## 1isrea2022001 - Israel: Macroeconomic and Policy Assessment (IMF 2022 Article IV staff report) ## Source details **Canonical URL:** [1isrea2022001 - Israel: Macroeconomic and Policy Assessment (IMF 2022 Article IV staff report)](https://www.imf.org/-/media/files/publications/cr/2022/english/1isrea2022001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2022/english/1isrea2022001.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2022/english/1isrea2022001.pdf.json) --- ### Macroeconomic performance and outlook - Growth and drivers: - Real GDP in 2021 reported as "8.2 percent in 2021" and elsewhere as "8.1 percent in 2021" (both figures appear in the text). - Recovery led by consumption and the high‑tech sector; rapid vaccination boosted confidence. - Labor market: - Unemployment declined to near pre‑pandemic levels; 2021 unemployment reported as "5.0 (percent)" in one table and "3.7 percent in January 2022" in another context. - Job vacancies are high across sectors, indicating skill mismatches. - Outlook (staff projections and assessment): - Recovery projected to solidify in 2022 and over the medium term; growth supported by private consumption, investment, and net exports. - With temporary factors winding down, inflation is projected to ease and stay within the BOI’s target band over the medium term. - External position assessed as moderately stronger than the level implied by medium‑term fundamentals. ### Fiscal policy findings, outlook, and recommendations - Near‑term and 2022 stance: - Headline deficit: "3.4 percent of GDP in 2022." - 2021 fiscal deficit: "-4.3 percent of GDP." - Pandemic support in 2022 is about "2¼ percent of GDP" and should target the most affected sectors and vulnerable population groups. - Health spending will remain larger by "¾ percent of GDP" relative to 2019 levels. - Funding for infrastructure will be higher by "1.3 percent of GDP" relative to 2019 levels. - Planned 2022 fiscal stance described as appropriate given narrowing output gap. - Medium‑term path and debt projections: - Authorities’ medium‑term target: government debt to "60 percent of GDP by 2027." - Staff baseline projects debt to "64 percent of GDP by 2027" and "60 percent of GDP in a decade". - Medium‑term plan reduces spending by about "1¾ percent of GDP by 2025." - Tripartite agreement envisages a cumulative increase of "13.5 percent in the minimum wage for 2022–25—less than cumulative nominal growth". - Revenue and expenditure policy options: - Scope to increase tax revenues by broadening the tax base and making the tax system more progressive (including raising personal and corporate income tax revenues). - Corporate tax: scale back profit‑based incentives; increase effective rates for intellectual property. - VAT: "VAT exemptions could also be streamlined." - Recommendation: review public spending efficiency; planned expenditure restraint may be challenging given Israel’s already low civil spending. - Fiscal framework and governance: - Strengthen fiscal framework via review assessing fiscal rules, necessary size of fiscal buffers, ability to face exceptional events, and potential usefulness of establishing an independent fiscal council. - Authorities’ views: MOF cautious optimism about 2022 revenues but agrees such revenues are unlikely to persist; views split on establishing a fiscal council. ### Monetary policy, inflation, and exchange rate policy - Inflation and policy rate: - Headline CPI: "1.5" (2021, average) in one table; headline year‑on‑year inflation reached "2.8 percent in December 2021" and "3.1 percent in January 2022". - Inflation expectations one‑ and two‑years ahead moved up sharply, reaching "2.9 percent" (one‑year ahead in January‑2022). - Israel’s price stability target: annual CPI increase in the range of "1–3 percent". - Conditions in place for the BoI to start raising the policy rate gradually; policy (discount) rate was cut to "0.1 percent" (effective lower bound). - Real policy interest rate described as now around "-3 percent" (ex‑ante real interest rate around -2.8 percent in January 2022). - FX intervention and reserves: - BoI preannounced foreign exchange purchases of "USD 30 billion" in 2021; purchases reached USD 34.8 billion during the year (over‑executed by USD 4.8 billion). - Gross official reserve assets: "USD 213 billion in December 2021" (45.6 percent of GDP). - Recommendation: taper off FX purchases, allow the shekel to be market‑determined while retaining option to intervene to prevent disorderly markets or to avoid de‑anchoring of inflation expectations if inflation falls below target. - Policy sequencing and tools: - Expiration of BoI liquidity support programs (asset purchases ended end‑December 2021) was appropriate given inflation emergence. - If underlying inflationary pressures persist, combine policy rate increases with unwinding liquidity support measures and clear communication. - Complementing short‑term rate increases with reduction of longer‑term asset purchase effects may strengthen transmission, particularly to cool the housing market. ### Financial sector risks and macroprudential recommendations - System resilience: - Banks maintained solid capital, liquidity, and asset quality; NPLs remained low and stable. - Leverage ratios and Tier 1 capital to risk‑weighted assets remain well above Basel III minimums. - BoI stress tests: under extreme scenarios none of the banks (or credit card companies) likely to see Tier 1 capital ratio fall below "6.5 percent". - Emerging risks: - Rapid mortgage growth contributed to a surge in housing prices: housing prices increased by "10 percent in 2021". - Mortgage and business lending grew faster than nominal GDP but remained fully funded by deposits. - Institutional investors’ share of consumer credit reached "11 percent in 2021"; credit card companies' share reached "12 percent". - Macroprudential and regulatory steps: - Further tightening of macroprudential measures (including lowering the debt‑service‑to‑income cap from its current "50 percent" ratio) could help stem banks’ exposures to housing market risks. - Advance structural measures to ease housing supply: reform property taxes, increase land auctions, streamline building regulations, fast‑track mixed‑use approvals. - Committee to review financial supervision structure is welcome given push for competition and innovation; ensure coordination across regulators. ### Structural and inclusion policies - Labor market and human capital: - Large number of vacancies across sectors indicates skill gaps and mismatches; staff estimate NAIRU at "3.7 percent". - Policies recommended: - Strengthen Active Labor Market Policies (ALMPs): expand vocational training, improve quality, provide apprenticeships, hiring and training subsidies. - Improve marketable skills of Haredi and Arab students: enhance core curriculum, increase Hebrew courses, improve teacher quality. - Improve access to childcare and early childhood education, especially in disadvantaged regions. - Increase digital penetration to improve access to government services and training. - Product markets and infrastructure: - Reduce trade barriers and red tape; lower barriers protecting low‑productivity domestic sectors. - Infrastructure budget: about "2½ percent of GDP in 2021–22"; acceleration needed to close gaps with OECD peers. - Tel Aviv metro construction expected 2025–2032 with cost close to "9¼ percent of GDP". - Housing and access: - Government plan: construction of "280,000 homes" and approval of "500,000 homes in 2022–25." - Parliamentary change: residential purchase tax on investors increased from "5 to 8 percent" for the next "3 years" (December decision). - Suggest public housing closer to economic centers targeted to disadvantaged groups; government’s 2022–25 plan envisages additional "1.2 percent of GDP in spending" for housing‑related infrastructure. ### Climate policy, emissions, and carbon pricing - Emissions and targets: - Total GHG: around "79 MtCo2e" (about "0.2 percent" of global emissions). - NDC targets: "27 and 85 percent by 2030 and 2050, respectively, relative to 2005 levels." - Authorities’ National Action Plan 2022–26: phase out coal by 2025; lift renewables to "30 percent of total generation by 2030" (renewables currently "6 percent"); target energy efficiency improvements of "1.3 percent annually". - Assessment of current plan: - Planned excise increases phased "2023–28" and coal phase‑out are necessary but insufficient to meet the 2030 overall NDC goal; limited reductions outside electricity. - By 2028, excise implications cited: - Coal and LPG: "about $60 per ton of CO2." - Diesel: "about $101 per ton of CO2." - Gasoline: "about $124 per ton of CO2" (unchanged). - Natural gas: "$19 per ton of CO2." - A hypothetical phased carbon tax of "$75 per ton of CO2" would not by itself achieve the 2030 target but would more than double new revenues relative to envisaged excise hikes. - Policy recommendations: - Implement more ambitious carbon pricing (e.g., gradual rise to "$75 by 2030" and further increases thereafter) while using revenues to fund capital expenditure and targeted social transfers. - Use additional carbon revenues to fund infrastructure for public transport and energy transition (assumed 65 percent) and social compensation (assumed 35 percent). - Accelerate photovoltaic deployment markedly; support R&D for green technologies and international cooperation to import green energy. - Consider competitiveness and compensation measures for industry exposed to international competition without carbon pricing. ### External sector, reserves, and REER assessment - Current account and NIIP: - Current account: surplus of "4.6 percent of GDP" in 2021 (four‑quarter). - NIIP fell from "46 to 35 percent of GDP" between end‑2020 and 2021Q3 (text table shows NIIP "34.6" in 2021 Sept). - Foreigners were net buyers of Israeli assets in 2021; non‑residents’ net purchases of Israeli assets equaled "USD 62bn" in the year to 2021Q3. - External buffers and reserves: - Gross official reserve assets reached "USD 213 billion in December 2021" (45.6 percent of GDP); BoI purchases during year totaled "USD 34.8 billion" (including pre‑announced USD 30 billion). - Reserve adequacy: level assessed as large and comfortably exceeding benchmarks; justified given geopolitical risks. - REER and external assessment: - REER appreciated about "4.5 percent during 2021" (CPI‑based) and "8.7 percent" (ULC‑based). - Model divergence: IMF staff assess REER gap in range "–8 to 30.5 percent", midpoint "11.25 percent". - EBA CA analysis suggests the cyclically adjusted 2021 CA balance is above warranted level by "3.4 percent of GDP"; after Covid adjustments the CA gap is "1.93 percent of GDP". - Policy guidance: - Allow market forces to determine the shekel; limit FXI to disorderly market conditions; taper FXI given inflation developments. ### Risks, stress tests, and contingency scenarios - Risks tilted to the downside; notable risks and policy responses: - Escalation of Ukraine‑Russia conflict: Likelihood "Medium"; Impact "Medium"; Policy: keep monetary policy accommodative and target support if necessary. - New COVID‑19 variants: Likelihood "Medium"; Impact "Medium"; Policy: reintroduce targeted support. - De‑anchoring of inflation expectations and global tighter financial conditions: Likelihood "Medium"; Impact "Low" to "Medium"; Policy: monitor financial conditions, use FXI for disorderly conditions. - Widespread social discontent and political instability: Likelihood "Medium"; Impact "High"; Policy: targeted support to vulnerable groups. - Intensified geopolitical tensions: Likelihood "High"; Impact "High"; Policy: allow temporary deviations of defense spending and rebuild buffers. - Debt sustainability and stress tests: - Under staff baseline, debt peaked at "72 percent of GDP in 2020" and is projected to decline gradually. - Stress scenarios: growth shock could raise debt to about "74 percent"; combined macro‑fiscal shock could raise debt to around "75 percent of GDP by 2025". - Consolidation scenario: additional fiscal adjustment of "1½ percent" spread 2023–25 could bring debt to about "59 percent by 2027" (compared to "64 percent in the baseline"). ### Policy support during the pandemic (selected measures and expirations) - Monetary measures: - BoI government bond purchases up to "NIS 85 billion" (ended when target reached; bonds held to maturity). - Dollar liquidity swaps up to "USD 15 billion" (inactive since July 2020). - Corporate bond purchases of "NIS 15 billion" (terminated on November 22, balance NIS 3.5bn). - Macroprudential measures: - Capital requirement reduction by "1 percent" (expired December 31, 2021). - LTV increased to up to "70 (from 50) percent" (expired September 30, 2021). - Leverage ratio minimum reduced by "0.5 percentage points" (expired). - Loan deferral framework (expired March 31, 2021); deferred loans peaked at almost "18 percent" of total loans and were around "1 percent" at end‑2021. - Fiscal measures: - Pandemic fiscal measures: "7.6 percent of GDP in 2020" and "4 percent of GDP in 2021" overall. - Selected supports (many expired): unemployment benefit extensions (expired June 30, 2021), return to work grant (expired April 30, 2021), various grants and tax deferrals (most expired in 2020–2021). - State guarantee loan programs for SMEs and large businesses with application windows and expirations noted (guarantees expire by 2028 depending on repayment schedules). ### Key statistics and projections (selected exact figures from source) - Real GDP (percent change): 2017: "4.4"; 2018: "4.0"; 2019: "3.8"; 2020: "-2.2"; 2021: "8.1 and 8.2" (both figures appear in the source); 2022 (projection): "5.0"; 2023–2027: "3.6, 3.5, 3.5, 3.5, 3.5". - Unemployment rate: 2021: "5.0 (percent)"; 2022–2027 projections: "3.9, 3.8, 3.7, 3.7, 3.7". - Inflation (CPI, percent change, average): 2021: "1.5"; 2022 (projection): "2.7"; 2023–2027: "2.1, 2.0, 1.9, 1.9, 1.9". - Public debt (general government, percent of GDP): 2021: "69.0"; 2022–2027 projections: "67.1, 66.4, 65.8, 65.2, 64.7, 64.2". - Current account balance (percent of GDP): 2021: "4.6"; 2022–2027 projections: "4.5, 4.2, 3.9, 3.7, 3.4, 3.1". - Foreign reserves (end of period, US$ billions): 2021: "213.0"; 2022–2027 projections: "243.9, 256.6, 270.0, 284.0, 297.6, 312.9". - Selected fiscal/Debt DSA figures: - Nominal gross public debt: "63.9 (2020); 71.7 (2021); 69.0 (2022); 67.1 (2023); 66.3 (2024); 65.8 (2025); 65.2 (2026); 64.7 (2027)". - Public gross financing needs: "9.4 (2020); 18.0 (2021); 10.0 (2022); 8.9 (2023); 9.2 (2024); 8.5 (2025); 8.6 (2026); 9.1 (2027)". *Source: IMF staff report for Israel, 2022 Article IV consultation (staff report content provided).* ### 8.2 percent in 2021. Consumption and the high-tech sector led the recovery. The 2021 f iscal ### 1isrea2022001 - Israel: 8.2 percent in 2021. Consumption and the high-tech sector led the recovery. The 2021 fiscal ### Macroeconomic performance and outlook - Real GDP in 2021 is reported in the source as "8.2 percent in 2021" and elsewhere as "8.1 percent in 2021" (both figures appear in the text). - Recovery drivers: - Consumption and the high-tech sector led the recovery. - Rapid vaccination boosted confidence. - 2021 fiscal and external outcomes: - 2021 fiscal deficit: -4.3 percent of GDP. - Public debt declined to 69 percent of GDP. - Current account: surplus of 4.6 percent of GDP, driven by exports of high-tech services. - Labor market: - Unemployment declined to near pre-pandemic levels. - Job vacancies are high across all sectors. - Outlook (staff projections and assessment): - The economic recovery is projected to solidify in 2022 and over the medium term. - Growth will be supported by strong private consumption, investment, and net exports. - With temporary factors winding down, inflation is projected to ease and stay within the BOI’s target band over the medium term. - The external position is assessed as moderately stronger than the level implied by medium-term fundamentals. ### Fiscal policy findings and recommendations - Near-term stance: - The planned 2022 fiscal stance is deemed appropriate. - In 2022, pandemic support should target the most affected sectors and vulnerable population groups. - Medium-term priorities: - Refocus on reducing public debt and rebuilding pre-pandemic buffers. - Reorient fiscal space toward productivity-enhancing spending (labor market policies, infrastructure, climate goals). - Revenue and expenditure policy options: - There is scope to increase tax revenues by broadening the tax base and making the tax system more progressive (including raising personal and corporate income tax revenues). - Authorities’ planned expenditure restraint may be challenging given Israel’s already low civil spending; a review of public spending efficiency is recommended. - Fiscal framework: - Strengthen the fiscal framework via a review assessing fiscal rules, necessary size of fiscal buffers, the ability to face exceptional events, and the potential usefulness of establishing an independent fiscal council. ### Monetary and exchange rate policy - Inflation and policy rate: - Inflation pressures have risen; inflation has exceeded the BOI’s target range despite appreciation of the shekel. - Signs of underlying inflationary pressures are strong; inflation expectations have increased quickly in line with CPI. - The conditions are in place for the BoI to start raising the policy rate gradually. - Foreign exchange intervention: - Foreign exchange purchases should taper off, allowing the shekel’s value to be determined by market forces. - This tapering should not preclude future purchases should appreciation pressures threaten to move inflation or inflation expectations below the target band. - Recent policy stance: - The recent discontinuation of liquidity programs is appropriate in view of the emergence of broad-based inflation pressures. - With the output gap closing rapidly, monetary policy needs to become less accommodative. ### Financial sector risks and recommendations - Emerging risks: - Rapid mortgage growth has contributed to a surge in housing prices. - Housing risks stress the need to advance structural measures to ease housing supply. - Macroprudential and regulatory steps: - Further tightening of macroprudential measures (including tightening of the debt-service-to-income cap) could help stem banks’ exposures to housing market risks and prevent potentially unsustainable borrowing. - Israel’s financial regulatory architecture has served well; the establishment of a committee to review it is welcome given the push for greater competition and financial innovation. ### Structural and inclusion policies - Labor market and human capital: - Large number of vacancies across sectors indicates skill gaps and mismatches. - Active Labor Market Policies (ALMPs) should expand vocational training and improve its quality. - Greater adaptation of different education streams is needed to align student qualifications with labor market needs. - Strengthening ALMPs, improving marketable skills of Haredi and Arab students, increasing digital penetration, and investing in future human capital are recommended. - Product markets, infrastructure, and digitalization: - Continued efforts to reduce trade barriers and red tape would promote efficient resource allocation, investment, and innovation. - Accelerating digital and physical infrastructure would improve job accessibility and support growth. - Climate policy: - Further efforts are needed to meet the authorities’ climate objectives. - Options include larger increases in carbon prices and providing greater regulatory and fiscal support for Israel’s innovative green technologies. ### Key statistics and projections (selected exact figures reported) - Real GDP 2017–2027: (select entries from table) - 2017: 4.4 (percent change) - 2018: 4.0 - 2019: 3.8 - 2020: -2.2 - 2021: 8.1 and 8.2 (both figures appear in the source) - 2022 (projection): 5.0 - 2023–2027 (projections): 3.6, 3.5, 3.5, 3.5, 3.5 - Unemployment rate: - 2021: 5.0 (percent) - 2022–2027 (projections): 3.9, 3.8, 3.7, 3.7, 3.7 - Inflation (CPI, percent change, average): - 2021: 1.5 - 2022 (projection): 2.7 - 2023–2027 (projections): 2.1, 2.0, 1.9, 1.9, 1.9 - Public debt (general government, percent of GDP): - 2021: 69.0 - 2022–2027 (projections): 67.1, 66.4, 65.8, 65.2, 64.7, 64.2 - Current account balance (percent of GDP): - 2021: 4.6 - 2022–2027 (projections): 4.5, 4.2, 3.9, 3.7, 3.4, 3.1 - Foreign reserves (end of period, US$ billions): - 2021: 213.0 - 2022–2027 (projections): 243.9, 256.6, 270.0, 284.0, 297.6, 312.9 *Source: IMF staff report for Israel, 2022 Article IV consultation (staff report content provided).* ### 6. Financial Soundness Indicators, Banks, 2015–21:Q2 ___________________________________________ 33 ### 6. Financial Soundness Indicators, Banks, 2015–21:Q2 ### Context - Israel led the world vaccination efforts, reaching 55 percent of the population by end-May (December 2020 campaign start), which boosted confidence and helped mitigate the pandemic’s impact. - Bank of Israel (BoI) liquidity measures amounted to near 8 percent of GDP. - Fiscal measures were 7.6 percent of GDP in 2020 and 4 percent of GDP in 2021. - Net international investment position (NIIP) was at 35 percent of GDP. - Gross external debt was 33.2 percent in 2021Q3. - Banks maintained solid capital, liquidity, and asset quality, supporting the economy amid low household and corporate leverage. - Long-standing structural challenges highlighted: labor productivity below peers, relative poverty among Israeli-Arab and Haredi groups driven by low labor force participation and skills, and an underfunded and poorly targeted social safety net. - Political context: a new broad-based coalition formed in May 2021; coalition agreement requires Prime Minister Naftali Bennett to rotate with Yair Lapid in August 2023. An Arab party joined the governing coalition for the first time in Israel’s history. - Government priorities include reducing red tape and trade barriers, completing pension reform, improving public transportation, strengthening government digitalization, and encouraging a transition to clean energy (including carbon taxes). - Progress on previous Article IV advice has been mixed: monetary policy remained accommodative; fiscal support tapered; major reforms (including tax reforms, deposit insurance, and deep education reform) are delayed. ### Recent economic developments - Real GDP grew by 8.1 percent in 2021. - Real GDP contracted in 2021Q1 due to third COVID-19 wave and lockdown; recovery accelerated in Q2 with vaccinations. - Real GDP exceeded its pre-pandemic level in 2021Q2. - Private consumption and private savings returned to pre-pandemic levels by Q4 2021. - High-tech sectors drove recovery; wholesale and retail trade and transportation also recovered strongly. - Output gap turned positive in 2021Q4. - Inflation: - After deflation in 2020, headline year-on-year inflation reached 2.8 percent in December 2021 and 3.1 percent in January 2022. - Inflation expectations one- and two-years ahead moved up sharply, reaching 2.9 percent. - Israel’s price stability target is an annual CPI increase in the range of 1–3 percent. - Drivers: base effects, temporary global factors (inflation in key import sources, supply bottlenecks, rebound in energy prices), and strong domestic demand. - Labor market: - Labor force and employment steadily increased and exceed end-2019 levels. - Unemployment fell to near pre-pandemic levels; average wages rose (concentrated in high-tech). - Employment growth in high-contact sectors lagged; high and rising job vacancies indicate post-pandemic skill mismatches. - Fiscal outcomes: - 2021 overall government deficit estimated at 4.3 percent of GDP—5.4 percentage points lower than projected during the 2020 Article IV consultation. - Drivers: buoyant tax revenues from robust consumption, IPOs and valuation increases in high-tech companies, and property-related tax revenues. Absence of a budget until November 2021 and winding down of pandemic support contained spending. - Key credit rating agencies confirmed Israel’s investment grade rating. - External sector: - High-tech exports (about two thirds of services exports) grew by 21 percent in the year to September 2021. - Four-quarter current account recorded a surplus of 4.5 percent of GDP despite a merchandise trade deficit. - Foreigners were net buyers of Israeli assets through 2021, with large bond portfolio and equity direct investments in H1 2021. - BoI preannounced foreign exchange interventions (FXI) of USD 30 billion in 2021, which were over-executed by USD 4.8 billion. - Israel’s share of the IMF’s 2021 allocation of Special Drawing Rights, equivalent to USD 2.6 billion, supplemented existing official reserve assets. - Financial sector: - Banks’ non-performing loans (NPLs) remained low and stable. - System-wide liquidity coverage ratio increased. - Return on equity, capital, and Tier 1 capital to risk-weighted assets strengthened. - Leverage ratios (Tier 1 capital to consolidated assets) stayed well above the Basel III minimum. - Lending expanded (mainly mortgage and business loans) faster than nominal GDP but remained fully funded by deposits. - Housing: mortgage lending rise combined with limited supply and a drop in construction investment in 2020 led to housing prices increasing by 10 percent in 2021. - Stock market: share prices of main financial institutions and broader indices surged. ### Outlook and risks - 2022 baseline projection: real GDP growth of 5.0 percent supported by strong private consumption and investment as private savings decline toward pre-crisis levels. - No significant lockdown measures envisaged under the baseline given high vaccination coverage. - Average unemployment expected to decline by about 1 percentage point, remaining marginally higher than pre-crisis level. - Output gap projected to approach ¾ percent of potential GDP in 2022. - Inflation expected to decline as temporary factors dissipate, but carry-over effects from 2021Q4 and a positive output gap will yield a higher average 2022 inflation rate. - Medium-term outlook: real output expected to exceed potential and pre-pandemic trend; employment projected to fully recover in the medium term. - Persistent structural challenges: raising productivity, increasing labor force participation (especially among minority groups), enhancing human capital, and strengthening capital accumulation (particularly infrastructure). - Risks tilted to the downside (Annex III): - Escalation of the conflict between Ukraine and Russia. - New COVID-19 variants that are more virulent or vaccine resistant. - Difficulty addressing skill gaps and mismatches; limited short-run impact of training. - Potential rise in inequality leading to social discontent and political instability for a slim, diverse coalition. - Geopolitical risks causing socioeconomic and political disruption. - Tightening global financial conditions could trigger a stock market fall, lower government revenues, and higher cost of capital. - Mitigating factors: government’s long debt maturities and mainly domestic borrowing; external and public debt sustainability risks are low (Annex IV). - Upside possibility: high-tech sector gains may be persistent, yielding significant productivity spillovers to other sectors. - Authorities’ view: BoI projected 2022 real GDP growth of 5.5 percent due to catch-up effects to higher projected potential output; authorities noted capacity constraints in high-tech and expected normalization of consumption away from durables to limit domestic demand boost in 2022. ### Policy discussions: navigating the recovery - Overall guidance: - Phasing out pandemic-related measures has been timely. - Conditions are in place for gradual withdrawal of monetary policy accommodation. - Targeted fiscal support and monetary easing may still be needed if downside risks materialize; policy should remain agile. - Medium-term policies should address labor market bottlenecks, support infrastructure spending, and advance climate objectives. - Fiscal policy (discussion opening in source): - The overall fiscal deficit is expected to revert to pre-pandemic levels (text continues beyond provided excerpt). *International Monetary Fund — Israel: 6. Financial Soundness Indicators, Banks, 2015–21:Q2 (excerpt)* ### 3.4 percent of GDP in 2022. Revenues are projected to remain strong, but will not keep up with ### 1isrea2022001 - 3.4 percent of GDP in 2022. Revenues are projected to remain strong, but will not keep up with ### Fiscal outlook and headline balances - Deficit: "3.4 percent of GDP in 2022." - Improvement in the headline deficit largely reflects lower spending due to the tapering of COVID-19 support measures (Annex I Table 3). - Pandemic support in 2022 is about "2¼ percent of GDP" and should target the most affected sectors and vulnerable population groups. - Health spending will remain larger by "¾ percent of GDP" relative to 2019 levels. - Funding for infrastructure will be higher by "1.3 percent of GDP" relative to 2019 levels. - The planned 2022 fiscal stance is described as appropriate in view of the projected narrowing of the output gap. ### Medium-term fiscal path and debt projections - The medium-term plan reduces spending by about "1¾ percent of GDP by 2025." - Tripartite agreement envisages a cumulative increase of "13.5 percent in the minimum wage for 2022–25—less than cumulative nominal growth" and is expected to contain the rise in the civil service wage bill. - Authorities’ medium-term target would bring government debt to "60 percent of GDP by 2027." - Staff baseline projects debt to "64 percent of GDP by 2027" and "60 percent of GDP in a decade" (Annex IV). - Staff supports the authorities’ medium-term fiscal path and plans to restore fiscal buffers, subject to further policy measures. - Recommendation: conduct a review of public spending efficiency. ### Revenue-side options and tax policy - There is scope to increase income tax revenues and make the system more progressive: - Raising low-bracket tax rates would raise the average rates for high-income taxpayers. - Increasing the earned income tax credit (EITC) would protect lower-income taxpayers and limit impact on work incentives. - Additional income tax revenue could be raised by reducing tax incentives for selected groups and streamlining pension tax exemptions. - Corporate tax measures: - Profit-based corporate tax incentives could be scaled back. - Increase effective rates for intellectual property. - VAT: "VAT exemptions could also be streamlined." - Note: Israel is a signatory of the OECD’s Statement on the Two-Pillar Solution; compliance may require higher CIT rates for Israel’s existing special regimes. ### Growth-enhancing spending priorities - Greater fiscal revenues should support larger growth-enhancing spending to: - Address long-standing challenges: gradual increase in the retirement age for women will improve actuarial balance of the pension system. - Support active labor market policies (ALMPs) and ongoing education reforms including better quality early childhood education. - Significantly boost infrastructure spending—current resources in the medium-term framework are insufficient. - Climate agenda: - Planned gradual increase in excises on coal and other fuels in "2023–28" supports environmental goals and provides modest revenues. - A further increase in carbon prices may have substantial distributional implications. - Meeting climate goals through investment in R&D would be costly. - Israel lacks a funded national action plan to prepare for the effects of climate change; a State Comptroller survey found only "18 percent" of public entities assess climate change risks, and only "16 percent" of envisaged tasks are budgeted and scheduled for implementation. ### Fiscal framework and governance - Israel’s fiscal framework needs strengthening (Annex V). - A review should assess whether fiscal rules are appropriate—binding, flexible, and transparent—and the desirable size of fiscal buffers. - Consideration should be given to establishing an independent fiscal council to strengthen effectiveness. - Authorities’ views: - MOF cautious optimism about strong 2022 revenues but agrees such revenues are unlikely to persist. - MOF foresees a robust rebuilding of fiscal buffers, relying on conservative spending projections consistent with fiscal rules. - MOF emphasizes rationalizing inefficient spending to create room for productivity-enhancing reforms and favors broadening tax bases. - Views split on establishing a fiscal council; MOF noted the expenditure rule has been an effective discipline device. ### Monetary policy and exchange rate - Monetary stance during pandemic: policy rate cut to "0.1 percent" and liquidity measures (asset purchases, repurchase and currency swap operations, long-term SME lending facility). - Inflation dynamics: - One-year ahead inflation expectations rose to "2.9 percent in January-2022." - Core inflation remains within the BoI’s target range; CPI has risen fast. - Underlying inflationary pressures noted: positive output gap, high capacity utilization, compressed unemployment-to-vacancy ratio, rising service prices. - Recommendation: BoI should continue gradual reduction of monetary policy accommodation and commence a data-dependent increase in interest rates to reduce accommodation. - If underlying pressures persist, combine policy rate increases with unwinding liquidity support measures. - Clear and effective communication of policy actions is important. - Foreign exchange intervention (FXI): - BoI’s FXI program: pre-announced purchases of (but not limited to) "USD 30 billion" during the year (compared to approximately "USD 21 billion in 2020"); program expired end-2021. - FXI has declined substantially since expiration. - Staff assessment: Israel’s external position is moderately stronger than justified by medium-term fundamentals; current account is above staff’s estimate of its norm (Annex II). - Recommendation: allow market forces to set the shekel, with FXI limited to addressing disorderly market conditions. - Caveat: if inflation returns below the target range while the interest rate is at the effective lower bound, FXI to lean against shekel appreciation could help prevent de-anchoring of inflation expectations. - Authorities’ views: BoI signaled possibility of gradual interest rate increases; considered inflation uncertainty high and monetary policy should remain data driven; acknowledged weakened case for FXI but emphasized risk that shekel appreciation could lower inflation and justify continued accommodative measures, including FXI. ### Financial sector policies and housing market - Financial system resilience: - Banks’ solid balance sheets, macroprudential easing, and double digit growth in business and mortgage lending in 2021. - BoI stress tests show system stable even under pessimistic scenarios; none of the banks (or credit card companies) likely to see capital ratio fall below a Tier 1 capital ratio of "6.5 percent" under the most extreme scenario (assuming credit continues to grow through the scenario). - Unwinding of COVID-19 support measures: - Reduction in banks’ capital requirement by "1 percent" and leverage ratio by "0.5 percent" expired end-2021. - Loan deferral framework expired end-March 2021; deferred loans peaked at almost "18 percent" of total loans and were around "1 percent" of total loans at end-2021. - Banks allowed to distribute dividends. - Housing market risks and policy: - Rapid rise in housing prices due to limited supply and rapid mortgage growth; house price-to-income and price-to-rent ratios at high levels. - BoI reversed increase in LTV limit and relaxation of an additional Tier 1 capital requirement for housing loans. - Suggested further tightening of macroprudential measures, e.g., lowering the debt-service-to-income cap from its current "50 percent" ratio. - Government announced a plan for construction of "280,000 homes" and approval of "500,000 homes in 2022–25." - Parliament increased residential purchase tax on investors from "5 to 8 percent" for the next "3 years" (December decision) to discourage investors and favor first-time resident buyers. - Recommendation: advance further structural measures to ease housing supply—reforming property taxes, increasing land auctions, streamlining building regulations, allowing fast-track approvals of mixed-use development. - Financial sector evolution: - Regulatory measures aim to increase competition by lowering bank switching costs and facilitating entry of new bank and non-bank institutions, including fintech. - Israel’s first digital bank (no branches) started operating in 2021. *International Monetary Fund — excerpt from Israel country report chapter* ### introduction of regulatory changes designed to foster competition in automation infrastructures. ### introduction of regulatory changes designed to foster competition in automation infrastructures. ### Financial sector developments and emerging risks - Institutional investors’ share of consumer credit (excluding mortgages) has quadrupled since 2013, reaching 11 percent in 2021. - Credit card companies have doubled their share since 2013, to 12 percent. - Potential risks to financial stability arise from: - the development of a securitization market; and - measures to attract new entrants that rely on favorable regulatory treatment (e.g., lower capital requirements). - Israel’s conservative regulatory emphasis on risk mitigation has protected the financial system from global negative spillovers and excessive risk-taking. - The push for greater competition and financial innovation will test the agility of the current three-regulator model; potential gaps and overlaps in responsibilities will require close coordination to preserve financial safety. - The establishment of a committee to review the financial supervision structure is explicitly welcomed. ### Authorities’ views on financial regulation and supervision - Authorities agreed banks’ strong balance sheets and macroprudential easing allowed the financial system to support the economy during the pandemic. - Authorities view supply-side housing bottlenecks as the key issue; they were less concerned about banks’ exposures to housing market risks due to conservative LTV ratios and capital buffers. - The committee reviewing the financial supervision structure was reported as just commencing its work; some committee members prefer retaining current bank supervision under the central bank given effective coordination during the pandemic. ### Macro‑structural policies — labor market, product markets, and infrastructure - COVID-19 exposed persistent labor market frictions; contact‑intensive sectors suffered disproportionately large job losses while high‑skilled ICT and professional activities expanded. - Staff sectoral output forecasts indicate medium‑term deepening of labor market duality: - Low-skill contact‑intensive sectors (trade and accommodation) are likely to lose about 1 percentage point of their employment share in the medium term. - Reallocation costs are high due to skill gaps and mismatches; past recessions suggest women, the low-skilled, and young workers are less likely to switch occupations. - Policies recommended to facilitate job creation and smooth reallocation: - Reduce variation of skills across Israeli workers. - Step up quality and selection of retraining programs and job-search support, particularly for vulnerable groups. - Foster digital penetration among the low-skilled to improve access to government services. - Provide favorable conditions for job access and labor force participation, such as affordable housing and quality childcare services. - Provide early childhood programs to enhance overall education quality. - Advance education reforms to address growing demand for marketable and digital skills and reduce differences between educational streams across communities. - Product market reforms: - Further reduce barriers to trade and investment, occupational entry, and price regulations that hamper competition. - Lower barriers protecting low‑productivity domestic sectors from international competition to promote investment and innovation. - Infrastructure: - Since 2015 the government increased infrastructure spending to raise core infrastructure stock; the infrastructure budget is about 2½ percent of GDP in 2021–22. - Despite being the highest in 25 years and slightly above other advanced economies, the pace needs to accelerate to close the infrastructure stock gap relative to other OECD countries. - Transportation improvements are particularly pressing; road network use is significantly higher than in other advanced economies. - The construction of the Tel Aviv metro is expected to start in 2025 and finish by 2032, with a cost close to 9¼ percent of GDP. - Climate policy: - Authorities submitted an updated NDC in mid-2021 aiming to reduce emissions by 27 and 85 percent by 2030 and 2050, respectively, relative to 2005 levels. - Staff analysis suggests the envisaged gradual phase-in of excises on coal and other fuels between 2023–28 and the phase-out of coal by 2025 are likely to fall short of achieving the authorities’ stated objectives. - By 2028, the excise tax on coal and LPG would imply a charge of about $60 per ton of CO2, while for diesel it would reach about $101. - The excise tax on gasoline would remain unchanged at about $124 per ton of CO2, while the excise tax rate on natural gas would reach only $19 per ton of CO2. - Even replacing the envisaged excises with a phased in carbon tax of $75 per ton of CO2 would not be sufficient to achieve the 2030 target and would have distributional implications (the lowest decile’s share of energy intensive goods is twice as large as the highest decile). - Alternative approaches are imperative, potentially leveraging Israel’s innovative technologies but likely requiring substantial fiscal support for R&D. - Authorities’ views: they agreed pre‑crisis structural challenges must be addressed to fully benefit from high‑tech growth and ensure smooth labor reallocation; they emphasized quality early childhood education and improving access for disadvantaged families. ### Staff appraisal, policy recommendations, and macroeconomic stance - Growth and inflation: - The economic recovery is projected to solidify in 2022 and over the medium term, supported by strong private consumption, investment, and net exports. - With temporary factors winding down, inflation is projected to ease and stay within the BOI’s target band over the medium term. - Inflation has exceeded the BOI’s target range and signs of underlying inflationary pressures are strong; conditions are in place for the BoI to start raising the policy rate gradually. - Foreign exchange purchases should taper off, allowing the shekel’s value to be determined by market forces, while retaining the option to purchase if appreciation pressures threaten to move inflation or inflation expectations below the target band. - Fiscal policy: - The planned 2022 fiscal stance is appropriate; medium‑term fiscal path aims to put debt on a downward path. - Pandemic support in 2022 should target the most affected sectors and vulnerable population groups. - Refocusing medium‑term policy on reducing public debt and rebuilding pre‑pandemic buffers is appropriate. - Authorities’ planned expenditure restraint may be challenging given Israel’s already low civil spending; a review of public spending efficiency is recommended. - There is scope to increase tax revenues by broadening the tax base and making the tax system more progressive to support growth‑enhancing spending. - The fiscal framework should be strengthened; a review should assess fiscal rules, size of fiscal buffers, ability to face exceptional events, and the potential usefulness of an independent fiscal council. - Financial stability: - Emerging risks in the financial system need to be addressed; housing risks call for structural measures to ease housing supply. - Further tightening of macroprudential measures could help stem banks’ exposures to housing market risks and prevent potentially unsustainable borrowing. - The committee to review the financial regulatory architecture is welcome given the push for competition and innovation. - Structural reforms: - Well‑targeted reforms could foster productivity, labor reallocation, and inclusiveness. - Active labor market policies should expand vocational training and improve quality. - Education adaptation is needed to align student qualifications with labor market needs. - Continued efforts to reduce trade barriers and red tape would promote efficient allocation, investment, and innovation. - Accelerating digital and physical infrastructure would improve job accessibility. - Climate policy: - Further efforts are needed to meet the authorities’ climate objectives, including larger increases in carbon prices and greater regulatory and fiscal support for green technologies. - Consultation cycle: - It is proposed that the next Article IV consultation with Israel take place on the standard 12-month cycle. ### Key statistics and numeric highlights (preserved exactly as in source) - Institutional investors’ share of consumer credit (excluding mortgages): quadrupled since 2013, reaching 11 percent in 2021. - Credit card companies’ share of consumer credit: doubled since 2013, to 12 percent. - Infrastructure budget: about 2½ percent of GDP in 2021–22. - Tel Aviv metro cost: close to 9¼ percent of GDP (construction expected 2025–2032). - NDC emissions reduction targets: 27 and 85 percent by 2030 and 2050, respectively, relative to 2005 levels. - Excise/carbon figures by 2028: - Coal and LPG: about $60 per ton of CO2. - Diesel: about $101 per ton of CO2. - Gasoline: about $124 per ton of CO2 (unchanged). - Natural gas: $19 per ton of CO2. - Hypothetical phased carbon tax referenced: $75 per ton of CO2. - Proposed timing for next Article IV consultation: standard 12-month cycle. *Source: 1isrea2022001 - introduction of regulatory changes designed to foster competition in automation infrastructures. https://www.imf.org/-/media/files/publications/cr/2022/english/1isrea2022001.pdf* ### Annex I. Policy Support During the Pandemic ### Annex I. Policy Support During the Pandemic ### Monetary Policy Measures - Government bond market - BoI purchases of government bonds, up to NIS 85 billion. - Status: Purchases ended in December when the NIS 85 billion target was reached. Bonds will be held to maturity. - Funding for SMEs - Term funding scheme provides 3–4-year loans for banks to fund credit for small and microenterprises. - Status: Expired, with balance of NIS 40bn. - Corporate bond market - Purchased corporate bonds on the secondary market of NIS 15 billion. - Status: Terminated on November 22, with balance of NIS 3.5bn. Bonds will be held to maturity. - Repos - Repo operations to provide shekel liquidity to eligible non-banks; expanded acceptable collateral for repos to include corporate bonds rated AA or higher. - Status: Balance of NIS 0.1bn. - Dollar liquidity swaps - Provided additional USD liquidity through foreign exchange swaps of up to USD 15 billion. - Status: Inactive since July 2020. - Note: As of December 31, 2021. ### Macroprudential Measures - Capital requirement - Commercial banks’ capital requirements reduced by 1 percent, until September 30, 2021. - Status: Extended on September 30, 2021, to December 31, 2021, and expired. - LTV - Increased to up to 70 (from 50) percent, until September 30, 2021. - Status: Expired on September 30, 2021. - Additional T1 capital for housing loans - Temporary relaxation of requirement that banks raise T1 capital target by 1 percent with respect to housing loans issued during temporary order. - Status: Expired on September 30, 2021. - Loan deferral framework - Adopted a framework to enable customers to defer loan repayments in three activity segments: mortgages, consumer credit, and business credit. - Status: Expired on March 31, 2021. - Restrictions on bank’s dividend distributions - Supervisor of Banks instructed the banks’ boards of directors to re-examine their dividend distribution and share buy-backs. - Status: On July 2021 the BSD announced that banks may resume dividend distribution with regard to profits earned in 2020 taking into account future impact of the COVID-19 crisis, though payout of more than 30 percent will not be considered prudent. On September 30, 2021, the supervisor announced that the same will apply to profits earned in 2021. - Leverage ratio - Reduced minimum leverage ratio for banks by 0.5 percentage points (from 6 to 5.5 for large banks, and from 5 to 4.5 for small banks). - Status: Extended on September 30, 2021, to December 31, 2021. Expired. - Limits on exposure to construction and real estate sector - The limitation on exposure to the construction and real estate industry was increased by 2 percentage points (from 24 percent to 26 percent of the total credit portfolio when national infrastructure is included; from 20 to 22 excluding infrastructure). - Status: Valid until 2025. ### Selected Fiscal Measures - Unemployment benefits - Payment of unemployment benefits was extended (after accrued benefits expires) until June 2021. Relaxation of unpaid leave duration requirement; increase unemployment benefits for those under 28 with a child, waiving the reduction of benefits after the 126th day, full-rate unemployment for those attending vocational training and the recurring unemployed. - Status: Expired on June 30, 2021. - Unemployment benefits for age 45+ - A supplement of unemployment days of 50 percent of initial allocation to be used up to end-2021. - Status: Expired on December 31, 2021. - Return to work grant - Return to work grant for those that resume working between November-April 2021. - Status: Expired April 30, 2021. - Maternity benefits - Maternity allowance for those giving birth between July-December 2021 that received benefits during pregnancy. - Status: Expired on January 14, 2022. - Long-term unemployment grant - A one-time grant for those who received benefits for 100 or more days and average wage below 422.04 a day. - Status: Expired in December 2020. - Adjustment grants for elderly - Workers aged 67 and older dismissed or placed on unpaid leave due to COVID-19 from March 2020 to September 2021 get a monthly grant. - Status: Expired in September 2021. - Exemption from insurance contributions for employees on unpaid leave - Employers were exempt from national and health insurance contributions for those on unpaid leave from April 2020 to June 2021. - Status: Expired at end-June 2021. - Quarantine benefit to employers - A quarantine benefit to employers that paid wages to their quarantine employees. - Status: Expired on October 31, 2021. - Passover grant - A one-time grant of NIS 500 per child. - Status: Expired in April 2020. - Citizen grants - 750 NIS to each resident and additional (300 to 500) for each child for those with income below NIS 649,560. - Status: Expired at end-2020. - Grants for self-employed - Grants for self-employed with reduced income due to COVID-19 from May 2020 to June 2021. - Status: Expired in June 2021. - Fixed-expenditure grant for businesses - A grant for May-June 2020 and May-June 2021. For business with turnover up to NIS 400 million. The amount is based on fixed expenses, with 7 eligibility periods between May and June 2021. - Status: Expired at end-June 2021. - VAT deferral - Reporting and payment of VAT for January-February 2020 was deferred until May 25, 2020. - Status: Expired on May 25, 2020. - Income tax deferral - Reporting for 2019 was deferred to July 30. - Status: Expired on July 30, 2020. - Tax refunds - Transfer of income and VAT tax refunds totaling NIS 1 billion. - Status: Expired at end-March 2020. - Property tax relief - A property tax refund for SMEs that experienced 60+ percent decrease in turnover Sep 2020- June 2021. - Status: Expired at end-June 2021. - Council tax discount - A 3-month discount in the council tax for business that were not allowed to remain open. - Status: Expired at end-June 2020. - Double rate depreciation - Double rate depreciation on equipment purchased from September 2020 to June 2021. - Status: Expired at end-June 2021. - Loans under the state guarantee Fund for large businesses (annual turnover over NIS 200 million) - Guarantee on loans for up to 5 years with 1-year grace period. Up to 8 percent of turnover and capped at NIS 100m. Guarantee cap at 75 percent of each loan and 15 percent of the portfolio. - Status: Applications accepted until May 2021. Guarantees will expire by 2028, contingent on the repayment schedule of each individual loan. - Loans under the state guarantee Fund for SMEs (annual turnover up to NIS 400 million) - Guarantees on loans of up to 10 years with up to 2-year grace period for which the state subsidizes interest payments during the first year. Up to 40 percent of turnover and capped at NIS 20m. Guarantee cap at 85 percent of each loan and 15 percent of the portfolio. A higher portfolio cap of 60 percent applies for business in the sectors more affected by the pandemic. - Status: Applications accepted until December 2021. - State guarantees for top-up coverage for short-term credit insurance - Providing state guarantees to private insurance companies to offer top-up coverage for short-term credit insurance against the risk of non-payment by buyers, beyond the basic coverage offered by the companies themselves. The top-up coverage provided under the plan is limited to up to 100 percent of the basic coverage provided by the private insurance company. - Status: Applications accepted until 31 of December 2022. Guarantees will expire in 2028. *Annex I. Tables and measures as provided in the source.* ### Annex II. External Sector Assessment ### Overall Assessment and Policy Response - Overall Assessment - The external position in 2021 is projected to be moderately stronger than the level implied by medium-term fundamentals and desirable policies. - Assessment is subject to uncertainty and based on incomplete information of the state of the economy in 2021. - Qualified by the limited extent to which the model captures Israel’s country-specific factors. - Ongoing real appreciation of the shekel—with REER models suggesting overvaluation—may have a lagged impact on the current account. - Potential Policy Responses - Structural reforms to improve productivity and strengthen the resilience of the economy, including much needed public investment spending, would help prevent potential accumulation of imbalances. - With inflation exceeding and inflation expectations within the target band, the BoI should taper off the use of FX intervention for managing inflation expectations and limit its use to addressing disorderly market conditions. ### Foreign Assets and Liabilities: Position and Trajectory - Background - The NIIP fell from 46 to 35 percent of GDP between end-2020 and 2021Q3, despite positive net purchases of assets abroad by Israeli residents (mainly reserves). - In the year to 2021Q3, non-residents’ net purchases of Israeli assets equaled USD 62bn, while international liabilities rose by 148bn, with the value of portfolio equity liabilities increasing by 83 percent. - Assessment - The NIIP does not represent a major risk. - Foreign assets, including international reserves at 45.6 percent of GDP at end-2021, exceed liabilities and provide a very large buffer. - FDI is the largest component of external liabilities, and the only negative net position: NIIPs for portfolio securities, other investment and financial derivatives are all positive. - The bulk of FDI liabilities consists of equity claims. Debt assets held abroad exceed debt liabilities to non-residents. - Key statistics (2021, Sept, percent GDP) - NIIP: 34.6 - Gross Assets: 147.2 - Reserve Assets: 44.5 - Gross Liab.: 112.6 - Debt Liab.: 33.1 ### Current Account - Background - The current account balance is projected to drop from 5.4 percent of GDP in 2020, to 4.6 percent in 2021. - Drivers: (i) a sharp rebound in imports as domestic activity recovered, pushing the merchandise trade balance down; and (ii) robust ICT service exports. - Over the medium term, the CA surplus is projected to decline toward about 3 percent of GDP. - Assessment - The EBA CA analysis suggests that the cyclically adjusted 2021 CA balance is above the level warranted by fundamentals and appropriate policies by 3.4 percent of GDP. - Pandemic related temporary factors raised the CA surplus by 1.47 percent of GDP (contributions of 0.4 and 1 percent, respectively, from the shift in household consumption from services to consumer goods and the impact on medical goods trade). - Staff assess the CA gap to be 1.93 percent of GDP after accounting for those temporary factors. - Text Table: Israel: Model Estimates for 2021 (Percent of GDP) - CA-Actual (projection) 4.6 - Cyclical Contributions -0.2 - EBA model results -0.2 - Text Table: Israel: Model Estimates for 2021 (Percent of GDP) (concluded) - Adjusted CA 4.8 - CA Norm (from model) 0.6 - Adjustments to the norm1/ 0.8 - Adjusted CA Norm 1.4 - EBA CA Gap 3.4 - o/w Policy gap 0.8 - Covid-19 Adjustors - Household consumption shift: Elasticity 0.44 - Medical goods: Elasticity 1.03 - Adjusted CA Gap: 1.93 - Elasticity: -0.24 (listed in table) - REER Gap -8.0, 30.5, 12.9 (as presented under model columns) ### Real Exchange Rate - Background - The REER has appreciated significantly over the past decade (by about 20 percent, using the CPI-based REER, and about 25 percent using the ULC-based REER, between end-2011 and end-2021). - It increased by 4.5 percent during 2021 (8.7 percent using the ULC based measure), pushed by an appreciating shekel, which reached its highest value in more than two decades. - Assessment - There is an extremely large divergence in the estimates from EBA models. The REER-index and REER-level models point to substantial overvaluation of 12.9 and 30.5 percent, respectively. - The REER gap implied by the CA model suggests an undervaluation of 8 percent. - Overall, IMF staff assess the REER gap to be in the range of –8 to 30.5 percent, with a midpoint of 11.25 percent. ### Capital Flows - Background - Non-residents remained net buyers of Israeli assets through the COVID-19 crisis. - Gross inflows increased in the first three quarters of 2021, with steady FDI and a rebound into portfolio securities, mainly in the first quarter. - Residents continued to accumulate portfolio and reserve assets abroad. - Assessment - Risks are limited. Israel’s high-tech sector remained attractive for foreign direct investors even during the pandemic. - Capital outflow risks are low due to low external indebtedness of the private sector, a banking system with limited reliance on non-core funding from abroad, and long maturity of external government debt. ### FX Intervention and International Reserves - Background - Gross official reserve assets reached USD 213 billion in December 2021 (from 173.7 billion at end-2020). This corresponds to 45.6 percent of GDP. - The increase was driven by the BoI’s purchases which reached USD 34.8 billion during the year, of which 30bn were pre-announced at the beginning of the year. - Predetermined net short-term drains on reserves are low, at USD 6.3 billion; domestic banks’ short-term external liabilities are low. - Assessment - Israel’s level of international reserves is large and comfortably exceeds standard benchmarks for reserve adequacy. - Large international reserves, and other buffers, are justified in Israel in view of the geopolitical risks that the country faces. - At the onset of the pandemic, the BoI’s intervention helped prevent substantial undershooting of the inflation target band from de-anchoring inflation expectations and supported the package of monetary easing measures. - Policy recommendation: With inflation well into the target band, foreign exchange intervention should cease to serve as a tool to manage inflation expectations; its use should now be limited to preventing disorderly market conditions. ### Risks, Likelihood, Impact, and Policy Responses - Global resurgence of the Covid-19 pandemic - Likelihood: Medium: Despite the high vaccination rate, a virulent variant leads to new lockdowns - Impact: Medium: While the economy has proven resilient overall, the impact on high contact service sectors and low-skill workers is significant. - Policy Response: Keep monetary policy accommodative; reintroduce support measures, targeting the most vulnerable sectors. - Disorderly transformations - Likelihood: Medium: A faster shift towards high-tech sector exacerbates the skill mismatch and the shekel appreciation pressures. - Impact: Medium: Reduced opportunities for low-skill workers, while high tech firms face hiring difficulties. Domestic wage pressures and shekel appreciation lead to external rebalancing. - Policy Response: Scope to use ALMPs, particularly training; address long-term education reforms. - De-anchoring of inflation expectations in the U.S. leads to rising core yields and risk premia - Likelihood: Medium. Higher interest rates in the U.S. results in capital outflows from Israel, a stock market fall and tighter financial conditions. - Impact: Low: public debt has long duration and bank funding is largely domestic. A decline in high-tech IPOs may slow growth in the sector and reduce fiscal revenues. Outflows from a strong external position are also likely. - Policy Response: Keep monitoring financial conditions. FXI if outflows result in disorderly market conditions. - Widespread social discontent and political instability - Likelihood: Medium. Exacerbated inequalities lead to social tensions and weaken the government coalition. - Impact: High. Damage to confidence could exacerbate precautionary behavior and slow down the recovery, increasing poverty and inequality. - Policy Response: Provide targeted support to vulnerable groups, including through ALMPs. - Intensified geopolitical tensions and security risks - Likelihood: High. Adverse developments could damage confidence and demand. - Impact: High. The recovery could be derailed, while higher defense spending would further limit fiscal space to address long term challenges. - Policy Response: Allow temporary deviations of defense spending. Rebuild structural and contingent buffers for geopolitical risks. *Annex II. External Sector Assessment as provided in the source.* ### Annex III. Risk Assessment Matrix ### Annex III. Risk Assessment Matrix ### Risk matrix overview - The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path. - Relative likelihood categories are staff’s subjective assessment: “low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent. ### Public DSA — summary of baseline and medium-term outlook - Under staff’s baseline scenario, the government debt to GDP ratio is projected to continue declining after peaking at 72 percent of GDP in 2020. - Government debt declined in 2021 due to buoyant revenues and the withdrawal of fiscal support amidst rapid economic recovery. - Going forward, debt is expected to decline gradually as economic growth remains strong, and spending is contained; nonetheless, debt to GDP will remain well above pre-crisis levels. - Gross financing needs decline sharply in 2021 and are expected to remain broadly stable in the medium term. - Projections and key assumptions: - Real GDP growth is projected to decline towards 3½ percent. - CPI Inflation is projected to remain close to the mid-point of the central bank target range. - About 94 percent of the increase in the primary deficit was rolled back in 2021, due to the withdrawal of fiscal support measures and strong one-off tax revenues. - The general government primary deficit is projected to fall below pre-crisis levels in 2022, with further declines in the medium term as a result of spending restraint. - The effective interest rate is projected to decline, reflecting a smaller share of private placements with pension funds. ### Financing and contingent liability risks - Financing and contingent liability risks are assessed as low and well-managed. - Specific metrics and facts: - The average term to maturity has increased further, reaching 9.2 years at 2021Q3. - Foreign currency-denominated debt are at about 11 percent of GDP. - Government debt creditors are mostly domestic institutional investors. - Risks associated with pandemic-related government guaranteed programs amount to about 0.4 percent of GDP. - Pension-fund related arrangement: - Current high effective interest rate reflects an arrangement providing pension funds non-tradable bonds with a return of 4.8 percent in real terms—equivalent to 30 percent of their asset portfolio. - As of 2023, the government will not issue such bonds, replacing them with a guarantee ensuring a 5.1 percent real return (over 5 years) on 30 percent of the pension funds’ portfolios; this will gradually reduce the cost of debt but will generate a contingent liability, for which the government plans to create a reserve. ### Stress tests and scenario outcomes - A range of common stress tests indicate that risks to debt sustainability are manageable; these shocks would not increase debt above 74 percent of GDP under most scenarios. - Scenario results: - Growth shock: - Lower real GDP (by one standard deviation for two years starting in 2022) would increase debt to about 74 percent, but debt will decline after the shock dissipates. - Gross financing needs would increase by about 1½ percentage points of GDP but would decline to around 10 percent of GDP. - Interest rate shock: - A shock pushing borrowing costs up by 350 basis points would see debt increasing but remaining below 67 percent of GDP by 2027, while pushing gross financing needs up by about 1 percent of GDP. - Combined macro-fiscal shock: - A shock combining exchange rate depreciation, an expansion of the primary deficit, an increase in interest rates, and a decline in real GDP would raise debt to around 75 percent of GDP by 2025—and with a slightly increasing trend. - Gross financing needs would peak below 12 percent of GDP in 2024 but decline afterwards. - Consolidation scenario: - An additional fiscal adjustment of 1½ percent spread over 2023-25 would bring the primary fiscal position to a surplus of about 0.9 percent of GDP by 2025. - Debt would decline to about 59 percent by 2027 (compared to 64 percent in the baseline), returning debt to pre-crisis levels faster. ### Baseline projections and key fiscal and market indicators (selected exact figures) - Sovereign spreads and debt indicators: - Nominal gross public debt: 63.9 (2020); 71.7 (2021); 69.0 (2022); 67.1 (2023); 66.3 (2024); 65.8 (2025); 65.2 (2026); 64.7 (2027); 64.2 (cumulative projection end). - Public gross financing needs: 9.4 (2020); 18.0 (2021); 10.0 (2022); 8.9 (2023); 9.2 (2024); 8.5 (2025); 8.6 (2026); 9.1 (2027); 8.9 (cumulative). - EMBIG (bp): 147. - 5Y CDS (bp): 57. - Macro projections (selected): - Real GDP growth (in percent): 4.0 (2011-2019 actual); -2.2 (2020); 8.1 (2021); 5.0 (2022); 3.6 (2023); 3.5 (2024); 3.5 (2025); 3.5 (2026); 3.5 (2027). - Inflation (GDP deflator, in percent): 1.4 (2011-2019 actual); 1.0 (2020); 2.6 (2021); 3.1 (2022); 2.5 (2023); 2.3 (2024); 2.2 (2025); 2.1 (2026); 2.1 (2027). - Nominal GDP growth (in percent): 5.5 (2011-2019 actual); -1.2 (2020); 10.9 (2021); 8.3 (2022); 6.1 (2023); 5.9 (2024); 5.7 (2025); 5.7 (2026); 5.7 (2027). - Effective interest rate (in percent): 4.4 (2011-2019 actual); 3.3 (2020); 3.8 (2021); 3.8 (2022); 3.5 (2023); 3.3 (2024); 3.1 (2025); 3.0 (2026); 3.1 (2027). - Contribution to changes in public debt (selected flows, percent of GDP): - Change in gross public sector debt: -1.2 (2020); 12.2 (2021); -2.7 (2022); -1.9 (2023); -0.7 (2024); -0.6 (2025); -0.5 (2026); -0.5 (2027); cumulative -4.8. - Identified debt-creating flows: -0.2 (2020); 11.2 (2021); -3.0 (2022); -1.8 (2023); -0.9 (2024); -0.9 (2025); -1.0 (2026); -1.0 (2027); cumulative -6.7. - Primary deficit: 0.4 (2020); 9.0 (2021); 2.0 (2022); 1.0 (2023); 0.7 (2024); 0.7 (2025); 0.6 (2026); 0.6 (2027); cumulative 4.4. - Primary (noninterest) revenue and grants: 35.9 (2020); 34.3 (2021); 36.9 (2022); 34.9 (2023); 34.8 (2024); 34.6 (2025); 34.6 (2026); 34.6 (2027); cumulative 208.1. - Primary (noninterest) expenditure: 36.4 (2020); 43.4 (2021); 38.9 (2022); 35.9 (2023); 35.5 (2024); 35.3 (2025); 35.3 (2026); 35.3 (2027); cumulative 212.5. - Automatic debt dynamics: -0.7 (2020); 2.2 (2021); -5.0 (2022); -2.8 (2023); -1.7 (2024); -1.7 (2025); -1.6 (2026); -1.7 (2027); cumulative -11.1. - Interest rate/growth differential: -0.6 (2020); 2.7 (2021); -4.6 (2022); -2.8 (2023); -1.7 (2024); -1.7 (2025); -1.6 (2026); -1.7 (2027); cumulative -11.1. - Of which: real interest rate: 1.8 (2020); 1.4 (2021); 0.6 (2022); 0.3 (2023); 0.6 (2024); 0.5 (2025); 0.6 (2026); 0.5 (2027); cumulative 3.0. - Of which: real GDP growth: -2.5 (2020); 1.3 (2021); -5.2 (2022); -3.2 (2023); -2.3 (2024); -2.2 (2025); -2.2 (2026); -2.2 (2027); cumulative -14.1. - Residual, including asset changes: -1.0 (2020); 1.0 (2021); 0.3 (2022); -0.1 (2023); 0.2 (2024); 0.4 (2025); 0.4 (2026); 0.5 (2027); cumulative 1.9. ### Composition of public debt and alternative scenarios (selected assumptions) - Baseline underlying assumptions (selected exact values): - Real GDP growth: 5.0 (2022); 3.6 (2023); 3.5 (2024); 3.5 (2025); 3.5 (2026); 3.5 (2027). - Inflation: 3.1 (2022); 2.5 (2023); 2.3 (2024); 2.2 (2025); 2.1 (2026); 2.1 (2027). - Primary Balance: -1.0 (2022); -0.7 (2023); -0.7 (2024); -0.6 (2025); -0.6 (2026); -0.6 (2027). - Effective interest rate: 3.8 (2022); 3.5 (2023); 3.3 (2024); 3.1 (2025); 3.0 (2026); 3.1 (2027). - Alternative scenarios shown include Historical and Constant Primary Balance scenarios with distinct primary balance and effective interest rate paths. ### Fiscal framework, pandemic response, and policy recommendations - Israel’s fiscal framework components: - (i) a multiannual target for the central government deficit, - (ii) an expenditure rule, - (iii) a rule on expenditure commitments. - The framework requires adoption of a two-year budget and parliament approves a 3-year deficit target, which can be revised. - The real expenditure growth limit is set at a 10-year historical average of real GDP growth, adjusted by the ratio between 60 and the actual central government debt in percent of GDP. - The commitment rule (introduced in 2016) limits the government’s ability to introduce spending commitments without identifying new funding. - Evaluations and limitations: - The framework has proven very rigid: - The expenditure rule has demanded significant medium-term expenditure restraint and has led to suboptimal decisions (cutting investment or overruns). - The expenditure limit was frequently circumvented by presenting expenditures as temporary, undermining deficit targets which were reset frequently. - Rules provide little flexibility over the cycle due to absence of structural and cyclical adjustments and lack of an escape clause. - The two-year budget requirement complicates planning during high uncertainty. - Consideration for a fiscal council: - Benefit may exist for establishing a fiscal council: no single independent body currently conducts both ex-ante and ex-post assessment of realism and implementation of fiscal targets vis-à-vis the fiscal rules. - The Bank of Israel (BoI) provides independent macro-fiscal projections and fiscal advice; the State Comptroller conducts ex-post assessments. - Pandemic experience and implications: - In the absence of a 2020 budget, an extra-budgetary fund (EBF) was used for COVID-related fiscal support, allowing a transparent and prompt response. - The EBF bypassed the budgetary process because parliament had not approved a budget since March 2018; the EBF was managed by the Ministry of Finance and used only funds allocated by parliament. - At end-2021, about 1½ percent of GDP of support measures remained unspent, and an additional 0.7 percent of GDP was approved by parliament in January 2022. - With the economy recovering, the need to maintain the COVID-19 EBF has diminished; normalization of budgetary practices, including contingency planning, is warranted to avoid fragmenting the budgetary process and institutionalizing EBF-like practices. - The authorities should ensure future emergency spending and pandemic-related impacts (e.g., contingent liabilities and risks) are well documented and disclosed. - The need to add an escape clause in case another large shock materializes has been made more evident. *Source: IMF staff.* ### Annex VI. Inflation and the Monetary Policy Stance ### Annex VI. Inflation and the Monetary Policy Stance ### Overview - Inflation has risen fast and has marginally breached the upper bound of the BoI’s target range. - The output gap is positive, and the labor market has tightened. - Inflation expectations are still anchored but rising, with expectations at the nearer policy relevant horizon having a large adaptive component. - A weak relationship between the real interest rate and future inflation points to the importance of having a good measure of the neutral rate of interest to correctly assess the monetary policy stance. - Staff’s estimates suggest that the neutral rate may be very low, while the current policy stance is highly expansionary. - Conditions are in place for the BoI to commence a data-driven tightening cycle. ### Inflation, underlying pressures, and inflation expectations - Headline inflation trajectory: - After nearly one year of falling prices, headline inflation turned positive in March 2021, crossed firmly into the BoI’s target range (1–3 percent), and reached 3.1 percent in January 2022. - Drivers of the surge: - Global factors and base effects initiated the rebound: supply bottlenecks and a rebound in the price of energy and other tradable goods. - Strong domestic demand amplified the surge: since May 2021 rising prices across most main categories of Israel’s CPI, with non-tradable inflation rising steeply and fast. - Housing: housing prices continued to rise almost uninterruptedly through the pandemic and pulled up real estate service prices and house maintenance and renovation costs. - Distributional shift: the distribution of price changes across CPI components moved to the right, showing relatively high year-on-year inflation for an increasing set of components. - Labor market and capacity indicators: - Unemployment rate at 3.7 percent in January 2022; staff estimate NAIRU at 3.7 percent. - Ratio of vacancies to unemployed and capacity utilization at their highest in nearly a decade. - Output gap moved into positive territory in the last quarter of 2021. - Mitigating factors: - Highest wage increases concentrated in export-oriented high-tech sectors. - Recently signed minimum wage agreement prescribes a cumulative increase of 13.5 percent in 2022–25. - Long period of shekel appreciation: appreciating by approximately 3 percent against the US dollar year-on-year in January 2022, with an estimated average passthrough to inflation of 25 percent in six months—exerts downward pressure on inflation. - Inflation expectations: - Expectations one-to-two years ahead reacted quickly to increases in observed inflation, consistent with significant responsiveness to past inflation. - Longer-horizon expectations are also catching up quickly. - Risk: if global factors are more persistent, rising expectations could embed into actual prices; price adjustment frequency may shorten as inflation and expectations rise. ### Monetary policy tools during the pandemic - Policy rate: - The BoI’s policy (discount) rate has never been lower than 0.1 percent; 0.1 percent is regarded as the effective lower bound. - Liquidity support measures deployed: - Purchased government bonds (across the term structure, predominantly maturities longer than 5 years). - Bought (non-bank) corporate bonds. - Provided medium-term loans for banks to extend credit to small companies. - Provided shekel liquidity through repo operations and expanded acceptable collateral for repos to include corporate bonds. - Provided dollar liquidity through currency swaps. - Key tools emphasized: - Purchases of government bonds and provision of long-term loans to on-lend to SMEs at negative interest rates. - Timing: - All asset purchases ended at end-December 2021. ### The neutral interest rate and monetary policy stance - Real policy rate developments: - Policy rate kept at 0.1 percent since April 2020, when expected inflation one year ahead was -0.8 percent. - Expected inflation one year ahead increased by 3.7 percentage points since then, pushing the ex-ante real interest rate (RIR) to -2.8 percent (January 2022). - Actual inflation has risen by over 3 percentage points. - Current real policy interest rate is described as now around -3 percent. - Limitations of using absolute real interest rate: - The absolute value of the real interest rate is a poor measure of the monetary policy stance; correlation between the real policy rate and future inflation (eighteen months or four-to-eight quarters ahead) is approximately 0.2. - Interest rate gap (policy stance indicator): - Short-term neutral rate proxied by the rolling five-year mean of the real policy rate. - Indicator of monetary policy stance constructed as the difference between the real policy rate and this proxy. - Correlation between the interest rate gap and average inflation eighteen months ahead is -0.43. - Neutral rate estimates: - Taylor-type rule implied neutral rate between -1.9 and -1.6 (for responsiveness to the output gap with coefficients between zero and 0.5), using a specification where i is the policy interest rate, r* the neutral real interest rate, Eπ expected inflation, π* the inflation target (mid-point), y output growth, and y* potential growth. - Asset pricing / consumption-based model implications: - Using long-run rate of growth in per capita income estimates, the consumption model gives an equilibrium rate in the 1-3 percent range. - Using an adjustment for habit persistence lowers the rate to a 0-2 percent range. - Assessment of the policy stance: - The real policy interest rate, around -3 percent, is substantially below neutral, stimulating aggregate demand and exerting upward pressure on inflation. - Expiration of BoI’s liquidity support programs in December 2021 was appropriate. - Reducing policy accommodation by raising interest rates, together with shekel appreciation and winding down base effects, should keep inflation within the target band in 2022. - Policy approach under uncertainty: - Given high inflation uncertainty, a data-driven approach remains appropriate. - If inflation and expectations continue to rise or underlying pressures strengthen, further policy tightening will be necessary. - Option to wind down BoI government bond portfolio to undo asset purchase effects on the yield curve and allow the term structure to reflect market forces. - Sequencing and transmission considerations: - Monetary transmission in Israel: effect of the policy rate on aggregate demand is low and slow. - Complementing policy rate increases with a limited release of asset-purchase effects on longer yields may strengthen transmission and allow a more gradual policy rate increase. - A blend of long- and short-term rate hikes may be more effective in cooling the housing market. - Sequencing must consider: functioning of bond markets, maturity structure of BoI’s corporate and government bond portfolios, signaling impacts, strength of transmission, impact on the yield curve, and risks to BoI’s policy credibility. *Prepared by Shakill Hassan.* ### 0.4 percentage points. ### 0.4 percentage points. ### Labor reallocation and skill requirements - A sizable share of workers in the affected sectors would need to find employment in other activities in the expanding sectors. - Skill requirements in the expanding sectors are substantial; high-level ICT skills are becoming increasingly important as more occupations are linked to new technologies. - The high knowledge and skill requirements of these sectors could be a challenge for the relatively low-skilled Israeli workforce. - The ease with which labor reallocation occurs is closely linked to the skill and knowledge gaps between the shrinking and expanding sectors and differs across demographic groups. - Average of skill requirement based on Labor Force Survey 2019. (Sources listed in original: CBS, O*NET, IMF staff calculations.) - Empirical basis: projections and estimates referenced include restaurants and hotels spending and international tourism receipts projections from Fitch Solutions, software sales projections from Fitch Solutions, and country and sector-specific estimates of the relationship between output and employment of 29 European countries (Regional Economic Outlook, Europe, Ch. 3. IMF. October 2021). ### Key findings on policy needs - Addressing long-standing labor market challenges requires a multiprong policy approach. - Policies should: - support disadvantaged workers to retrain and upskill and gain better access to jobs; - raise the quality of the education system to meet labor market demands; - launch policies ensuring future generations have the versatility to meet growing education and skill needs. ### Strengthening active labor market policies (ALMPs) - Better funded vocational training and mentorship programs should offer a greater selection of programs targeted at disadvantaged adults who lack marketable skills (e.g., Haredi men). - Encourage the private sector to support additional training programs (e.g., apprenticeships). - Provide hiring and training subsidies to companies to improve the quality and market relevance of training programs. - Contextual statistic: Public spending on ALMPs (2019, share of GDP) is reported in the source (OECD Labor Market Programs Database comparison across countries). ### Reducing skill gaps (education reforms) - Greater adaptation of education systems is needed to align student qualifications with increasingly digitalized labor market needs. - Ongoing efforts to attract more students to tech-related programs are positive steps toward enhancing digital skills. - Further efforts should aim at reducing differences between the educational streams of Israeli minorities by: - improving the core curriculum of Haredi students; - increasing the Hebrew courses of Arab students; - improving teacher quality in disadvantaged schools. ### Increasing digital penetration - Improving access of low-skilled workers to online government services would: - support their training and labor reallocation needs; - increase take-up of targeted labor and social programs; - foster entrepreneurship among disadvantaged groups. - Reference: IMF Country Report 2021/20 cited in original text. ### Improving access to childcare and early childhood education - Access to quality childcare and early childhood learning has significant long-term benefits: it improves future education and skill achievement among youth and fosters current labor force participation, especially among women. - Publicly provided early childhood education should be significantly strengthened in disadvantaged regions because Arab-Israeli and Haredi children tend to have much lower participation in quality early childhood programs than other ethnic groups. - Building public childcare centers and improving hours and quality of existing ones would further promote female labor participation among Arab and Haredi women. ### Improving the supply of affordable housing - Promoting public housing closer to economic centers, targeted to disadvantaged groups (e.g., using mixed neighborhood models of the UK and US), would allow low-income workers better proximity to available jobs. - Addressing severe housing supply shortages is required. - The government’s 2022–25 plan to increase the stock of available housing envisages additional 1.2 percent of GDP in spending; it includes support for new schools, sewage, and other related infrastructure. - Strengthening municipal incentives to issue permits for residential housing will also require tax and land reforms, and potentially, a municipal reform. - Less costly options to provide affordable housing farther from economic centers carry trade-offs with the cost of better transport and digital infrastructure to ensure physical and digital accessibility to available jobs. ### Housing affordability indicators (as presented) - Rents are a high share of poor households’ income (share of population in the bottom quintile spending more than 40% of disposable income on rent, 2015 or latest year available). - A small share of affordable homes is near jobs (public housing units by district, % of total; districts listed include Judea-Samaria, Jerusalem, Haifa, Tel Aviv, Center, North, South). - Sources for charts and figures in the original: OECD Economic Survey 2020; Ministry of Construction and Housing; OECD, Israel 2020 Economic Survey. *Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1isrea2022001.pdf* ### Annex VIII. Addressing the Challenge of Reducing Greenhouse ### Annex VIII. Addressing the Challenge of Reducing Greenhouse Gas Emissions ### Current situation and challenges - Israel’s total greenhouse gas emissions (GHG) stand around 79 MtCo2e emission—only 0.2 percent of total global emissions. - In per capita terms, emission levels are similar to those in other advanced economies. - Main sources of emissions: generation of electricity, transportation, and industrial processes. - Electricity sector progress: - Decline of about 1½ tCo2e in per capita emissions over a decade. - The decline—about 14 percent—has been similar to that in Europe and the United States. - A more than 30-percent decline in GHG emissions of the electricity sector has been the driving force, following a transition out of coal and into natural gas. - Constraints on further electricity decarbonization: - Heavy reliance on coal and natural gas; recent shift from coal to natural gas delivered large GHG reductions. - Israel does not have favorable conditions for hydro- or wind-power generation; transition has relied largely on solar (photovoltaic). - Israel has not invested in nuclear energy generation; the 2022-26 National Action Plan on Climate Change does not envisage nuclear as an option. - Other sectoral challenges: - Limited progress reducing emissions per capita outside electricity. - Booming demand for motor vehicles driven by high population growth; infrastructure lags and congestion has increased. - Excises on gasoline and diesel are high by international standards; further increases could be politically difficult without investment in public transport and zero-emission vehicle promotion. - Industrial processes face competition from countries without carbon taxes, raising concerns about competitiveness if carbon pricing rises. ### Emission reduction goals and the authorities’ plans - Historical and stated targets: - Israel adopted the 1992 climate change convention; participated in Kyoto Protocol and Paris Agreement. - 2021 National Determined Contribution (NDC) sets targets relative to 2015 emission levels: 27 percent reduction by 2030, and a 85 percent reduction by 2050. - Sectoral targets focus on electricity, industry and waste for reaching the 2030 overall target. - At COP26 in November, PM Bennet announced Israel will seek net zero emissions by 2050; this commitment has not been reflected in an amended NDC. - National Action Plan on Climate Change 2022–26 (policies): - Includes taxes to increase the price of carbon emissions, shifting electricity generation towards renewables, and more than 100 measures across electricity, transportation, industry, buildings and waste. - Fuel excise increases envisaged to be phased 2023–28 (government decision No. 286, August 1, 2021; still needs parliamentary approval). - Current excises imply heterogeneous taxation across fuels: - Heavy fuel oil, petcoke and natural gas are taxed at very low rates. - Gasoline is taxed at over US$120 per Co2 ton. - Envisaged increases are larger for coal and heavy fuel, more modest for natural gas and diesel, and gasoline taxes will not change. - Electricity sector objectives in the plan: - Phase out coal power generation by 2025. - Lift the share of renewables to 30 percent of total generation by 2030 (renewables currently at only 6 percent; photovoltaic expected to be main driver). - Target improvements in energy efficiency of 1.3 percent annually. - Seek international cooperation for projects to import green energy. - Transportation measures include encouraging public transportation, mass public infrastructure, grants for zero emission public vehicles, and regulation discontinuing sales of new vehicles with combustion engines by 2030. - Industry measures aim to encourage: (i) energy efficiency, (ii) emission reduction efforts, (iii) resource efficiency, (iv) transition to green refrigerants, and (iv) adoption of international standards for certification of green infrastructure. - The plan comprises over 100 measures; authorities are still mapping their impact on GHG emissions. ### Assessment of policies (IMF–World Bank carbon pricing tool analysis) - Methodology and scope: - Assessment uses the carbon pricing assessment tool (spreadsheet model) to project fossil fuels, emissions, and economic and fiscal impacts of carbon pricing and mitigation policies. - Analysis assesses impact by 2030 of: envisaged excise increases and phasing out of coal power plants. - Additional policies are not quantified when the scale-up of photovoltaic generation is capped at the pace shown in recent history. - The model assumes autonomous improvements in efficiency; it does not separately assess efficiency-enhancing measures beyond these assumptions. - Zero-emission vehicle efforts are not modeled (main policy—discontinuing sales of combustion-engine vehicles—occurs in 2030). - Key findings: - The measures included in the national plan will likely not be sufficient to achieve the 2030 emission reduction goal; overall emission target will not be met given limited reductions outside electricity. - Electricity sector: - The 2030 electricity sector target is feasible; phasing out coal plants is expected to result in reaching the 2030 electricity sector target by 2026. - Achieving a 30 percent share of renewable energy by 2030 would require a much faster pace of photovoltaic adoption than recent experience. - Non-electricity sectors: - Envisaged excise increases are not enough to reduce emissions in other sectors (transport and industry). - Industrial processes rely on natural gas; transport relies on gasoline and diesel. - Hikes in excises are not large enough to discourage gasoline and diesel use; emissions in these sectors will likely continue to grow given population and economic growth, even with assumed efficiency improvements. - Carbon pricing scenarios: - Two alternative carbon tax options analyzed: one that gradually increases carbon taxes to US$75 by 2030, and another that considers additional increases at a constant pace afterwards. - Even more ambitious carbon pricing would not be sufficient to achieve the overall 2030 target. - A US$75 carbon tax would more than double new revenues relative to the envisaged hike in excises. - Revenues from carbon taxes could be used to fund complementary policies and transfers to alleviate impacts on the most vulnerable sectors. - Economic and fiscal impacts: - Carbon taxes would have a small negative impact on GDP in the short-run but could boost GDP in the long-run. - Fiscal neutrality and actual impact depend on how revenues are used; assumed multipliers guide outcomes. - Assumed fiscal use in scenarios: - Excises scenario: assume 100 percent of newly generated revenue used to increase capital expenditure. - Carbon tax scenario: assume 35 percent of new revenues used for social transfers and 65 percent used for capital expenditure. - Under these assumptions: - In the short-run, excises would not have a negative impact on GDP and may appear preferable to large carbon taxes. - In the long-run, carbon taxes provide more resources for capital expenditures and thus contribute to higher long-term growth. - Model caveat: results are based on assumed broad multipliers; specific spending choices would determine actual impacts. ### Policy implications and recommendations - The national plan’s core measures (coal phase-out and excise hikes) are necessary but insufficient to meet the 2030 overall target; additional measures and funding are required. - Recommended complementary actions to approach targets: - Implement more ambitious carbon pricing (e.g., gradual rise to US$75 by 2030 and further increases thereafter) to raise revenues for mitigation and support measures—while recognizing carbon pricing alone will not achieve the 2030 target. - Use additional carbon revenues to: - Fund infrastructure and capital expenditures that enable public transportation and energy transition (65 percent assumed in model scenarios). - Provide targeted social transfers to protect the most vulnerable from cost impacts (35 percent assumed in carbon tax scenario). - Accelerate photovoltaic deployment markedly beyond recent historical pace to reach a 30 percent renewable share by 2030. - Support research and development in green technologies and international cooperation (including import of green energy) to facilitate faster shift out of natural gas and into low-emission generation. - Accelerate improvement in transportation infrastructure and policies to promote zero-emission vehicle adoption ahead of 2030. - Consider reassessing the role of nuclear energy in the context of achieving 2050 goals and energy security (noted as a possible additional option). - Design compensation and competitiveness measures for industry exposed to competition from countries without carbon pricing to address concerns about unfair competition. - Fiscal design priorities: - Structure carbon pricing and excise reforms with clear revenue-use strategies to maximize long-term GDP benefits (investment in capital expenditure yields higher long-run multipliers). - Ensure measures to protect vulnerable households and sectors are in place when raising carbon prices or excises. *Prepared by Enrique Flores — Annex VIII, “Addressing the Challenge of Reducing Greenhouse Gas Emissions.”* ### 2018. The Fund has also provided TA for capacity development, particularly in the areas of Anti- ### 1isrea2022001 - 2018. The Fund has also provided TA for capacity development, particularly in the areas of Anti- ### Technical assistance and capacity development - The Fund has provided TA for capacity development in: - Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) - Banking supervision and regulation - Public financial management - Revenue administration - Macroeconomic statistics - Recent technical assistance to Israel covered: - Income tax reform - Macroeconomic forecasting - Systemic risk assessment and stress testing - Fiscal regime for mining - A medium-term budget framework - Strengthening banking supervision processes and tools - Implementation of IFRS - Resident Representative: - The office of the IMF Resident Representative for the WBG was established in July 1995. ### I. Assessment of Data Adequacy for Surveillance - General: - Macroeconomic statistics are of generally high quality and broadly adequate for surveillance, although there are few shortcomings particularly in monetary and government finance statistics. - A Report on the Observance of Standards and Codes—Data Module, a Detailed Assessments Using the Data Quality Assessment Framework (DQAF), and a Response by the Authorities were published on the IMF website on March 24, 2006 (IMF Country Report No. 06/125). - National Accounts: - No issues to report. - Price Statistics: - No issues to report. - Government Finance Statistics: - Annual data on the overall annual fiscal balance submitted by the Central Bureau of Statistics (CBS covers all the General Government units) are compiled according to the GFSM2014 methodology. - Implementation of the accrual basis of recording for the interest expense series has been followed. - Quarterly data for the consolidated budgetary central government and social security fund submitted by the CBS are accrual-based and broadly follow the GFSM2014 format. - For financial assets and liabilities, only transaction data are currently submitted, although a financial balance sheet (stocks of financial assets and liabilities) is under preparation. - In-year monthly reports on central government operations—compiled by the MOF on a cash basis—cover only the main aggregates of budgetary government accounts and net accounts of the social security fund, not broken down by components. - Monetary Statistics: - Monthly monetary and financial statistics in IMF’s Standardized Reporting Format (SRF) for the central bank, other deposit takers, and other financial corporations are reported to the IMF. - Israel reports data on some key series and indicators of the Financial Access Survey (FAS), including the two indicators (commercial bank branches per 100,000 adults and ATMs per 100,000 adults) adopted by the UN to monitor Target 8.10 of the Sustainable Development Goals (SDGs). - Financial sector surveillance: - Data on financial soundness indicators (FSIs) are compiled and reported to IMF on a quarterly basis and cover deposit takers, other financial corporations, nonfinancial corporations and households. - Balance of Payments: - Balance of payments and international investment position data are compiled on a quarterly basis and follow the sixth edition of the Balance of Payments Manual. - External sector data were not examined in the Report on the Observance of Standards and Codes. - Country participates in Coordinated Direct Investment Survey and in Coordinated Portfolio Investment Survey. ### II. Data Standards and Quality - Participant in the Special Data Dissemination System (SDDS) since April 1996, and in full observance of the SDDS’s prescriptions for data coverage, periodicity and timeliness, and for the dissemination of advance release calendars. - Data ROSC published on March 24, 2006. ### III. Reporting to STA (Optional) - Data are regularly reported for publication in the Government Finance Statistics Yearbook and in the IFS. ### Common Indicators Required for Surveillance (summary as of January 31, 2022) - Exchange Rates - Date of latest observation: Same day - Date received: Same day - Frequency of Data, Reporting, Publication: D and M - International Reserve Assets and Reserve Liabilities of the Monetary Authorities - Date of latest observation: Jan-22 - Date received: Feb-22 - Frequency: M / M / M - Reserve/Base Money - Date of latest observation: Jan-22 - Date received: Feb-22 - Frequency: M / M / M - Broad Money - Date of latest observation: Jan-22 - Date received: Feb-22 - Frequency: M / M / M - Central Bank Balance Sheet - Date of latest observation: Jan-22 - Date received: Feb-22 - Frequency: M / M / M - Consolidated Balance Sheet of the Banking System - Date of latest observation: Sep-21 - Date received: Dec-21 - Frequency: M / M / M - Interest Rates - Date of latest observation: Same day - Date received: Same day - Frequency: D / D / D - Consumer Price Index - Date of latest observation: Jan-22 - Date received: Feb-22 - Frequency: M / M / M - Revenue, Expenditure, Balance and Composition of Financing – General Government - Date of latest observation: 2020 - Date received: Sep-21 - Frequency: A / A / A - Revenue, Expenditure, Balance and Composition of Financing – Central Government - Date of latest observation: Jan-22 - Date received: Feb-22 - Frequency: M / M / M - Stocks of Central Government and Central Government-Guaranteed Debt - Date of latest observation: Q3-21 - Date received: Dec-21 - Frequency: Q / Q / Q - External Current Account Balance - Date of latest observation: Q3-21 - Date received: Dec-21 - Frequency: Q / Q / Q - Exports and Imports of Goods and Services - Date of latest observation: Q3-21 - Date received: Dec-21 - Frequency: Q / Q / Q - GDP/GNP - Date of latest observation: Q4-21 - Date received: Feb-22 - Frequency: Q / Q / Q - Gross External Debt - Date of latest observation: Q3-21 - Date received: Dec-21 - Frequency: Q / Q / Q - International Investment Position - Date of latest observation: Q3-21 - Date received: Dec-21 - Frequency: Q / Q / Q ### Supplementary information prepared by European Department (information available since staff report issued March 4, 2022) - Key updates: - Data released in March confirms Israel’s strong performance in 2021 and sustained momentum into the first quarter of 2022. - The second estimate of the 2021 national accounts showed a slight upward revision of 2021 growth from 8.1 percent to 8.2 percent. - The 17.6-percent annualized qoq growth in the last quarter implies a carry-over of 4.8 percent for 2022. - Fiscal revenues for February and the labor force survey for the first half of February suggest the economy has been resilient during the Omicron wave, which has continued to dissipate. - Impact of the war in Ukraine (as of March 14, 2022): - The war has had a limited impact on Israeli capital markets thus far. - Aggregate value of listed shares in the Tel Aviv Stock Exchange fell by approximately 3 percent on February 24 but subsequently stabilized and recovered the losses. - After an initial depreciation, the shekel has also recovered, with no intervention by the Bank of Israel. - The war in Ukraine has had no discernable effect on Israeli bond yields. - Market indicators and exposures: - Israel’s direct export exposure to Russia and Ukraine: - Exports to Russia and Ukraine account for a total of 2 percent of Israel’s merchandise exports (less than 0.4 percent of GDP). - Imports: - About half of Israel’s imported wheat is supplied by Russia or Ukraine. - Banking sector: - Israeli banks have no significant cross-border exposures to Russia or Ukraine. - Outlook and uncertainties: - Israel’s economic outlook remains subject to significant uncertainty. - Potential spillovers from a weaker global outlook could affect Israel via higher energy and wheat prices and lower external demand. - Israel’s own production of natural gas would mitigate the energy shock, but higher prices will put additional pressure on headline inflation. - Higher energy and commodity prices may impact domestic demand, buffered somewhat by households’ savings accumulated during the pandemic. - The impact on net exports and the current account is uncertain but likely mitigated by the resilience of the high-tech sector. - Staff appraisal: - The thrust of the staff appraisal remains unchanged. *Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1isrea2022001.pdf* --- _Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1isrea2022001.pdf_