessment and recommendations - Fiscal support effectiveness - Healthcare funding (~1 percent of GDP) was urgently needed and boosted capacity. - Support for households (unemployment and furlough benefits, grants for self-employed) mitigated the pandemic’s negative distributional impacts and supported aggregate demand due to high marginal propensity to consume among low-income households. - Liquidity support for businesses (guaranteed loans, tax deferrals, grants) was the main focus for corporate support. - Poorly targeted universal programs (e.g., “grants for every citizen”) likely had lower growth and distributional impact. - Adequacy and sequencing - The volume of fiscal support in 2020 is assessed as adequate given plans: general government deficit estimated at about 13 percent of GDP in 2020 (an increase of about 9 percent of GDP relative to pre-crisis). - As recovery becomes established and scarring risks recede, fiscal consolidation should resume to rebuild buffers. - Distributional and labor-market priorities - Focus support on low-skilled and low-income workers disproportionately affected (those more likely to be furloughed or dismissed). - Invest in policies that enhance labor reallocation toward higher-productivity sectors and skills. - Risks and contingency - Prepare for the possibility that larger fiscal support could be required in a downside scenario, with careful attention to fiscal sustainability and financing conditions. ### Fiscal stance and near-term policy - Fiscal expansion balanced protecting the economy and preserving fiscal space. - Government debt financing: average maturity increased from 8.2 years at end-2019 to 9.5 years at end-June 2020. - Fiscal policy should remain supportive in 2021; prompt adoption of the 2021 budget recommended to: - prioritize and reallocate spending to areas of greatest need, - plan for growth-boosting reforms, - make contingencies for downside risks, - support transparency and confidence. - Some stimulus measures expected to expire by end-2020; unemployment benefits and grants for businesses extended to mid-2021. - Infrastructure spending has low implementation rate and is likely to carry over to 2021. - Revenues projected to recover with the economic rebound. - General government deficit is projected to decline by about 3½ percent of GDP in 2021 in the absence of further support measures. - Authorities should consider maintaining fiscal support if downside risks materialize by: - allocating additional funding for health services, - extending unemployment benefits beyond mid-2021, - providing further grants for the self-employed. ### Withdrawal timing and multiplier assumptions - Withdrawal of fiscal support may need to occur more slowly than projected under the baseline if the output gap and scarring are larger than envisaged. - Analysis assumes higher multipliers than typical for Israel (slightly below one), commensurate with the higher than typical output gap. - Multipliers embedded in 3 models used by the BoI average about 2/3 for public consumption and indirect taxes, and about 1/3 for direct taxes. - Projections subject to great uncertainty; authorities need to continue balancing support with preserving fiscal space. ### Fiscal policy mix and stages: Lockdown, Reopening, Recovery - Lockdown measures: - Households: grants and unemployment benefits with greater coverage and duration. - Firms: tax deferrals, property tax cuts, SME loan guarantees supported liquidity. - Modest public investment funded. - Reopening measures: - Unemployment benefits (including for furloughed) extended and linked to unemployment levels. - Grants introduced during lockdown allowed to expire. - New employment encouragement grants started in July; take-up minimal as of August. - Provision of guaranteed loans gradually slowed. - Recovery priorities: - Phase out blanket transfers and benefits; develop plans to bolster social protection and strengthen targeted benefits. - Preserve incentives to work by raising the earned income tax credit. - Replace one-off employment encouragement grants with active labor market policies (ALMPs). - Scale up public investment projects in pipeline focusing on job-rich and inclusive projects. - Implement comprehensive tax and benefit reform to stabilize debt while supporting productivity and growth. ### Quantitative fiscal outlook and consolidation needs - Debt and deficits - Staff baseline projects general government debt will increase from 60 percent of GDP at end-2019 to 80 percent by end 2021 and will remain on a mildly upward path over the medium term even with roll-off of pandemic-related measures. - As stimulus measures expire and the output gap narrows over the medium term, the deficit is expected to decline to about 4½ percent of GDP. - The 2025 primary deficit is projected to be slightly above the debt-stabilizing primary balance and higher than the level needed gradually to rebuild buffers. - Once recovery is on firm ground, a structural consolidation of about 2–2½ percent of GDP would be needed to place debt on a solid downward path under the baseline. - Such a consolidation would be sufficient to stabilize debt even under a severe economic scarring scenario. - Pre-COVID debt-to-GDP target of the government was 60 percent. - Tax reform and revenue measures - Revenues should be the main driver of fiscal adjustment given low level of civilian spending and need to raise infrastructure, education, and ALMP spending. - Options and recommendations: - Reduce tax benefits while preserving incentives for labor force participation, particularly of minority segments. - Increase personal income tax rates to raise revenues at higher incomes without hurting marginal work incentives. - Raise the earned income tax credit to protect the poor and improve progressivity. - Reduce tax incentives that disproportionately favor selected subgroups (e.g., training fund allowances). - Streamline pension tax exemptions that reduce revenues and undermine equity and efficiency. - Scale back profit-based corporate tax incentives and increase statutory rates on intellectual property income. - Authorities concurred fiscal support short-term and plan consolidation long-term; agreed on need to pass a 2021 fiscal budget that remains supportive and approves reforms to encourage growth. ### Social protection and program execution details - Providing unemployment benefits for furloughed workers is similar to short-term work programs—to the extent beneficiaries return to work for the same employer. - It took 4-months to execute 80 percent of the SME allocation. - Unemployment benefits rules: benefits will be reduced by 10 percent if unemployment and furlough declines below 10 percent and eliminated if it falls below 7.5 percent or after June 2021—whichever is earlier. ### Monetary and financial policies - Monetary actions and liquidity - Decisive, early, and appropriate monetary policy measures helped provide market liquidity and sustain credit flow to households and businesses. - Measures reduced pressures on exchange rates, bond yields and corporate spreads since March. - Measures helped accommodate increase in government financing needs; bond market protected from severe disruptions; problem assets not a pressing concern thus far. - Roadmap highlights: - Monetary policy: moderate rate easing of 15 bps given zero lower bound and greater use of unconventional tools via asset purchase programs. Maintain monetary policy accommodation until policy objectives are achieved. - Liquidity to core funding markets: secondary market purchases of government bonds (up to NIS 85 bill); FX swaps (up to $15 bill). BoI asset purchases keep market financing costs and premia contained; adjust pricing as appropriate to prepare for exit. Withdraw support in recovery stage. - Liquidity to financial institutions: secondary market purchases of government bonds and repos providing liquidity. Maintain monetary operations and asset purchase operations; maintain liquidity support as required for monetary policy accommodation. - Provision of credit and macroprudential measures: released 1 pp of capital buffers and 1 pp tier 1 capital requirement on housing loans; reduced banks’ leverage ratio by 0.5 pp in November; allowed LTV cap increase from 50 to 70 percent. - The BoI used over $14 billion in FX purchases as an unconventional monetary policy tool to curb the exchange rate pass-through from the shekel appreciation to prices. - The BoI’s asset purchase program ceilings: government bonds is 6.6 percent of GDP, 40 percent of which unutilized, and corporate bonds is 1.1 percent of GDP, 75 percent of which unutilized, as of end-November 2020. - The BoI estimates the passthrough from the NIS/USD exchange rate to inflation at approximately 10 percent. - Given comfortable reserve levels, exchange rate flexibility should be the first line of defense against external shocks. - As inflation trends toward the target band, the BoI should cease FX intervention in managing inflation expectations and limit its use to addressing disorderly market conditions. ### Financial sector measures and macroprudential stance - Macroprudential and banking sector resilience - Leniency on LTV caps; encouraged but no explicit ban on dividend and buybacks. - Macroprudential flexibility has been retained. - The initial government guaranteed loan allocation to SMEs (NIS 18 bn) was fully disbursed; second NIS 18 bn allocation adopted. - Re-build capital and liquidity buffers gradually over time while ensuring financial institutions’ capacity to extend credit. - Banks entered the COVID-19 crisis with strong capital and profitability positions, underpinned by conservative business models. - Capital buffers remain strong even after the release of 1 percentage point of capital and elimination of additional Tier-1 equity capital requirements for housing loans. - Lowering banks’ leverage ratio by 0.5 percentage points in November provided additional lending space. - The relaxation of the LTV cap from 50 to 70 percent for residential loans remains still conservative on a cross-country basis. - Banks are funded predominantly by domestic deposits and a focus on diversified household lending has contained credit risks. - Insurance and pension sectors have raised their share of foreign equity investments following a rebound in global capital markets. - Addressing problem assets and provisioning - Guidance on asset classification and provisioning encourages restructuring of affected borrowers. - Banks allowed to use pre-COVID income for capital calculation. - Require banks to develop credible plans to reduce problem assets. - Create asset management companies and markets for problem assets. - Banks have started raising credit loss provisions in 2020 in anticipation of larger losses. - BoI sensitivity tests show banks have ample capital to absorb losses in medium severity scenarios, but some banks will approach their minimum capital targets in the most severe scenario. - Household scenario (housing loans and household related credit) erased 0.7–1.5 percentage points of bank capital. - SME scenario erased 0.3–1.3 percentage points of capital. - In every scenario all banks remain above the regulatory minima (9 percent for largest two banks; 8 percent for others). - Private debt restructuring, loan deferrals, and insolvency preparedness - Mortgage forbearance allowed, and a framework for loan deferrals adopted (about NIS 10 bn in loans of 0.8 mill borrowers deferred in March-October, representing about 15 percent of banks’ total loan portfolio and a quarter of mortgages). - Deadline for deferral requests was extended to prevent widespread insolvencies. - Banks’ discretion to defer household loans should be gradually restored. - Facilitate debt restructuring to reduce debt burden. - Prepare for efficient and effective insolvency procedures. - New Insolvency Law (in effect as of September 2019) added provisions for out-of-court restructuring; adequate resources and mechanisms to implement the legislation efficiently need to be put in place ahead of a possible insolvency surge. - Liquidity support and targeting - Liquidity support extended in response to new lockdowns could be more targeted and needs to be supported by adequate corporate data analysis. - If lockdowns and distancing measures are prolonged, potential deterioration of credit quality could emerge as a key downside risk, especially if economic disruptions continue well into 2021. - Targeted fiscal measures instead of credit could be a more efficient way to help the most vulnerable firms and individuals. - Financing support should remain helpful but eligibility criteria would gradually have to be tightened to ensure support goes only to viable firms. - Strengthening data collection and methodologies is critical to better assess vulnerabilities of households and firms. - The FSC should play a focal role ahead in analysis and policy coordination in addressing such vulnerabilities. ### Macro-structural policies: labor market, digitalization, education, and public investment - Labor market and ALMPs - Structural policies need to mitigate long-term scarring and strengthen the resilience of the economy. - Addressing vulnerabilities in the labor market should take priority. - More than 30 percent of employed workers were furloughed; about 26 percent of contact-intensive sector workers remained furloughed as of end-October. - These sectors have accounted for more than half of job losses. - Employment among those working part-time remains 37 percent below its pre-COVID level. - More than two thirds of employees in the affected sectors are low-skilled—with a high-school degree or less—making retraining and reallocation challenging. - Funding should increase significantly for ALMPs that promote reskilling and upskilling, encourage job search and reduce hiring costs. - Vocational training programs could be expanded to address skill gaps of low-skilled workers. - Digitalization and education - Digitalization: less than 40 percent of Israelis visit or interact with existing online/electronic government platforms vs. 70 percent in OECD countries. - Only half of low-skilled individuals in Israel have internet access (vs. near 70 percent on average in OECD). - Only 9 percent of low-skilled individuals in Israel interact with public authorities via the internet (vs. a third of low-skilled in OECD countries). - Policies that broaden digital penetration among low-skilled individuals have high potential to increase knowledge diffusion and productivity and mitigate skill shortages. - Education setbacks from lockdowns require planning, training, and investment in technology; emphasis on math, sciences, and technology recommended. - Among advanced economies, Israel has one of the highest numbers of expected years of education and the second lowest PISA score. - Education reforms that raise schooling achievement scores above the average in advanced economies could boost (pre-COVID) productivity by 5–15 percent in the long run. - Public investment - Israel’s stock of public capital is below that of peer countries; public investment is likely to have an unusually powerful growth impact given the output gap and underutilized resources. - Public investment projects—particularly in health care, transportation, digitalization infrastructure—can strengthen crisis resilience and encourage private investment. ### Governance, procurement, and AML/CFT - AML/CFT and supervision - Improvements in the AML/CFT framework have raised Israel’s capacity to one of the most effective among advanced economies, though scope exists to improve the regime and risk-based supervision of certain unregulated entities (e.g., real estate agents). - Further efforts needed to ensure financial institutions consistently apply enhanced due diligence. - Procurement - Procurement reforms recommended: reduce exceptions from competitive bidding rules; ban entities convicted of crimes abroad from participating in procurement tenders; publish verified beneficial owners of procurement contracts; develop a strategy for assessing procurement risks. - Public procurement in Israel is 15 percent of GDP relative to a 12-percent OECD average. ### Staff appraisal and policy recommendations (summary) - The Israeli economy entered the COVID-19 pandemic from a position of strength but experienced an historic contraction. - Appropriately rapid and large monetary and fiscal support helped soften the impact of the pandemic. - Real GDP is projected to rebound in 2021 but to remain below its pre-COVID trend; risks to the outlook are significant. - Fiscal policy should remain supportive and gradually become more targeted; prompt adoption of the 2021 budget would help prioritize spending. - Fiscal support should be maintained beyond mid-2021, particularly if further downside risks materialize; focus on health sector, social protection, ALMPs, and job-rich public investment. - Once recovery is on firm ground, fiscal effort will be needed to restore pre-crisis buffers and rebuild fiscal space. - Monetary policy should remain accommodative with emphasis on asset purchases to keep term premia in check and preserve bond market functioning. - Israel’s financial system is well prepared to face the COVID-19 shock; unless downside risks materialize, the level of minimum regulatory capital should not be lowered further and structural buffers should eventually be restored. - Efficient handling of potential increase in nonperforming loans and insolvencies would help limit debt overhang and spur productivity-enhancing capital reallocation. - Structural policies should strengthen resilience: labor activation, digital penetration, education reforms, and completing governance reforms to support public investment. ### Risk Assessment Matrix (Box 1) — selected scenarios - Unexpected shift in the Covid-19 pandemic - Likelihood: High (downside), Low (upside). - Impact: High (downside), Medium (upside). - Policy response: Provide adequate health support; target fiscal policy to viable companies and vulnerable households and workers. - Widespread social discontent and political instability - Likelihood: High. - Impact: High. - Policy response: Provide targeted support to vulnerable groups, including ALMPs; adopt the 2021 budget promptly. - Intensified geopolitical tensions and security risks - Likelihood: High. - Impact: High. - Policy response: Allow temporary deviation of defense spending; gradually rebuild structural and contingency buffers for geopolitical risks. ### Annex I. External Sector Assessment — key findings - Overall assessment - External position in 2020 was "moderately stronger than the level implied by medium-term fundamentals and desirable policies." - CA balance projected to have improved in 2020 amid sharp decline in trade. - Foreign assets and liabilities - NIIP projected to increase from 41 percent of GDP in 2019 to 46 percent of GDP in 2020. - Gross external debt projected to increase to 32 percent of GDP, mainly due to government foreign bond issuances of $19 billion. - New government debt issued at very long maturities (above 10 years), lengthening average maturity of government external debt to 17 years. - 2020 projections (percent of GDP): NIIP: 46.1; Gross Assets: 141.8; Debt Assets: 76.5; Gross Liab.: 95.7; Debt Liab.: 31.8. - Current account - CA balance projected to increase from 3.4 percent in 2019 to 4.0 percent of GDP in 2020. - EBA CA analysis: cyclically adjusted 2020 CA balance is above the level warranted by fundamentals and appropriate policies by 1.3 percent of GDP, with a policy gap of 0.4 percent of GDP. - Text Table: Israel: Model Estimates for 2020 (Percent of GDP) - CA-Actual: 4.04 - Cyclical Contributions: 1.72 - EBA model results: 0.63 - Oil adjustment: 0.64 - Tourism adjustment: 0.45 - Adjusted CA: 2.32 - CA Norm (from model) 1/: 0.20 - Adjusted CA Norm: 1.00 - CA Gap: 1.32 (o/w Policy gap: 0.45) - Elasticity: -0.23 - REER Gap: -5.74 - REER level: -5.7 - REER index: 23.8 - REER (third column): -2.6 - Real exchange rate (REER) - CPI-based REER appreciated by 9 percent over the last decade; ULC-based REER appreciated by 20 percent. - Large variation in REER gap estimates across models: REER-index model implies overvaluation of 10.7 percent; REER-level model implies overvaluation of 23.8 percent; implied CA gap suggests an undervaluation of 5.7 percent. - Capital and financial accounts - Net capital inflows of $10.8 billion occurred in 2020H1, substantially larger than $0.5 billion in 2019H1. - Drivers include upsurge of inward FDI ($15.8 billion) and government foreign bond issuance. - FX intervention and reserves - Net international reserves rose to $166.9 billion (43.1 percent of GDP, 18 months of imports) by November 2020 from $126.0 billion (32 percent of GDP) at end-2019. - BoI intervention averaged $1.5 billion per month in 2020. - Recommendation: cease FX intervention to manage inflation expectations as inflation trends toward target; limit FX intervention to disorderly market conditions. ### Annex II. Scarring scenarios (summary) - Range of medium-term scarring relative to pre-COVID trend: 0.3–4.2 percent. - Baseline: annual persistence between 0.6 and 0.8 → output around 1 percent below pre-COVID level by 2025. - Worse scenario (persistence 0.9): output 4.2 percent below pre-COVID path by 2025. - Less severe (persistence ~0.45): medium-term scarring would be less than 0.3 percent. - Drivers and quantitative impacts: - Productivity: Israel’s pre-pandemic labor productivity was 24 percent lower than the OECD average (BoI, 2019). COVID-19 could cause contemporaneous productivity loss of about 1 percent and cumulative loss of about 4 percent in the medium term. - Precautionary savings: household propensity to make major purchases declined by more than 30 percentage points since beginning of 2020; estimated household savings could rise from 21.4 percent of disposable income to 23.4 percent under certain scenarios. - Corporate vulnerabilities in hard-hit sectors could lead to investment declines of 0.8-2.7 percent of total fixed assets. ### Annex III. Withdrawing Fiscal Stimulus: When and How Fast? - Context and model setup - Staff’s baseline projections: deterioration of the primary fiscal balance of about 7 percent of GDP in 2020; output gap of about 5.2 percent of potential GDP. - Model: calibrated Fournier (2019) buffer-stock model; Carnot rule used as a rule-of-thumb. - Baseline model findings - Model suggests a slightly smaller stimulus withdrawal in 2021—by about 0.3 percent of GDP—relative to staff’s baseline, helping close the output gap faster but raising debt. - Need for a larger fiscal consolidation in the long run than staff’s baseline; consistent with advice of pursuing an adjustment of 2–2½ percent of GDP once growth is on a strong footing. - Sensitivities and scenarios - Lower potential growth → less room for countercyclical policy. - Lower interest rates → more room for countercyclical policy. - More effective fiscal policy (higher multipliers) → reduces the size of needed stimulus and helps preserve fiscal space. - High hysteresis (high scarring) calls for stronger countercyclical policy now and faster fiscal adjustment later. - Policy implications - Fiscal stimulus should focus on programs with high impact on aggregate demand given multiplier considerations. - Fiscal policy should respond flexibly to evolving circumstances and be ready to adjust as evidence on persistence and scarring emerges. - Planning for an appropriate contingency reserve in the 2021 budget is recommended. ### Appendix IV: Public DSA — composition and stress tests (selected points) - Baseline macro-fiscal assumptions (selected) - Real GDP growth: 2020 -4.0; 2021 4.1; 2022 5.0; 2023 4.6; 2024 4.1; 2025 3.6 - Inflation: 2020 -0.8; 2021 1.1; 2022 0.7; 2023 0.8; 2024 0.9; 2025 0.9 - Primary Balance: 2020 -11.3; 2021 -7.5; 2022 -4.6; 2023 -2.5; 2024 -2.2; 2025 -1.9 - Effective interest rate: 2020 4.5; 2021 3.7; 2022 3.3; 2023 3.1; 2024 3.0; 2025 2.9 - External DSA highlights - External debt: 2019 26.6 percent of GDP; projected 2020 31.8 percent of GDP; projected to decline to 24.7 percent of GDP in 2025 under baseline. - Gross external financing needs (billions of US dollars): 2015 24.5; 2016 24.5; 2017 24.4; 2018 30.9; 2019 26.3; 2020 34.9; 2021 30.2; 2022 31.3; 2023 33.7; 2024 32.2; 2025 29.7 - Share of short-term external debt: 36 percent at end-June 2020 and fully covered by international reserves (reserves equal to 4 times short-term debt). - Sensitivity: a 30 percent real depreciation in 2020 would increase external debt by 11 percent of GDP, with more than half of the increase dissipating in the medium term. ### Political developments and recent events (as of January 2021) - Parliament was dissolved on December 23 after the coalition government failed to agree on a budget for 2020, triggering parliamentary elections in March; PM Netanyahu heads interim caretaker government. - Ad-hoc parliamentary approval for NIS 72 billion (about 5 percent of GDP) in pandemic-related spending in line with authorities’ 2021 plans. - Legal amendments allow 2021 government spending allocation to increase in line with population growth rather than with inflation. - Authorities report rapid vaccine campaign: administering more than 1.8 million doses to around 20 percent of the population as of January 10, 2021. - BOI optimistic scenario: GDP expected to expand by 6.3 percent in 2021 and 5.8 percent in 2022 (assumes rapid inoculation until May 2021 and no government restrictions thereafter). - Staff baseline: 4.1 percent in 2021 and 5 percent in 2022. - BOI pessimistic scenario: GDP growth of 3.5 percent in 2021 and 6 percent in 2022 (assumes inoculation lasting until June 2022). - Fiscal authorities note pre-crisis public debt up to 60 percent of GDP and emphasize objective of returning and preserving IP as a recovery tool. - BOI actions: rapid liquidity supply in shekels and FX, programs to support credit to small businesses, and on January 17, 2021 announced change in restriction on mortgage loans indexed to the policy rate (from one-third to two-third of the loan) to reduce mortgage burden. - Financial system monitoring: BoI sensitivity tests show banks stable under severe scenarios; Financial Stability Committee and CMISA active. _Italic: Source: IMF staff chapter "1. Roadmap of Fiscal Actions" and associated annexes and boxes (extracted content; 1isrea2021001)._ ### 1. Roadmap of Fiscal Actions ____________________________________________________________________ 14 ### 1. Roadmap of Fiscal Actions ### Context - Pre-pandemic growth and structure - Real annual GDP growth averaged about 3.5 percent in 2000–19. - ICT sector accounts for 19 percent of value added and is a major contributor to growth. - Labor productivity outside ICT is low; overall labor productivity is well below that of other small open advanced economies. - Precrisis fiscal and financial buffers - Household debt at end-2019: about 42 percent of GDP (about two-thirds high-quality mortgage loans). - Corporate debt: 68 percent of GDP (largely domestic). - Net international investment position: 40 percent of GDP at end-2019. - Gross external debt: 27 percent of GDP. - Social and political context - Relative poverty concentrated among Israeli-Arab and Haredi groups. - Fragile coalition with political uncertainty; a two-year budget was envisaged but deadline extended. - Geopolitical tensions exist; peace accords with the UAE and Bahrain are a positive development. ### Recent Economic Developments - Pandemic impact and containment - Early containment measures, reopening in mid-April, resurgence in June, second nationwide lockdown in mid-September. - Macroeconomic outcomes through 2020 - Real output collapsed by 3 percent yoy in January–September 2020. - Private consumption fell by 10 percent yoy (largest contribution to output plunge). - Severely affected sectors: accommodation and food services, transportation, wholesale and retail trade (heavily affected sectors ~15 percent of gross value added). - Revenues in accommodation and transportation were 41 and 21 percent below pre-COVID levels as of September. - Monetary policy and financial stability measures (Bank of Israel actions) - Policy interest rate reduced by 15 basis points to 0.1 percent. - Asset purchase programs with a total ceiling of about 6½ percent of GDP (NIS 85 billion); about 3.4 percent of GDP utilized as of end-November. - Corporate bond purchase program ceiling: NIS 15 billion (around NIS 3.5 billion purchased by end-November). - Term funding to banks (two tranches, 3-year and 4-year) for on-lending to SMEs. - Macroprudential easing: reduced regulatory capital by 1 percentage point, eliminated additional Tier-1 capital charge on housing loans, reduced leverage ratio requirements in November, raised loan-to-value cap on residence-backed loans from 50 to 70 percent, and other targeted measures. - Fiscal policy response - Planned fiscal stimulus in 2020: NIS 138 billion (about 10¼ percent of GDP), including: expanded health funding; benefits for unemployed and furloughed workers and grants for the self-employed; guaranteed loans, temporary property tax exemptions, tax and payment deferrals; infrastructure and investment support. - Execution rate expected to exceed 86 percent by year end. - 2020 deficit outturn expected to be about 13 percent of GDP. - Additional funding of NIS 72½ billion approved for 2021 (including to extend benefits for unemployed and furloughed workers). - Labor market and prices - 1.8 million workers (31 percent of labor force) were furloughed at peak. - More than 80 percent of furloughed workers recouped jobs before the second lockdown. - Seasonally adjusted unemployment rate: 4.7 percent in October 2020 (compared with 3.6 percent at beginning of 2020). - Real wages increased by 7 percent in the first eight months of 2020. - Headline CPI: declined by 1.6 percent yoy in May and remained suppressed; core inflation also negative. - 5- and 10-year inflation expectations remain anchored within the 1–3 percent target band. - External sector - Imports down 10 percent yoy in January–September, driven by a 40 percent drop in transportation equipment and fuel imports. - Exports increased by 0.3 percent, supported by ICT exports (high-tech: about 50 percent of goods exports and over 50 percent of service exports). - Net international reserves: $166.9 billion in November 2020 (18 months of imports), up from $126 billion at end-2019; $19 billion of the increase due to sovereign bond issuances. ### Outlook and Risks - Near-term outlook (staff baseline) - 2020: Real GDP decline projected at 4.0 percent. - 2020 inflation projections: headline –0.5 percent (average), core –0.4 percent (average). - Output gap in 2020: negative 5.2 percent of potential GDP. - Unemployment projected to rise to over 5 percent by end-2020. - 2021: Real GDP projected to increase by 4.1 percent; real GDP projected to remain 5.7 percent below its pre-COVID level in early 2021. - Medium-term scarring - Real GDP and potential output projected about 1 percent below the 2025 pre-COVID trend (Annex II). - Scarring projected to be relatively limited compared to other advanced economies, partly due to ICT share of value added (19 percent vs OECD average 11 percent). - Negative output gap not projected to close until 2025; inflation below BoI’s target well into the medium term. - Risks: unprecedented and multidimensional - Upside: early widespread vaccine distribution could boost confidence and speed recovery (Israeli contracts with major vaccine producers for early delivery and vaccination commencing in December cited as a plausible upside). - Downside: reescalation of the pandemic with tighter or prolonged lockdowns, higher fiscal support needs that could exhaust fiscal space and jeopardize fiscal sustainability; tightening of global financing conditions; adverse regional geopolitical developments; deglobalization and reshoring risks. - Macroeconomic projection table (selected rows, in percent / percent of GDP) - Real GDP growth: 2019 3.4, 2020 -4.0, 2021 4.1, 2022 5.0, 2023 4.6, 2024 4.1, 2025 3.6 - Unemployment: 2019 3.8, 2020 4.5, 2021 5.9, 2022 4.9, 2023 4.5, 2024 4.2, 2025 4.0 - Inflation (eop): 2019 0.6, 2020 -0.7, 2021 0.5, 2022 0.5, 2023 0.8, 2024 0.8, 2025 0.8 - Fiscal balance (percent of GDP): 2019 -3.9, 2020 -13.3, 2021 -9.7, 2022 -6.8, 2023 -4.9, 2024 -4.5, 2025 -4.3 - Current account balance (percent of GDP): 2019 3.4, 2020 4.0, 2021 3.7, 2022 3.5, 2023 3.3, 2024 3.1, 2025 2.9 ### Policy Discussions: Navigating Reopening and Recovery - Overarching policy guidance - Near term: fiscal policy should become more targeted to maximize impact of available fiscal space; monetary policy should remain accommodative. - Structural policies should mitigate labor market vulnerabilities, strengthen economic resilience, and foster a more inclusive recovery. - Medium term: resume fiscal consolidation in a growth-friendly way to restore pre-COVID fiscal buffers; gradually withdraw exceptional monetary easing. - Fiscal policy assessment and recommendations - Fiscal support effectiveness - Healthcare funding (~1 percent of GDP) was urgently needed and boosted capacity. - Support for households (unemployment and furlough benefits, grants for self-employed) mitigated the pandemic’s negative distributional impacts and supported aggregate demand due to high marginal propensity to consume among low-income households. - Liquidity support for businesses (guaranteed loans, tax deferrals, grants) was the main focus for corporate support. - Poorly targeted universal programs (e.g., “grants for every citizen”) likely had lower growth and distributional impact. - Adequacy and sequencing - The volume of fiscal support in 2020 is assessed as adequate given plans: general government deficit estimated at about 13 percent of GDP in 2020 (an increase of about 9 percent of GDP relative to pre-crisis). - As recovery becomes established and scarring risks recede, fiscal consolidation should resume to rebuild buffers. - Distributional and labor-market priorities - Focus support on low-skilled and low-income workers disproportionately affected (those more likely to be furloughed or dismissed). - Invest in policies that enhance labor reallocation toward higher-productivity sectors and skills. - Risks and contingency - Prepare for the possibility that larger fiscal support could be required in a downside scenario, with careful attention to fiscal sustainability and financing conditions. *Source: IMF staff chapter "1. Roadmap of Fiscal Actions" (extracted content).* ### 2019. Nonetheless, in view of the exceptional uncertainty, the fiscal expansion has balanced ### 1isrea2021001 - 2019. Nonetheless, in view of the exceptional uncertainty, the fiscal expansion has balanced ### Fiscal stance and near-term policy - Fiscal expansion balanced protecting the economy and preserving fiscal space. - Government debt financing: average maturity increased from 8.2 years at end-2019 to 9.5 years at end-June 2020. - Fiscal policy should remain supportive in 2021; prompt adoption of the 2021 budget recommended to: - prioritize and reallocate spending to areas of greatest need, - plan for growth-boosting reforms, - make contingencies for downside risks, - support transparency and confidence. - Some stimulus measures expected to expire by end-2020; unemployment benefits and grants for businesses extended to mid-2021. - Infrastructure spending has low implementation rate and is likely to carry over to 2021. - Revenues projected to recover with the economic rebound. - General government deficit is projected to decline by about 3½ percent of GDP in 2021 in the absence of further support measures. - Authorities should consider maintaining fiscal support if downside risks materialize by: - allocating additional funding for health services, - extending unemployment benefits beyond mid-2021, - providing further grants for the self-employed. ### Withdrawal timing and multiplier assumptions - Withdrawal of fiscal support may need to occur more slowly than projected under the baseline if the output gap and scarring are larger than envisaged. - Analysis assumes higher multipliers than typical for Israel (slightly below one), commensurate with the higher than typical output gap. - Multipliers embedded in 3 models used by the BoI average about 2/3 for public consumption and indirect taxes, and about 1/3 for direct taxes. - Projections subject to great uncertainty; authorities need to continue balancing support with preserving fiscal space. ### Fiscal policy mix and stages: Lockdown, Reopening, Recovery - Overall view: mix appropriate during lockdown and reopening; should gradually become more targeted, with priority on health sector to ensure hospital capacity, testing and tracing, and unmet care needs. - Lockdown measures: - Households: grants and unemployment benefits with greater coverage and duration. - Firms: tax deferrals, property tax cuts, SME loan guarantees supported liquidity. - Modest public investment funded. - Reopening measures: - Unemployment benefits (including for furloughed) extended and linked to unemployment levels. - Grants introduced during lockdown allowed to expire. - New employment encouragement grants started in July; take-up minimal as of August. - Provision of guaranteed loans gradually slowed. - Recovery priorities: - Phase out blanket transfers and benefits; develop plans to bolster social protection and strengthen targeted benefits. - Preserve incentives to work by raising the earned income tax credit. - Replace one-off employment encouragement grants with active labor market policies (ALMPs). - Scale up public investment projects in pipeline focusing on job-rich and inclusive projects. - Implement comprehensive tax and benefit reform to stabilize debt while supporting productivity and growth. ### Quantitative fiscal outlook and consolidation needs - Staff baseline projects general government debt will increase from 60 percent of GDP at end-2019 to 80 percent by end 2021 and will remain on a mildly upward path over the medium term even with roll-off of pandemic-related measures. - As stimulus measures expire and the output gap narrows over the medium term, the deficit is expected to decline to about 4½ percent of GDP. - The 2025 primary deficit is projected to be slightly above the debt-stabilizing primary balance and higher than the level needed gradually to rebuild buffers. - Once recovery is on firm ground, a structural consolidation of about 2–2½ percent of GDP would be needed to place debt on a solid downward path under the baseline. - Such a consolidation would be sufficient to stabilize debt even under a severe economic scarring scenario. - Rebuilding pre-crisis buffers will take a long time; further measures needed to create fiscal space to strengthen the safety net and improve infrastructure. - Pre-COVID debt-to-GDP target of the government was 60 percent. ### Tax reform and revenue measures - Revenues should be the main driver of fiscal adjustment given low level of civilian spending and need to raise infrastructure, education, and ALMP spending. - Options and recommendations: - Reduce tax benefits while preserving incentives for labor force participation, particularly of minority segments. - Increase personal income tax rates to raise revenues at higher incomes without hurting marginal work incentives. - Raise the earned income tax credit to protect the poor and improve progressivity. - Reduce tax incentives that disproportionately favor selected subgroups (e.g., training fund allowances). - Streamline pension tax exemptions that reduce revenues and undermine equity and efficiency. - Scale back profit-based corporate tax incentives and increase statutory rates on intellectual property income. - Authorities concurred fiscal support short-term and plan consolidation long-term; agreed on need to pass a 2021 fiscal budget that remains supportive and approves reforms to encourage growth. ### Social protection and program execution details - Providing unemployment benefits for furloughed workers is similar to short-term work programs—to the extent beneficiaries return to work for the same employer. - It took 4-months to execute 80 percent of the SME allocation. - Unemployment benefits rules: benefits will be reduced by 10 percent if unemployment and furlough declines below 10 percent and eliminated if it falls below 7.5 percent or after June 2021—whichever is earlier. ### Monetary and financial policies - Decisive, early, and appropriate monetary policy measures helped provide market liquidity and sustain credit flow to households and businesses. - Measures reduced pressures on exchange rates, bond yields and corporate spreads since March. - Measures helped accommodate increase in government financing needs; bond market protected from severe disruptions; problem assets not a pressing concern thus far. - Roadmap highlights (Text Table 2): - Monetary policy: moderate rate easing of 15 bps given zero lower bound and greater use of unconventional tools via asset purchase programs. Accommodation maintained to date. Maintain monetary policy accommodation until policy objectives (e.g., inflation target) are achieved. - Liquidity to core funding markets: secondary market purchases of government bonds (up to NIS 85 bill); FX swaps (up to $15 bill). BoI asset purchases keep market financing costs and premia contained; adjust pricing as appropriate to prepare for exit. Withdraw support in recovery stage. - Liquidity to financial institutions: secondary market purchases of government bonds and repos providing liquidity. Maintain monetary operations and asset purchase operations; maintain liquidity support as required for monetary policy accommodation. - Provision of credit and macroprudential measures: released 1 pp of capital buffers and 1 pp tier 1 capital requirement on housing loans; reduced banks’ leverage ratio by [text truncated in source]. *Source: IMF staff report excerpt provided in the content unit.* ### 0.5 pp in November; allowed ### 1isrea2021001 - 0.5 pp in November; allowed ### Financial sector measures and macroprudential stance - Leniency on LTV caps; encouraged but no explicit ban on dividend and buybacks. - Macroprudential flexibility has been retained. - The initial government guaranteed loan allocation to SMEs (NIS 18 bn) was fully disbursed; second NIS 18 bn allocation adopted. - Re-build capital and liquidity buffers gradually over time while ensuring financial institutions’ capacity to extend credit. - Banks entered the COVID-19 crisis with strong capital and profitability positions, underpinned by conservative business models. - Capital buffers remain strong even after the release of 1 percentage point of capital and elimination of additional Tier-1 equity capital requirements for housing loans. - Lowering banks’ leverage ratio by 0.5 percentage points in November provided additional lending space. - The relaxation of the LTV cap from 50 to 70 percent for residential loans remains still conservative on a cross-country basis. - Banks are funded predominantly by domestic deposits and a focus on diversified household lending has contained credit risks. - Insurance and pension sectors have raised their share of foreign equity investments following a rebound in global capital markets. ### Addressing problem assets and provisioning - Guidance on asset classification and provisioning encourages restructuring of affected borrowers. - Banks allowed to use pre-COVID income for capital calculation. - Measures have been maintained through the reopening phase. - Require banks to develop credible plans to reduce problem assets. - Handle weak banks with significant credit losses. - Create asset management companies and markets for problem assets. - Banks have started raising credit loss provisions in 2020 in anticipation of larger losses. - The BoI’s sensitivity tests show banks have ample capital to absorb losses in medium severity scenarios, but some banks will approach their minimum capital targets in the most severe scenario. - The household scenario (housing loans and household related credit) erased 0.7–1.5 percentage points of bank capital, while the SME scenario erased 0.3–1.3 percentage points of capital. - In every scenario all banks remain above the regulatory minima (9 percent for largest two banks; 8 percent for others). ### Private debt restructuring, loan deferrals, and insolvency preparedness - Mortgage forbearance allowed, and a framework for loan deferrals adopted (about NIS 10 bn in loans of 0.8 mill borrowers deferred in March-October, representing about 15 percent of banks’ total loan portfolio and a quarter of mortgages). - Deadline for deferral requests was extended to prevent widespread insolvencies in the face of ongoing lockdowns. - Banks’ discretion to defer household loans should be gradually restored. - Facilitate debt restructuring to reduce debt burden. - Prepare for efficient and effective insolvency procedures. - The BoI has established a framework for bank loan deferrals of smaller loans (including for SMEs), which has been extended several times. - The new Insolvency Law, in effect as of September 2019, added provisions for out-of-court restructuring; adequate resources and mechanisms to implement the legislation efficiently need to be put in place ahead of a possible insolvency surge. ### Liquidity support and targeting - Liquidity support extended in response to new lockdowns could be more targeted and needs to be supported by adequate corporate data analysis. - If lockdowns and distancing measures are prolonged, potential deterioration of credit quality could emerge as a key downside risk, especially if economic disruptions continue well into 2021. - Targeted fiscal measures instead of credit could be a more efficient way to help the most vulnerable firms and individuals. - Financing support should remain helpful but eligibility criteria would gradually have to be tightened to ensure support goes only to viable firms. - Strengthening data collection and methodologies is critical to better assess vulnerabilities of households and firms. - The FSC should play a focal role ahead in analysis and policy coordination in addressing such vulnerabilities. ### Monetary policy, FX intervention, and reserves - Monetary accommodation through unconventional measures and liquidity support should be maintained. - Extending the current set of policies remains broadly appropriate given low near-term inflation expectations, negative output gap projections, and uncertainties on renewed lockdowns. - While keeping the policy rate around the zero-lower bound, the authorities’ emphasis on unconventional measures, such as asset purchases, is also appropriate. - Term premia, most notably for corporate bond spreads, remain elevated; preserving bond market functioning anchored by the benchmark government yield curve remains crucial for financing. Some scope exists for continuing government and corporate bond purchases. - The BoI used over $14 billion in FX purchases as an unconventional monetary policy tool to curb the exchange rate pass-through from the shekel appreciation to prices. - The BoI’s asset purchase program ceilings: government bonds is 6.6 percent of GDP, 40 percent of which unutilized, and corporate bonds is 1.1 percent of GDP, 75 percent of which unutilized, as of end-November 2020. - The BoI estimates the passthrough from the NIS/USD exchange rate to inflation at approximately 10 percent. - Given comfortable reserve levels, exchange rate flexibility should be the first line of defense against external shocks. - As inflation trends toward the target band, the BoI should cease FX intervention in managing inflation expectations and limit its use to addressing disorderly market conditions. ### Macro-structural policies: labor market, digitalization, education, and public investment - Structural policies need to mitigate long-term scarring and strengthen the resilience of the economy. - Addressing vulnerabilities in the labor market should take priority. - More than 30 percent of employed workers were furloughed; about 26 percent of contact-intensive sector workers remained furloughed as of end-October. - These sectors have accounted for more than half of job losses. - Employment among those working part-time remains 37 percent below its pre-COVID level. - More than two thirds of employees in the affected sectors are low-skilled—with a high-school degree or less—making retraining and reallocation challenging. - Funding should increase significantly for ALMPs that promote reskilling and upskilling, encourage job search and reduce hiring costs. - Vocational training programs could be expanded to address skill gaps of low-skilled workers. - Digitalization: less than 40 percent of Israelis visit or interact with existing online/electronic government platforms vs. 70 percent in OECD countries. - Only half of low-skilled individuals in Israel have internet access (vs. near 70 percent on average in OECD). - Only 9 percent of low-skilled individuals in Israel interact with public authorities via the internet (vs. a third of low-skilled in OECD countries). - Policies that broaden digital penetration among low-skilled individuals have high potential to increase knowledge diffusion and productivity and mitigate skill shortages. - Education setbacks from lockdowns require planning, training, and investment in technology; emphasis on math, sciences, and technology recommended. - Among advanced economies, Israel has one of the highest numbers of expected years of education and the second lowest PISA score. - Education reforms that raise schooling achievement scores above the average in advanced economies could boost (pre-COVID) productivity by 5–15 percent in the long run. - Israel’s stock of public capital is below that of peer countries; public investment is likely to have an unusually powerful growth impact given the output gap and underutilized resources. - Public investment projects—particularly in health care, transportation, digitalization infrastructure—can strengthen crisis resilience and encourage private investment. ### Governance, procurement, and AML/CFT - Improvements in the AML/CFT framework have raised Israel’s capacity to one of the most effective among advanced economies, though scope exists to improve the regime and risk-based supervision of certain unregulated entities (e.g., real estate agents). - Further efforts needed to ensure financial institutions consistently apply enhanced due diligence. - Procurement reforms recommended: reduce exceptions from competitive bidding rules; ban entities convicted of crimes abroad from participating in procurement tenders; publish verified beneficial owners of procurement contracts; develop a strategy for assessing procurement risks. - Public procurement in Israel is 15 percent of GDP relative to a 12-percent OECD average. ### Staff appraisal and policy recommendations - The Israeli economy entered the COVID-19 pandemic from a position of strength but experienced an historic contraction. - Appropriately rapid and large monetary and fiscal support helped soften the impact of the pandemic. - Real GDP is projected to rebound in 2021 but to remain below its pre-COVID trend; risks to the outlook are significant. - Fiscal policy should remain supportive and gradually become more targeted; prompt adoption of the 2021 budget would help prioritize spending. - Fiscal support should be maintained beyond mid-2021, particularly if further downside risks materialize; focus on health sector, social protection, ALMPs, and job-rich public investment. - Once recovery is on firm ground, fiscal effort will be needed to restore pre-crisis buffers and rebuild fiscal space. - Monetary policy should remain accommodative with emphasis on asset purchases to keep term premia in check and preserve bond market functioning. - Israel’s financial system is well prepared to face the COVID-19 shock; unless downside risks materialize, the level of minimum regulatory capital should not be lowered further and structural buffers should eventually be restored. - Efficient handling of potential increase in nonperforming loans and insolvencies would help limit debt overhang and spur productivity-enhancing capital reallocation. - Structural policies should strengthen resilience: labor activation, digital penetration, education reforms, and completing governance reforms to support public investment. *Description of Israeli authorities’ actions as of November 2020.* ### Box 1. Risk Assessment Matrix ### Box 1. Risk Assessment Matrix ### Risks Overview - The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). - The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline: - "low" is meant to indicate a probability below 10 percent, - "medium" a probability between 10 and 30 percent, - "high" a probability between 30 and 50 percent. ### Unexpected shift in the Covid-19 pandemic - Scenario descriptions: - Downside: The disease proves harder to eradicate (e.g., due to difficulties in finding/distributing a vaccine), requiring more containment efforts and impacting economic activity directly and through persistent behavioral changes (prompting costly reallocations of resources). - Upside: Recovery is faster than expected due to discovery of an effective and widely available vaccine and/or a faster-than-expected behavioral adjustment to the virus that boosts confidence and economic activity. - Likelihood: - High (downside): Failure to contain heightened morbidity leads to prolonged lockdowns. - Low (upside): Earlier than expected vaccine and/or low mortality ease concerns of hospital congestion and allay precautionary behavior. - Impact: - High (downside): Recovery would be more uneven and scarring deeper. Higher solvency risks would lead to corporate bankruptcies and labor market hysteresis, with spillovers to the financial system. Need for greater fiscal support could exhaust limited fiscal space and jeopardize sustainability. - Medium (upside): Strong confidence impact in the near term; activity recovers faster than expected over the medium term and limits or eliminates scarring. - Policy response: - Provide adequate support to the health system and to ensure effective containment through testing and tracing. - Target fiscal policy: provide support to viable companies and vulnerable households and workers. ### Widespread social discontent and political instability - Scenario description: - Social tensions erupt as the pandemic and inadequate policy response cause economic hardship and exacerbate preexisting socioeconomic inequities. Growing political polarization and instability weaken policy-making and confidence. - Likelihood: High: A lack of political consensus on the approach to contain the pandemic raises social discontent. Unresolved disagreements in the weak government coalition result in early elections. - Impact: High: Further damage to confidence (e.g., due to failure to reach an agreement on 2021 budget) could exacerbate precautionary behavior and slow down the recovery. Uneven participation of the vulnerable groups in the recovery could deepen poverty and inequality. - Policy response: - Provide targeted support to vulnerable groups, including through ALMPs to ensure inclusive recovery. - Adopt the 2021 budget promptly to ensure continued support to the economy. ### Intensified geopolitical tensions and security risks (e.g., in response to pandemic) - Scenario description: - Adverse developments could further damage confidence and demand; intensified geopolitical tensions and security risks cause socio-economic and political disruption. - Likelihood: High: Adverse developments could further damage confidence and demand. - Impact: High: The recovery could be derailed. Increased defense spending could further limit fiscal space available to support the economy. Recent peace accords may reduce regional tensions and lead to enhanced trade and commercial relations. - Policy response: - Allow temporary deviation of defense spending. - Gradually rebuild structural and contingency buffers for geopolitical risks. *Source: Box 1. Risk Assessment Matrix, IMF staff.* ### Annex I. External Sector Assessment ### Annex I. External Sector Assessment ### Overall assessment - The external position in 2020 was "moderately stronger than the level implied by medium-term fundamentals and desirable policies." - The current account (CA) balance is projected to have improved in 2020, against the backdrop of a sharp decline in overall trade, especially imports. - The assessment is supported by the strength of the net international investment position and international reserves but is subject to "unprecedented uncertainty around the impact of the pandemic" and based on incomplete information for 2020. - The assessment is qualified by the limited extent to which the model captures Israel’s country-specific factors. ### Potential policy responses - Near-term focus: saving lives and providing sufficient fiscal and monetary support to households and businesses to face the economic and social impact of the pandemic. - Medium- and long-term aims: structural measures to strengthen resilience, including much needed public investment spending, to minimize scarring and prevent accumulation of imbalances. - Strengthen the social safety net to improve resource allocation and reduce large precautionary savings. - Monetary policy guidance: "As inflation trends toward the target band, the BoI should cease FX intervention in managing inflation expectations and limit its use to addressing disorderly market conditions." ### Foreign assets and liabilities: position and trajectory - Background: - NIIP projected to increase from 41 percent of GDP in 2019 to 46 percent of GDP in 2020, supported by a stronger rise in gross assets than in gross liabilities. - More than half of foreign liabilities are FDI; their share is projected to remain high over the medium term. - Gross external debt projected to increase to 32 percent of GDP, mainly due to government foreign bond issuances of $19 billion. - New government debt issued at very long maturities (above 10 years), lengthening average maturity of government external debt to 17 years. - Assessment: - "The NIIP does not represent a major risk, due to the high share of FDI and long-term government debt in foreign liabilities." - Foreign assets, including international reserves at 41 percent of GDP, exceed liabilities and provide a very large buffer. - 2020 projections (percent of GDP): - NIIP: 46.1 - Gross Assets: 141.8 - Debt Assets: 76.5 - Gross Liab.: 95.7 - Debt Liab.: 31.8 ### Current account - Background: - CA balance projected to increase from 3.4 percent in 2019 to 4.0 percent of GDP in 2020 amid a sharp contraction in overall trade. - In the first nine months of 2020, exports fell by 3 percent yoy and imports by 13 percent. - Fall in trade reflected global and domestic collapse in demand, fall in oil prices, and suspension of travel. - Sustained exports of high-tech sectors supported the CA increase. - Over the medium term, CA surplus projected to decline below 3 percent of GDP as pandemic shock dissipates and imports recover. - Assessment: - EBA CA analysis: cyclically adjusted 2020 CA balance is above the level warranted by fundamentals and appropriate policies by 1.3 percent of GDP, with a policy gap of 0.4 percent of GDP. - Cyclically adjusted CA balance includes multilaterally consistent adjustment for the output gap and terms of trade (0.6 percent), and COVID-related decline in oil imports and net tourism exports (summing to 1.1 percent). - The CA norm includes an adjustment for geopolitical uncertainty. - Other country-specific factors not reflected in the CA norm may play a role in Israel’s high savings rate, including high level of transfer and grant inflows and mandatory pension contributions (see notes on pension law effects). - Text Table: Israel: Model Estimates for 2020 (Percent of GDP) - CA-Actual: 4.04 - Cyclical Contributions: 1.72 - EBA model results: 0.63 - Oil adjustment: 0.64 - Tourism adjustment: 0.45 - Additional temporary/statistical factors: 0.0 - Adjusted CA: 2.32 - CA Norm (from model) 1/: 0.20 - Adjustments to the norm: .80 - Adjusted CA Norm: 1.00 - CA Gap: 1.32 - o/w Policy gap: 0.45 - Elasticity: -0.23 - REER Gap: -5.74 - REER level: -5.7 (column entry aligned with CA Gap) - REER index: 23.8 (column entry) - REER (third column): -2.6 (column entry) - Note: The footnote explains the geopolitical uncertainty adjustment derived from the EBA-lite model suggesting an impact of about 0.8 percent of GDP in 2020. ### Real exchange rate (REER) - Background: - CPI-based REER appreciated by 9 percent over the last decade; ULC-based REER appreciated by 20 percent. - During the pandemic onset, CPI-based REER continued to appreciate by 0.6 percent yoy in the first ten months, mostly driven by a 2.7-percent nominal appreciation of the shekel against the currency basket. - ULC-based REER depreciated somewhat due to lower ULC in Israel outweighing nominal appreciation. - Assessment: - Large variation in REER gap estimates across models: - REER-index model implies overvaluation of 10.7 percent. - REER-level model implies overvaluation of 23.8 percent. - However, the implied CA gap (basis for bottom-line assessment) suggests an undervaluation of 5.7 percent. - Footnote: REER-level model estimated without Israel in sample; coefficients applied to Israel data reduce robustness. ### Capital and financial accounts: flows and policy measures - Background: - Net capital inflows of $10.8 billion occurred in 2020H1, substantially larger than $0.5 billion in 2019H1. - Drivers include upsurge of inward FDI ($15.8 billion) and government foreign bond issuance. - Net portfolio, financial derivatives, and other investment flows were smaller and mostly offset between Q1 and Q2. - Assessment: - Risks remain limited. - Competitiveness of Israel’s high-tech sectors remained attractive for foreign direct investors during the pandemic. - Capital outflow risks are low due to low external indebtedness of the private sector, a resilient banking system, and long maturity of government debt. ### FX intervention and reserves level - Background: - Net international reserves rose to $166.9 billion (43.1 percent of GDP, 18 months of imports) by November 2020 from $126.0 billion (32 percent of GDP) at end-2019. - Increase driven mainly by government foreign bond issuances and BoI FX purchases, which averaged $1.5 billion per month in 2020. - Assessment: - Israel’s level of international reserves is large and exceeds benchmark reserve adequacy metrics by more than fivefold for months of imports and 20 percent of broad money. - Large net international reserves—and other buffers—are justified given significant geopolitical risks. - Since the onset of the pandemic, BoI intervention helped prevent a very sharp inflation undershooting from de-anchoring medium-term inflation expectations and sustained the positive impact of monetary easing measures on financial markets and financial stability. - Going forward, "foreign exchange intervention should cease to serve as a tool to manage inflation expectations and remain a tool to prevent disorderly market conditions." ### Annex II. Scarring scenarios (summary) - Context: - COVID-19 has introduced unprecedented uncertainty and significant downside risk to near-term growth. - Supply shocks (unemployment, corporate balance sheet impairment, productivity slowdown) and demand shocks (precautionary saving) could leave persistent scarring to potential growth. - Historical reference: - During the Global Financial Crisis (GFC), output fell by 1.3 percent below pre-GFC projection and returned to trend after 2009. - The most severe recent crisis was 2000–2005 (Dotcom + Second Intifada): real output declined by 4.3 percent in 2001–5 relative to pre-crisis forecasts and a cumulative 7.3 percent contraction versus an early-2000 WEO projection; annual persistence of 0.6. - Scenario outcomes (medium-term scarring relative to pre-COVID trend): - Range: 0.3–4.2 percent. - Baseline: annual persistence between 0.6 and 0.8 → output around 1 percent below pre-COVID level by 2025. - Worse scenario (COVID-19 shock follows USA GFC persistence of 0.9): output 4.2 percent below pre-COVID path by 2025. - Less severe (persistence around 0.45 as in previous health crises): medium-term scarring would be less than 0.3 percent. - Caveat: previous health crises were localized; COVID-19’s global nature could be more persistent. - Drivers of scarring and quantitative impacts: - Supply vs demand: G20MOD projections indicate negative supply shocks (lockdown-induced unemployment, investment fatigue, productivity slowdown) reduce near-term potential output and quickly dissipate; demand shock from precautionary savings has a protracted impact on medium-term growth capacity. - Labor market hysteresis: - Leave-without-pay program prevented mass dismissals, but unemployment rose. - Historical evidence: high unemployment reduces labor market fluidity and prolongs unemployment duration (share of long-term unemployed more than doubled during 2000–5 crisis). - Low-skilled, contact-intensive workers face greater re-employment challenges. - Corporate vulnerabilities in hard-hit sectors: - Pre-pandemic leverage (liabilities/assets) exceeded European median by 30 percent in accommodation and food services and arts and entertainment; by 20 percent in transportation. - Liquidity (current liabilities/current assets) lower than European median by 50 percent in accommodation and food services and by 25 percent in arts and entertainment and transportation. - Resulting investment decline in hard-hit sectors could be 0.8-2.7 percent of total fixed assets. - Productivity: - Israel’s pre-pandemic labor productivity was 24 percent lower than the OECD average (BoI, 2019). - Health crises usually associated with productivity decline; COVID-19 could cause contemporaneous productivity loss of about 1 percent and cumulative loss of about 4 percent in the medium term. - Precautionary savings: - Likelihood that Israeli households make major purchases in next 12 months declined by more than 30 percentage points since beginning of 2020. - Estimated relationships suggest increase in unemployment and growth volatility could raise household savings from 21.4 percent of disposable income to 23.4 percent and significantly discourage private consumption. *Source: Annex I. External Sector Assessment (1isrea2021001).* ### Annex III. Withdrawing Fiscal Stimulus: When and How Fast? ### Annex III. Withdrawing Fiscal Stimulus: When and How Fast? ### Context and objectives - The Israeli authorities implemented a significant fiscal stimulus in 2020 in response to the global pandemic. - Staff’s model-based analysis evaluates the appropriate fiscal stance in 2021 by balancing countercyclical support to stabilize the economy against risks to debt sustainability and government market access. - The analysis is sensitive to: - The degree of persistence of the pandemic. - The size of possible economic scarring (hysteresis). - The magnitude of fiscal multipliers. ### Key empirical inputs and starting point - Staff’s baseline projections: - Deterioration of the primary fiscal balance of about 7 percent of GDP in 2020. - Output gap of about 5.2 percent of potential GDP. - The model calibration begins in 2021 to assess the pace of stimulus withdrawal. ### Model and rule-of-thumb used - Calibrated Fournier (2019) buffer-stock model for the government: - Summarizes the state of the economy by the structural primary balance, public debt level, and the output gap. - Government chooses a change in the structural primary balance to close the output gap and avoid negative gaps that might feed back to potential output (hysteresis). - Higher debt increases the government risk premium and risk of losing market access. - Fiscal stance is decided one year ahead to reflect implementation lags. - Carnot rule (simplified version) used as a benchmark: - Targets an underlying fiscal effort equivalent to a quarter of the sum of the primary gap and the output gap. - Serves as a rule-of-thumb analogous to a Taylor rule but for fiscal sustainability and stabilization. ### Baseline model findings - The model baseline suggests: - A slightly smaller stimulus withdrawal in 2021—by about 0.3 percent of GDP—relative to staff’s baseline, which helps close the output gap faster but raises debt. - Need for a larger fiscal consolidation in the long run than staff’s baseline projection. - This is broadly consistent with staff’s advice of pursuing an adjustment of 2–2½ percent of GDP once growth is on a strong footing. - While a more aggressive countercyclical policy increases debt relative to staff forecast initially, a strong medium-term adjustment puts debt on a declining path. - The Carnot rule produces results similar to the model baseline: - Suggests a smaller stimulus withdrawal in 2021, but a similar fiscal stance thereafter. ### Sensitivities and scenarios - General sensitivities: - Lower potential growth → less room for countercyclical policy. - Lower interest rates → more room for countercyclical policy. - More effective fiscal policy (higher multipliers) → reduces the size of needed stimulus and helps preserve fiscal space. - Lower persistence of the shock (e.g., faster vaccine adoption/treatment improvements) → reduces need for fiscal stimulus. - High hysteresis (high scarring) scenario: - Model baseline assumes no scarring; a high hysteresis scenario implies permanent decline in potential output during downturns. - High scarring would call for stronger countercyclical policy during downturns to close the output gap faster and limit scarring, at the cost of larger increases in debt. - Such a scenario would also require a faster pace of fiscal adjustment afterwards. - Uncertainty ranking: - The largest uncertainty arises from the persistence of the pandemic and the degree of possible economic scarring. - Other parameter uncertainty (multipliers, potential growth, interest rates) has more modest impacts on the desirable pace of consolidation. ### Policy implications and recommendations - Fiscal stimulus should focus on programs with high impact on aggregate demand given multiplier considerations. - Fiscal policy should respond flexibly to evolving circumstances and be ready to adjust as evidence on persistence and scarring emerges. - Planning for an appropriate contingency reserve in the 2021 budget is recommended to ensure a prompt response to downside risks. - Once growth is on a strong footing, pursue a medium-term fiscal adjustment of about 2–2½ percent of GDP to restore fiscal buffers and place debt on a declining path. *Source: IMF staff analysis in Annex III. Withdrawing Fiscal Stimulus: When and How Fast?* ### Appendix IV Figure 3. Israel: Public DSA – Composition of Public Debt and Alternative ### Appendix IV Figure 3. Israel: Public DSA – Composition of Public Debt and Alternative Scenarios ### Baseline and Alternative Macro-Fiscal Assumptions (Underlying Assumptions) - Baseline scenario (selected variables by year): - Real GDP growth: 2020 -4.0; 2021 4.1; 2022 5.0; 2023 4.6; 2024 4.1; 2025 3.6 - Inflation: 2020 -0.8; 2021 1.1; 2022 0.7; 2023 0.8; 2024 0.9; 2025 0.9 - Primary Balance: 2020 -11.3; 2021 -7.5; 2022 -4.6; 2023 -2.5; 2024 -2.2; 2025 -1.9 - Effective interest rate: 2020 4.5; 2021 3.7; 2022 3.3; 2023 3.1; 2024 3.0; 2025 2.9 - Historical scenario (selected variables by year): - Real GDP growth: 2020 -4.0; 2021 3.8; 2022 3.8; 2023 3.8; 2024 3.8; 2025 3.8 - Inflation: 2020 -0.8; 2021 1.1; 2022 0.7; 2023 0.8; 2024 0.9; 2025 0.9 - Primary Balance: 2020 -11.3; 2021 -0.4; 2022 -0.4; 2023 -0.4; 2024 -0.4; 2025 -0.4 - Effective interest rate: 2020 4.5; 2021 3.7; 2022 3.5; 2023 3.3; 2024 3.2; 2025 3.0 - Constant Primary Balance scenario: - Primary Balance held at -11.3 for 2020–2025 - Effective interest rate: 2020 4.5; 2021 3.7; 2022 3.2; 2023 2.9; 2024 2.8; 2025 2.7 - Real GDP growth and inflation align with baseline values. ### Composition and Dynamics of Public Debt (Findings and Projections) - Gross nominal public debt and public gross financing needs are presented as time-series projections from 2018 through 2025 under Baseline, Historical, and Constant Primary Balance scenarios (figures and percent-of-GDP series shown in source charts). - Maturity composition (by maturity) and currency composition (local vs. foreign currency denominated) of public debt are tracked historically and projected through 2025 (charts indicate shares of short-term and medium-and long-term, and shares denominated in local and foreign currency, expressed in percent of GDP). - Projections indicate rising public gross financing needs in 2020 with gradual decline thereafter under the baseline projection (see Public Gross Financing Needs projection series in source charts). ### Stress Tests and Sensitivity Analysis (Public DSA Stress Tests) - Stress test scenarios considered (with underlying assumptions reported for each year 2020–2025): - Primary Balance Shock - Real GDP Growth Shock - Real Interest Rate Shock - Real Exchange Rate Shock - Combined Shock - Consolidation Shock - Selected scenario assumptions (examples shown in source): - Primary Balance Shock scenario shows Primary balance: 2020 -11.3; 2021 -9.4; 2022 -6.0; 2023 -3.6; 2024 -2.4; 2025 -2.0 - Real GDP Growth Shock scenario shows Real GDP growth: 2020 -4.0; 2021 3.1; 2022 4.0; 2023 4.6; 2024 4.1; 2025 3.6 - Real Interest Rate Shock scenario shows Effective interest rate rising to 3.8–3.9 in projection years in some variants - Real Exchange Rate Shock includes inflation path variant (e.g., 2021 inflation 1.5 in one shock) - Combined Shock and Consolidation Shock adjust primary balance and effective interest rate according to the combined assumptions in source figures - Outcomes illustrated in source charts: - Gross Nominal Public Debt (in percent of GDP) and Gross Nominal Public Debt (in percent of Revenue) under baseline and each stress scenario for 2020–2025 - Public Gross Financing Needs (in percent of GDP) under baseline and stress scenarios for 2020–2025 ### External DSA: Key Findings and Projections - Gross external debt path and drivers: - External debt: 26.6 percent of GDP in 2019; projected 31.8 percent of GDP at end-2020; projected to decline to below 25 percent of GDP in 2025 under the baseline. - Increase to 31.8 percent of GDP at end-2020 mainly driven by the large GDP contraction due to the COVID-19 crisis and associated government financing needs. - External debt had dropped by 2 percentage points since 2015 (26.6 percent in 2019 vs. earlier). - General government external debt remained around 9.5 percent of GDP; private sector and banks’ external debt fell by a total of 4 percentage points of GDP. - External financing needs: - Gross external financing needs projected to remain comfortably low; after a temporary increase in 2020, projected to fall to under 7 percent of GDP by 2024 (pre-pandemic level). - Gross external financing need (in billions of US dollars): 2015 24.5; 2016 24.5; 2017 24.4; 2018 30.9; 2019 26.3; 2020 34.9; 2021 30.2; 2022 31.3; 2023 33.7; 2024 32.2; 2025 29.7 - Gross external financing need (in percent of GDP): 2015 8.2; 2016 7.7; 2017 6.9; 2018 8.3; 2019 6.7; 2020 (value shown as a label near charts; see table for levels) - Risk and resilience: - Share of short-term external debt was 36 percent at end-June 2020 and is fully covered by international reserves (reserves equal to 4 times short-term debt). - External assets of public, private, and banking sectors exceed external liabilities. - External debt dynamics robust to standard interest rate, growth, and current account shocks. - More sensitive to real depreciation: a 30 percent depreciation in 2020 would increase external debt by 11 percent of GDP, with more than half of the increase dissipating in the medium term. - Table 1 highlights (selected rows, percent of GDP unless otherwise indicated): - Baseline: External debt: 2015 28.6; 2016 27.3; 2017 25.5; 2018 25.5; 2019 26.6; 2020 31.8; 2021 29.0; 2022 27.2; 2023 25.9; 2024 25.1; 2025 24.7 - Change in external debt: 2015 -1.7; 2016 -1.3; 2017 -1.8; 2018 -0.1; 2019 1.1; 2020 5.2; 2021 -2.7; 2022 -1.9; 2023 -1.3; 2024 -0.7; 2025 -0.4 - Identified external debt-creating flows (sum of items): 2015 -5.7; 2016 -5.3; 2017 -8.3; 2018 -5.3; 2019 -6.8; 2020 -4.9; 2021 -6.5; 2022 -6.4; 2023 -5.9; 2024 -5.4; 2025 -5.1 - Current account deficit, excluding interest payments: 2015 -5.9; 2016 -4.1; 2017 -3.9; 2018 -2.8; 2019 -4.1; 2020 -4.8; 2021 -4.5; 2022 -4.2; 2023 -4.0; 2024 -3.7; 2025 -3.5 - Residual, incl. change in gross foreign assets: 2015 4.0; 2016 4.0; 2017 6.5; 2018 5.2; 2019 7.9; 2020 10.1; 2021 3.8; 2022 4.6; 2023 4.6; 2024 4.6; 2025 4.7 - External debt-to-exports ratio: 2015 92.5; 2016 92.2; 2017 89.0; 2018 85.8; 2019 91.1; 2020 111.2; 2021 99.1; 2022 91.0; 2023 85.3; 2024 81.3; 2025 78.2 - Key macroeconomic assumptions noted in Table 1 (baseline projections and historical averages): - Real GDP growth (historical average): 2.2; Standard deviation 1.0; Baseline 2020 -4.0; 2021 4.1; 2022 5.0; 2023 4.6; 2024 4.1; 2025 3.6 - GDP deflator in US dollars (change in percent): historical average -5.3; baseline 2020 2.3; 2021 3.1; 2022 1.0; 2023 1.0; 2024 1.1; 2025 1.1 - Nominal external interest rate (in percent) historical average 2.7; baseline path includes values such as 2020 2.9; 2021 2.5; 2022 2.5; 2023 2.5; 2024 2.6; 2025 2.6 - Growth of exports (US dollar terms, in percent): baseline series includes 2020 -3.9; 2021 10.0; 2022 8.0; 2023 7.3; 2024 7.3; 2025 7.2 - Growth of imports (US dollar terms, in percent): baseline series includes 2020 -12.4; 2021 15.4; 2022 9.0; 2023 8.7; 2024 8.4; 2025 8.1 - Current account balance, excluding interest payments (percent of GDP): historical average 5.9; baseline 2020 3.8; 2021 4.5; 2022 4.2; 2023 4.0; 2024 3.7; 2025 3.5 ### External Debt Stress Tests and Bound Tests (Summary) - Bound tests and sensitivity analyses include permanent one-half standard deviation shocks to interest rate, growth rate, and current account balance, and a one-time real depreciation of 30 percent in 2021. - Selected stress-test outcomes shown in charts: - Interest rate shock, current account shock, growth shock, and combined shocks produce alternative external debt paths (external debt in percent of GDP) for 2015–2025 under baseline and scenario assumptions. - A 30 percent real depreciation shock increases external debt substantially in the short run (chart shows notable deviation from baseline with peak increases). *Source: IMF Staff Calculations; content from Appendix IV Figure 3, Appendix IV Figure 5, Annex V (External DSA), and Table 1 in the provided IMF staff report content.* ### 1. Parliament was dissolved on December 23 after the coalition government failed to ### 1isrea2021001 - 1. Parliament was dissolved on December 23 after the coalition government failed to ### Political developments and recent events - Parliament was dissolved on December 23 after the coalition government failed to agree on a budget for 2020, triggering parliamentary elections in March. PM Netanyahu is the head of the interim caretaker government. - Political fragmentation has risen, posing risks of a stalemate in establishing a governing coalition; nonetheless, the general course of economic policies is unlikely to change. - With potentially significant delays in the adoption of the 2021 budget, parliament approved government spending to mitigate the fiscal contraction that would otherwise occur: - NIS 72 billion (about 5 percent of GDP) in pandemic-related spending in line with the authorities’ 2021 plans. - Legal amendments allow an increase in the 2021 government spending allocation—based on the 2019 budget—in line with population growth rather than with inflation. - The approved general government expenditures are about ½ percent of GDP lower than previously projected, which could result in a slightly tighter fiscal stance than implied by the baseline if a 2021 budget is not adopted. - The government approved a program to target 2 billion Shekels to businesses that experienced a sharp reduction in their income. ### Recent developments reported by the authorities - The COVID-19 crisis followed continued growth, low debt to GDP ratio, and an improvement in inequality indicators in Israel. - When restrictions on supply were lifted after lockdowns, economic activity rose quickly and sharply; high-tech service industry sustained services exports growth. - The vaccine campaign in Israel began earlier than expected and is the fastest in international perspective: administering more than 1.8 million doses to around 20 percent of the population as of January 10, 2021. - Israel experienced a fast recovery of economic activity in November and December after the second lockdown. - The broad unemployment rate (including employees on unpaid leave) reached about 23% during the second lockdown and declined to about 12.7% in the first half of December. - The authorities note concern that unemployment has not reduced below about 12.7% and are prepared to mitigate this with supportive policy. ### Outlook and risks - Political uncertainty and the race between the spread of COVID-19 and vaccine distribution have widened risks to the economic outlook. - The sharp rise in new COVID-19 cases in December and early-January necessitated a third nation-wide lockdown, which together with political instability could exacerbate precautionary behavior and drag growth. - If vaccination pace and effectiveness are sustained, Israel may reach herd immunity in 2021Q2, significantly boosting confidence and recovery prospects. - Medium-term risks widened: rapid vaccine distribution could limit economic scarring, while political uncertainty could jeopardize reform progress. - Growth scenarios and projections cited by the authorities and staff: - BOI optimistic scenario: GDP is expected to expand by 6.3% percent in 2021 and by 5.8% in 2022; assumes rapid inoculation until May 2021 and no government restrictions with significant positive impact beyond May 2021. - Staff baseline (more pessimistic): 4.1% in 2021 and 5% in 2022; assumes restrictions fade during 2021 as vaccine coverage expands. - BOI pessimistic scenario: GDP growth of 3.5% in 2021 and 6% in 2022; assumes a more prolonged inoculation process lasting until June 2022. ### Fiscal policy - Authorities appreciate staff’s view that the volume of fiscal support has been adequate; support was possible thanks to prolonged reduction of public debt, up to 60% of GDP prior to the crisis. - The health crisis prompted extensive assistance to the unemployed, affected businesses, and the health system. - The Ministry of Finance has been publishing a monthly report on government programs to aid planning and policy analysis. - The lack of an orderly government budget for 2021 and reliance on an interim budget weigh on the government’s ability to operate, though ad-hoc budget expansions for 2021 indicate continued support availability. - Staff’s baseline projection for debt is more pessimistic than the authorities’ projections; authorities cite fast recoveries, promising vaccination, and long-standing fiscal responsibility as improving prospects. - The structural deficit predating the pandemic remains a concern and should be addressed. - On tax policy, the authorities note that top PIT rates in Israel are relatively high and emphasize the government's objective of returning and preserving IP as a tool to enhance recovery. ### Monetary policy and inflation - The Bank of Israel (BOI) acted rapidly to supply liquidity in shekels and foreign currency to address initial COVID-19 financial market shocks; this mitigated pressures on exchange rates, bond yields, and corporate spreads. - The BOI ensured credit markets supported the needs of households, businesses, and the government, including programs to ensure credit flow to small businesses. - Inflation in Israel was low before the crisis and declined further with the drop in demand; the BOI assesses that within several months year-over-year inflation will return to positive and increase gradually towards the lower bound of the target range. - Inflation expectations for medium- and long-term remained anchored within the inflation range target throughout the crisis. - Exchange rate developments: - After remaining relatively stable since April, the shekel began to strengthen at the beginning of October; this trend accelerated in November and December, resulting in 6.5% and 3.3% appreciation of the shekel against the dollar and an aggregate of trade-currencies respectively. - IMF REER-index and REER-level models point to an overvaluation of 10%-20%, while the implied CA gap suggests an undervaluation of 5.7%. - Given uncertainty and unusual times of negative inflation, the BOI decided to act to soften the ongoing appreciation, consistent with overall expansionary monetary policy. ### Financial sector stability measures - The BOI, within the Banking Supervision Department’s authority, took a broad range of steps to ensure banks could continue extending credit. - The BOI eased macroprudential and supervisory requirements and implemented several specific steps to support credit provision. - On December 2020, the BOI announced that on January 17th, 2021 the restriction on the part of mortgage loans indexed to the policy rate interest rate will be two-third of the loan instead of one-third, to reduce the mortgage burden on households. - BOI sensitivity tests show Israeli banks would stay stable even under the most severe scenarios. - Financial system stability has been closely monitored by the Financial Stability Committee (headed by the BOI and established in November 2018) and by the Capital Markets, Insurance and Savings Authority (CMISA). ### Macro-structural policies and reform priorities - Staff’s analysis on policies to mitigate long-term scarring and improve resilience is appreciated by the authorities; the crisis should not be wasted. - Crisis-driven developments providing opportunities: - Creation of useful databases to deploy ALMPs that promote reskilling and upskilling during recovery. - Increased digitalization capacity across sectors, including wholesale and education. - Government steps in recent years to increase long-run productivity: - Increased expenditure on education and improved affirmative action. - Shifted infrastructure investment from roads to mass transportation. - The BOI published an extensive report in August 2019 with recommendations to deploy more policies to enhance productivity growth. - A cautious consolidation policy is expected to create budgetary space needed to finance productivity-enhancing policies in coming years. *Statement by Mr. Anthony De Lannoy, Alternate Excutive Director and Mr. Shay Tsur, Senior Advisor to the Executive Director on Israel — January 19, 2021* --- _Source: https://www.imf.org/-/media/files/publications/cr/2021/english/1isrea2021001.pdf_