## 1isrea2023001 - 2023

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---

### Context and structural features
- Political and policy context:
  - A new government coalition took power last December composed of the Likud, Religious Zionism, Shas and United Torah Judaism parties.
  - Key policy initiatives include judicial reform with two main objectives: (i) reconfiguring the Committee for the Selection of judges providing for six out of eleven of its members to be from the governing coalition; (ii) limiting the Supreme Court’s authority to strike down laws, while empowering the Knesset to either overrule such decisions or preemptively shield legislation from judicial review, in both cases by a simple majority.
  - Policy measures to address cost of living: removing import barriers, increasing financial market competitiveness, transfers for child-care and orthodox education, safeguards for infrastructure projects, and reform of the property tax structure to promote house development.
  - The proposed judicial reforms have triggered large-scale protests and social confrontation.
- Dual structure of the economy:
  - High-tech sector: about 17 percent of GDP; 10 percent of total employment; 56 percent of total exports.
  - Overall GDP in 2022 was about 13 percent higher than its pre-Covid level, with growth mainly driven by high-tech while other sectors struggled to recover.
- Inclusion challenges:
  - Low labor market participation and skills among the Arab-Israeli and Haredi populations.
  - Underfunding of active labor market policies and poor targeting of education spending.

### Recent macroeconomic developments and labor market
- Growth and demand:
  - GDP increased 6.5 percent in 2022, led by domestic demand; 2023:Q1 figures show the economy started to slow.
  - External demand was negative on net as imports outgrew exports.
- Labor market:
  - Labor force participation recovered during 2022; vacancies declined.
  - Unemployment increased to 4.2 percent in December, from about 3.5 percent in July 2022.
  - Employment recovery uneven: construction and high-tech surpassed pre-Covid levels; other sectors lag.
  - Amid high inflation, private sector real wages have fallen but remain above pre-Covid levels; public sector wages have dropped below.

### Inflation, monetary policy, and financial conditions
- Inflation and policy rates:
  - Headline inflation breached the upper bound of the target range (of one to three percent) in January 2022 and reached 5.4 percent y-o-y twelve months later.
  - Headline inflation was 5 percent y-o-y as of April 2023.
  - Core inflation oscillated around 5.1 percent between Q4–2022 and Q1–2023.
  - Housing has a weight of 24.73 in Israel’s headline CPI and has been the largest driver of inflation.
  - The Bank of Israel raised the policy rate from 0.1 in April 2022 to 4.75 percent by May 2023.
- Financial conditions and credit:
  - Loosening financial conditions up to mid-2022; Financial Conditions Index shows significant tightening starting in mid-2022.
  - Loan books grew rapidly, with annual growth in total credit outstanding peaking at 15.9 percent in July 2022.
  - Growth in loans to the business sector reached 24 percent across all activity segments.
  - Sectoral leverage ratios: household debt about 44 percent of GDP; non-financial corporate debt about 70 percent of GDP.

### Housing market and macroprudential measures
- Housing market dynamics:
  - Housing price growth reached 20 percent y-o-y in September 2022; overall house price level increased by 17 percent for the year.
  - Mortgage credit growth reached 17.7 percent y-o-y in May 2022 with overall growth of 13.8 percent for the year.
  - Housing loans grew 11.6 percent y-o-y in February 2023; housing price growth began to decelerate from October 2022 amid rising lending rates.
  - Building starts increased significantly in 2022 (to the highest level since the mid-1990s); stock of new dwellings for sale is rising.
  - Average household indebtedness is about 44 percent of GDP.
- Macroprudential measures and borrower metrics:
  - Temporary relaxation during Covid reversed with retightening by end-2021.
  - Average LTV on new housing loans stable around 55 percent; risk weights reach 75 percent for LTVs above 60 percent.
  - Average PTI reached 27.9 percent—up one percentage point during the first three quarters of 2022.
  - Share of loans with PTI between 30 and 40 percent is about 48 percent.
  - PTI on new loans capped at 50 percent, with a capital surcharge for those between 40 and 50 percent.
  - Purely fixed rate loans account for about one-quarter of mortgage balances.

### Fiscal outturn, buffers, and public debt
- 2022 fiscal outcomes:
  - General government fiscal balance improved from a deficit of 3.7 percent of GDP in 2021 to a surplus of about 0.6 percent of GDP in 2022.
  - Improvement explained by: reduction of Covid-related programs of about 3 percent of GDP; tax buoyancy and strong recovery increased revenue by about 0.8 percent of GDP; reduction in other spendings of about 0.4 percent of GDP.
  - Debt-to-GDP ratios fell from near 71 to about 61 percent of GDP from 2020 to 2022.
- Projections and composition:
  - Structural deficit projected at 1.5 percent of potential GDP in 2023—up from a deficit of 0.2 percent of potential GDP in 2022—implying an expansionary fiscal stance in 2023.
  - Primary balance projected to be a surplus at 1.7 percent of GDP in 2023.
  - Medium term: structural deficit expected to converge to about 3 percent of GDP by 2028; debt ratios expected to fall to about 55 percent of GDP by 2028.
  - Capital spending projected at about 2.7 percent of GDP in 2023.
  - Civil spending of the central government projected at about 21.3 percent of GDP in 2023.
  - Israel invested in transportation infrastructure on average of 1 percent of GDP per year during 2017–21; BOI estimates a needed yearly average of about 2–3 percent of GDP to close the gap with other developed countries.

### External position and external-sector metrics (Annex I)
- Current account and NIIP:
  - The current account registered a surplus in 2022 of 3.7 percent.
  - Net international investment position (NIIP) positive at 32.1 percent of GDP by end-2022.
  - Gross external debt about 30 percent of GDP.
  - Gross international reserves at 37.2 percent of GDP at end-2022.
- Assessment and model estimates:
  - Staff assess the external position in 2022 to be stronger than fundamentals and desirable policy settings.
  - Text Table: CA-Actual: 3.7; Cyclical Contributions: 1.3; Adjusted CA: 5.0; CA Norm: 0.9; Adjusted CA Norm: 1.7; EBA CA Gap: 3.3; REER level: -14.3; REER index: 17.3; REER (other): 11.2.
  - Reserve assets: Gross Assets: 123.1; Reserve Assets: 37.2; Gross Liabilities: 91; Debt Liabilities: 29.3 (percent of GDP, 2022).
- REER and capital flows:
  - REER depreciated in 2022 by about 7 percent (CPI-based) and by about 4 percent (ULC-based); nominal exchange depreciated approximately 9 percent to the US dollar.
  - Non-residents were net buyers of Israeli assets through each quarter of 2022; residents continued to accumulate assets abroad.
  - Gross official reserve assets fell to USD 194 in December 2022 (from 213 billion at end-2021) due to valuation effects; corresponds to 37 percent of GDP and 14 months of imports.

### Outlook and risks
- Growth and labor market:
  - Staff projects growth to slow to about 2.5 percent in 2023 as purchasing power moderates and firms rein in investment.
  - Labor market expected to remain tight; unemployment rate expected to marginally increase amid increasing labor force participation.
- Inflation and monetary transmission:
  - Inflation projected to reach the target range by end-2024 with a monetary transmission lag of one-to-two years.
  - Imputed rents expected to remain a key driver of core inflation in the near term.
  - Shekel depreciation in first half of 2023 may slow return of inflation to target.
- Downside risks:
  - Spillovers from a weaker global outlook; renewed surge in global energy prices; supply chain disruptions; increase in geopolitical tensions; geo-economic fragmentation; heightened global financial volatility.
  - Exchange-rate risk from rising geopolitical tensions or falling interest rate differentials could further depreciate the shekel.
- Judicial reform uncertainty:
  - BOI analysis links uncertainty to increases in Israel’s risk premium, adverse impact on exports, and declines in domestic investment and private consumption.
  - Estimated impacts:
    - Overall impact estimated to lower the level of GDP by between 0.8 to 2.8 percent per year over a three-year period depending on magnitude and persistence.
    - MOF staff estimate a fall of about 0.8 percent in potential real GDP per capita.
  - Potential channel: relocation of high-tech firms could damage capital stock and labor market productivity.

### Policy discussions and recommendations — fiscal
- Staff view:
  - Fiscal stance assessed as appropriate given consolidation in 2022 and rebuilding of buffers; protect growth-enhancing spending, including education and infrastructure.
- Revenue and tax recommendations:
  - Proactively take additional revenue measures to finance growth-enhancing spending while maintaining buffers. Options include:
    - Raising low-bracket tax rates while increasing the earned income tax credit to protect lower-income taxpayers.
    - Reducing tax incentives for selected groups and streamlining tax exemptions.
    - Scale back profit-base corporate tax incentives, increase effective rates for intellectual property, and streamline VAT exemptions.
- Fiscal-framework and governance measures:
  - Review whether fiscal rules are binding, flexible, and transparent.
  - Develop a framework to define priorities across competing needs to support budgetary planning of growth-enhancing expenditure.
  - Consider a mechanism to ringfence allowances for infrastructure and education projects while keeping a fiscal envelope that protects buffers.
  - Consider establishing an independent fiscal council to advise on project criteria, assess enforcement, evaluate fiscal stance, assess budgetary forecasts, monitor the fiscal rule, and advise on reprioritization of spending; safeguards to guarantee minimum qualifications and avoid conflicts of interest.

### Policy discussions and recommendations — monetary and exchange rate policy
- Monetary stance and guidance:
  - Central bank appropriately moved policy stance above neutral and should maintain this stance while underlying inflation pressures remain strong.
  - Staff assess output gap as still positive; real policy rate turned positive around November 2022; monetary policy stance became tight around January 2023.
  - Given a transmission lag of about one to two years, prudent to keep policy rate elevated and restrictive until clearer signs that aggregate demand is cooling.
  - BOI should stand ready to further hike the policy rate if inflation surprises on the upside or if inflation expectations rise past the target band again.
- Policy-rate level and exchange-rate approach:
  - Staff estimates current policy rate (4.75 percent) is roughly in the vicinity of the optimal level for Israel.
  - Staff’s estimates of the neutral real rate suggest a likely (but very uncertain) range between 0 and 1.
  - Market forces should be allowed to set the shekel price; FX intervention limited to addressing disorderly market conditions; FXI may be appropriate under certain shocks as outlined in the IMF’s Integrated Policy Framework.
- Transmission:
  - Research shows a faster and larger positive pass-through of the shekel exchange rate to inflation than the negative pass-through from the policy rate to inflation.

### Financial sector assessment, supervision, and macroprudential recommendations
- Banking sector health and key statistics:
  - Staff assesses the banking sector to be broadly robust.
  - Capital ratio about 14 percent at 2023:Q3 with Tier I capital beyond minimum requirements.
  - Liquidity Coverage Ratio at 125 percent in 2022:Q3; Net Stable Funding Ratio 126 percent for the average bank in 2022:Q3.
  - Banks’ profits rebounded strongly in 2021 and 2022; ratio of nonperforming loans to total loans in 2022:Q3 fell to a decade low.
  - Bank loans for residential and commercial real-estate combined reached 54 percent of total in 2022:Q3, up by approximately 10 percentage points in the last five years.
- Supervisory and macroprudential recommendations:
  - Use existing credit bureau information to improve supervisory models at individual exposure level.
  - Combine proposed microprudential frameworks with macroprudential stress tests to quantify potential contagion losses.
  - Develop legal framework to delineate banks and non-banking institutions to enhance consumer protection and safeguard financial stability.
  - Staff cautions against interference in market interest rate setting; initiatives to impose minimum payments on retail deposits and caps on mortgage rates would distort pricing and transmission.
- AML/CFT actions:
  - Continue strengthening AML/CFT framework; include real estate agents, trusts and company service providers.
  - Banks should continue enhanced due diligence and enforce dissuasive sanctions for AML/CFT failures.

### Contingent policies if downside risks materialize
- Fiscal: play a counter-cyclical role; clearly communicate reasons and return path if exceeding deficit/expenditure ceilings.
- Monetary: balance risks to output, inflation and financial stability; BOI should be ready to tighten if exchange-rate shocks dominate, or ease if growth decelerates substantially or inflation subsides.
- Financial sector: adjust prudential policies to support credit provision while protecting buffers; targeted fine-tuning and enhanced supervision.
- FX intervention: may be appropriate under certain shocks per the IPF.

### Structural policies: education, infrastructure, and product market reforms
- Education and labor market:
  - Address skill gaps among Haredi and Arab communities; allocate added hours in Arab schools to Hebrew instruction; increase labor-market-relevant subjects among the Haredi population.
  - Expand Active Labor Market Policies and vocational training; encourage employer involvement in training.
- Infrastructure:
  - Infrastructure spending reached about 3 percent of GDP in 2021–22 but projected to decrease in the 2023–24 budget.
  - Stock of public capital notably below OECD averages; staff analysis: increasing public investment by 30 percent (from 2021 levels) would raise GDP growth in the long run by 10 percent, while reducing labor market inequality.
  - Prioritize transportation networks in large cities and digital infrastructure for poor communities.
- Product market reforms:
  - Decrease trade barriers; allow import of products meeting EU standards; reduce regulation of parallel imports; remove barriers to entry of service companies; implement health insurance cost reduction reform; increase financial market competitiveness.
- Public investment surge modeling (Annex VIII):
  - Surge experiment: a 33 percent increase in capital spending for three years, convergence by year eight; financing mix with 휒 = 50 percent.
  - Baseline investment efficiency assumed at 80 percent; low-efficiency scenario at 60 percent can almost completely wipe out growth returns and raise debt.
  - Central scenario: long-run output about 10 percent higher than baseline; trend growth from slightly above 3 percent to about 3.4 percent.
  - Policy implications: prioritize project quality and execution; consider complementary education reform; maintain sound public finances and buffers; balance domestic and commercial borrowing.

### Risk assessment and scenarios (Annex VII and Annex IV)
- Political/social risks:
  - Judicial reform uncertainty: Likelihood: High; Impact: High. Policy response: find durable, politically sustainable solution to lower uncertainty and protect rule of law.
  - Social discontent: Likelihood: High; Impact: High. Policy response: safeguard rule of law and broaden participation in reform design.
- Geopolitical and external risks:
  - Intensification of regional conflict(s): Likelihood: High; Impact: Medium. Policy response: allow temporary defense spending deviations; rebuild buffers.
  - Deepening geo-economic fragmentation: Likelihood: High; Impact: Medium. Policy response: diversify economy.
- Economic/financial risks:
  - Abrupt global slowdown: Likelihood: Medium; Impact: Medium. Policy response: monitor financial conditions; allow market forces to set shekel price except in disorderly conditions.
  - Monetary policy miscalibration and systemic financial instability: Likelihood: Medium; Impact: Medium. Policy response: credible commitment to tightening and monitoring financial distress signals.
- Quantified adverse scenarios:
  - IMF staff estimates a tightening cycle of financial conditions could lower output by approximately 2.6 percent—on average over the next three years (98 percent confidence interval).
  - BOI scenarios on judicial reform uncertainty: total impact for low persistence: -0.8 (per year, over three years); high persistence: -2.8 (per year, over three years).

### Data, TA, and statistical issues
- Fund technical assistance provided in AML/CFT, banking supervision and regulation, public financial management, revenue administration, macroeconomic statistics.
- Macroeconomic statistics generally high quality; some shortcomings in monetary and government finance statistics.
- Israel participates in SDDS since April 1996 in full observance of SDDS prescriptions.
- Common indicators and data frequencies (as January 31, 2023): Consumer Price Index latest observation April -23; GDP/GNP latest observation Q1-23; External Current Account Balance latest observation Q4-2022; International Reserve Assets latest observation April-23; Stocks of Central Government Debt latest observation Q4-22.

_Source: IMF staff report (1isrea2023001 - 2023)._

### 2023. The staff team comprised Messrs. Segoviano (head), Druck,

### 1isrea2023001 - 2023

### CONTEXT
- A new government coalition took power last December. The coalition is made up of the Likud, Religious Zionism, Shas and United Torah Judaism parties.
- Key policy initiatives under the new government include:
  - Judicial reform with two main objectives: (i) reconfiguring the Committee for the Selection of judges providing for six out of eleven of its members to be from the governing coalition; (ii) limiting the Supreme Court’s authority to strike down laws, while empowering the Knesset (parliament) to either overrule such decisions or preemptively shield legislation from judicial review, in both cases by a simple majority.
  - Policies to address the increase in the cost of living, including improving market competition by removing import barriers and increasing financial market competitiveness.
  - Transfers to make child-care more accessible and for orthodox education.
  - Structural reforms, including improving safeguards to ensure infrastructure projects are completed, and a reform of the property tax structure to promote house development.
- The proposed judicial reforms have triggered large-scale protests and social confrontation, drawing widespread criticism from civil society groups, opposition politicians, and the international community focused on the scale and speed of the proposed changes to the Knesset.
- Israel’s economy exhibits a pronounced dual structure:
  - High-tech sector: about 17 percent of GDP, 10 percent of total employment, and 56 percent of total exports.
  - Overall GDP in 2022 was about 13 percent higher than its pre-Covid level, with growth mainly driven by high-tech while other sectors struggled to recover.
- Inequality and inclusion challenges:
  - Asymmetric growth dynamics contribute to relatively high inequality compared to other OECD countries.
  - Low labor market participation rates and skills among the Arab-Israeli and Haredi populations remain significant challenges.
  - Underfunding of active labor market policies and poor targeting of education spending have limited integration of the most vulnerable in the economy.
- Spillovers from Russia’s war in Ukraine have been limited so far:
  - Israel’s direct trade exposures to countries in the conflict are minor.
  - Israel’s energy dependence is moderate, with local production covering more than half of domestic consumption.
  - Media reports suggest about 70 thousand people of working age (or 1 percent of Israel’s labor force) arrived from the conflict region in 2022.

### RECENT ECONOMIC DEVELOPMENTS
- Aggregate growth and demand:
  - GDP increased 6.5 percent in 2022, led by domestic demand with increases in investment (broadly split between residential and nonresidential infrastructure) and consumption.
  - External demand was negative on net as imports outgrew exports.
  - 2023:Q1 figures show that the economy started to slow.
- Labor market:
  - Labor force participation recovered during 2022; vacancies declined.
  - Unemployment increased to 4.2 percent in December, from about 3.5 percent in July 2022.
  - Employment recovery is uneven: construction and high-tech sectors have surpassed pre-Covid levels; other sectors lag.
  - Amid high inflation, private sector real wages have fallen but remain above their pre-Covid levels; public sector wages have dropped below.
- Inflation and monetary policy:
  - Headline inflation breached the upper bound of the target range (of one to three percent) in January 2022 and reached 5.4 percent y-o-y twelve months later.
  - Headline inflation was 5 percent y-o-y as of April 2023.
  - Core inflation oscillated around 5.1 percent between Q4–2022 and Q1–2023.
  - The largest driver of both core and headline inflation has been housing; housing has a weight of 24.73 in Israel’s headline CPI.
  - Near-term inflation expectations (one year ahead) fell back to the target range in late 2022 but remained near the upper bound and uncertain in the near term.
  - The Bank of Israel raised the policy rate from 0.1 in April 2022 to 4.75 percent by May 2023.
- Financial conditions and credit:
  - Loosening financial conditions up to mid-2022 reflected low funding constraints (Annex IX).
  - Loan books grew rapidly, with annual growth in total credit outstanding peaking at 15.9 percent in July 2022.
  - Growth in loans to the business sector reached 24 percent across all activity segments.
  - Sectoral leverage ratios: household debt about 44 percent of GDP; non-financial corporate debt about 70 percent of GDP.
- Housing market developments:
  - Housing price growth reached 20 percent in September 2022 y-o-y with the overall house price level increasing by 17 percent for the year.
  - Mortgage credit growth reached 17.7 percent y-o-y in May 2022 with overall growth of 13.8 percent for the year.
  - Housing loans grew 11.6 percent y-o-y in February 2023.
  - Amid rapid rise in lending rates, housing price growth began to decelerate from October 2022.
  - Mortgage credit growth, issuance of new mortgages, and total housing transactions started to gradually decline during 2022, while the stock of new dwellings for sale is rising.
  - Building starts increased significantly in 2022 (to the highest level since the mid-1990s).
  - Average household indebtedness is about 44 percent of GDP, low compared to the rest of Europe, but lower-income households and those that purchased in overvalued areas or at the maximum of their budget are particularly vulnerable.
  - Rising house prices pushed the price-to-rent and price-to-income ratios to a zenith in 2022 (albeit below the OECD average).

### KEY STATISTICS AND INDICATORS (as reported)
- GDP: increased 6.5 percent in 2022.
- High-tech sector: about 17 percent of GDP; 10 percent of total employment; 56 percent of total exports.
- Headline inflation: breached 3 percent in January 2022; 5.4 percent y-o-y twelve months later; 5 percent y-o-y as of April 2023.
- Core inflation: around 5.1 percent between Q4–2022 and Q1–2023.
- Policy interest rate: 0.1 in April 2022 → 4.75 percent by May 2023.
- Unemployment: about 3.5 percent in July 2022 → 4.2 percent in December 2022.
- Credit growth: total credit outstanding growth peaked at 15.9 percent in July 2022; business sector loans up 24 percent.
- Household debt: about 44 percent of GDP.
- Non-financial corporate debt: about 70 percent of GDP.
- Housing price growth: 20 percent y-o-y in September 2022; overall house price level up 17 percent in 2022.
- Mortgage credit growth: 17.7 percent y-o-y in May 2022; housing loans grew 11.6 percent y-o-y in February 2023.
- Housing weight in CPI: 24.73.

*Source: IMF staff report (1isrea2023001 - 2023).*

### 13.      The retightening of macro-prudential measures contributed to containing

### The retightening of macro-prudential measures contributed to containing unwarranted risk taking

### Macroprudential measures and housing-market risk
- Risk taking rose during a temporary relaxation of macroprudential measures adopted in response to the Covid-19 shock; these measures were re-tightened by end-2021 (Annex II).
- New-loan LTV dynamics:
  - Increase in the volume of new loans with high LTVs (defined as those between 60 and 75 percent) during early 2022 reversed.
  - The average LTV on new housing loans is stable around 55 percent.
  - Risk weights increase with LTVs—reaching 75 percent for LTVs above 60 percent, which also trigger additional provisioning.
- Payment-to-income (PTI) dynamics:
  - The average PTI reached 27.9 percent—increasing one percentage point during the first three quarters of 2022 alone.
  - Significant increase in the share of loans with PTI between 30 and 40 percent, which is about 48 percent.
  - The PTI on new loans is capped at 50 percent, with a capital surcharge for those between 40 and 50 percent.
- Interest-rate and loan structure effects:
  - Rising average debt payments-to-income reflect rapidly rising interest rates on monthly mortgage payments and the high degree of indexation.
  - Purely fixed rate loans account for about one-quarter of mortgage balances.

### Fiscal outturn, buffers, and public debt
- 2022 fiscal outturn:
  - General government fiscal balance improved from a deficit of 3.7 percent of GDP in 2021 to a surplus of about 0.6 percent of GDP in 2022.
  - Improvement explained by:
    - Reduction of Covid-related programs of about 3 percent of GDP.
    - Tax buoyancy and strong recovery that further increase revenue during 2022, by about 0.8 percent of GDP.
    - Reduction in other spendings of about 0.4 percent of GDP.
- Debt and buffers:
  - Debt-to-GDP ratios fell from near 71 to about 61 percent of GDP from 2020 to 2022 (Figure 5).
- Fiscal stance and projections:
  - Structural deficit projected at 1.5 percent of potential GDP in 2023—up from a deficit of 0.2 percent of potential GDP in 2022—implying an expansionary fiscal stance in 2023.
  - Primary balance projected to be a surplus at 1.7 percent of GDP in 2023.
  - The level of the structural deficit is expected to remain well below pre-pandemic levels that averaged about 3.5 percent of GDP during 2017-19.
  - For the medium term: revenue in terms of GDP expected to continue falling, fiscal spending in terms of GDP expected to remain low and broadly stable; structural deficit expected to converge to about 3 percent of GDP by 2028, while debt ratios are expected to continue falling to reach about 55 percent of GDP by 2028.
- Composition and spending notes:
  - Capital spending projected at about 2.7 percent of GDP in 2023.
  - Civil spending of the central government projected at about 21.3 percent of GDP in 2023.
  - Israel invested in transportation infrastructure on average of 1 percent of GDP per year during 2017–21; BOI estimates Israel would need to invest in transportation infrastructure a yearly average of about 2–3 percent of GDP to close the gap with other developed countries.

### External position and external-sector metrics
- Current account and external balances:
  - The current account registered a surplus in 2022 (3.7 percent), despite the deficit in merchandise trade.
  - Net international investment position (NIIP) remains positive at 32 percent of GDP by end-2022.
  - Gross external debt is sustainable (about 30 percent of GDP).
  - Gross international reserves at 37 percent of GDP at end 2022.
- Assessment:
  - Staff assess the external position in 2022 to be stronger than fundamentals and desirable policy settings (Annex 1, Figure 6).
  - Israel’s share of world service exports continues to grow rapidly, driven by the high technology sector.

### Outlook and risks
- Growth outlook:
  - Staff projects economic growth to slow to about 2.5 percent in 2023, as households’ purchasing power moderates and firms rein in investment, reflecting declining real wages and high interest rates.
  - Labor market expected to remain tight; unemployment rate expected to marginally increase amid increasing labor force participation.
  - Fiscal policy will be supporting growth in 2023; public debt to GDP projected to decrease further and stay below 60 percent.
  - External sector projected to remain robust with a moderate current account surplus, positive NIIP, sustainable external debt, and ample international reserves.
- Inflation and monetary transmission:
  - Inflation is projected to reach the target range by end-2024, as the tighter monetary stance acts—with a transmission lag of one-to-two years—on all demand-sensitive components of the CPI.
  - Imputed rents will remain a key driver of core inflation in the near term; headline inflation subject to uncertainty about future commodities prices.
  - Some pass-through of the shekel depreciation during the first half of 2023 expected to slow the return of inflation to target.
- Downside and upside risks:
  - Downside risks: spillovers from a weaker global outlook, renewed surge in global energy prices, new supply chain disruptions, increase in geopolitical tensions (including a possible escalation of Russia’s war in Ukraine), broader geo-economic fragmentation, and heightened global financial volatility due to stress in foreign banking sectors.
  - Exchange-rate risk: rising geopolitical tensions, or a falling interest rate differential versus major central banks, could exert further depreciation pressure on the shekel.
- Judicial reform uncertainty:
  - Continued uncertainty around the judicial reform is a notable downside risk.
  - BOI analysis links uncertainty to increases in Israel’s risk premium, adverse impact on exports, and declines in domestic investment and private consumption.
  - Estimated impacts:
    - Depending on magnitude and persistence, overall impact estimated to lower the level of GDP by between 0.8 to 2.8 percent per year over a three-year period.
    - MOF staff estimate a fall of about 0.8 percent in potential real GDP per capita.
  - Potential channel: relocation of high-tech firms could damage the stock of capital and labor market productivity, jeopardizing Israel’s strong economic growth potential.

### Policy discussions and recommendations — fiscal
- Staff view:
  - The fiscal stance is assessed as appropriate given stronger-than-anticipated consolidation in 2022 and rebuilding of buffers.
  - Care should be taken to protect growth-enhancing spending, including education and infrastructure.
- Revenue and tax recommendations:
  - Israel should proactively take additional revenue measures to finance growth-enhancing spending while maintaining robust buffers. Options include:
    - Raising low-bracket tax rates while increasing the earned income tax credit to protect lower-income taxpayers.
    - Reducing tax incentives for selected groups and streamlining tax exemptions.
    - On the corporate side, scale back profit-base corporate tax incentives, increase effective rates for intellectual property, and streamline VAT exemptions.
- Fiscal-framework and governance measures:
  - Consider measures to strengthen the fiscal framework:
    - Review whether fiscal rules are binding, flexible, and transparent.
    - Develop a framework to define priorities across competing needs to support budgetary planning of growth-enhancing expenditure.
    - The “projections procedure” that provides MOF staff independence in macroeconomic and financial projections is helpful.
    - Consider a mechanism to ringfence allowances for infrastructure and education projects while keeping a fiscal envelope that protects buffers.
  - Consider establishing an independent fiscal council to serve an advisory role:
    - Propose criteria for projects to be included under the allowance for growth-enhancing measures and assess enforcement.
    - Evaluate the fiscal stance, assess budgetary forecasts, monitor the fiscal rule, and advise on reprioritization of spending.
    - Safeguards should guarantee minimum qualifications and avoid council members’ conflicts of interest.

### Policy discussions and recommendations — monetary and exchange rate policy
- Monetary policy stance:
  - The central bank appropriately moved the monetary policy stance above neutral and should maintain this stance while underlying inflation pressures remain strong.
  - Staff assess the output gap as still positive; labor market cooling but remains tight.
  - The real policy rate turned positive around November 2022; staff estimates that the monetary policy stance became tight around January 2023.
  - Given the transmission lag from the policy rate to inflation of about one to two years, it would be prudent to keep the policy rate elevated and restrictive until clearer signs that aggregate demand is cooling.
  - BOI should stand ready to further hike the policy rate if inflation surprises on the upside or if inflation expectations rise past the target band again.
- Policy-rate level:
  - Staff estimates indicate that the current level of the policy rate (4.75 percent) is roughly in the vicinity of the optimal level for Israel.
  - Staff’s estimates of the neutral real rate of interest in Israel suggest a likely (but very uncertain) range between 0 and 1.
- Exchange-rate policy:
  - Market forces should be allowed to continue to set the price of the shekel, with interventions limited to addressing disorderly market conditions.
  - FX intervention (FXI) may be appropriate under certain shocks and circumstances, as outlined in the IMF’s Integrated Policy Framework (IPF).
- Transmission and pass-through:
  - Research shows a faster and larger (positive) pass-through of the shekel exchange rate to inflation than the (negative) pass-through from the policy rate of interest to inflation.

### Authorities’ views (selected)
- Fiscal authorities:
  - The MOF and the BOI view the fiscal stance to be adequate and agree on the need to protect fiscal buffers and to increase growth-enhancing expenditure.
  - Views differ on budgetary planning: some see the framework as adequate; others see room for improvement to define priorities and ringfence allowances for growth-enhancing expenditure. Any change should keep fiscal envelopes that protect fiscal buffers.
  - On the fiscal council, MOF considers the current framework adequate; others see a council as potentially valuable.
- Monetary authorities:
  - The BOI agrees with staff that the monetary policy stance needs to remain tight while underlying pressures remain high.
  - BOI sees inflation as likely to have peaked and estimates output growth to converge to trend before end-2023.
  - BOI favors maintaining a tight stance and stands ready to increase the policy rate if needed.
  - Authorities do not envisage intervening in the FX market under current conditions (unless markets become disorderly) and view the external position as strong.

*Source: IMF staff report excerpt.*

### 31.      Debt servicing capacity should be monitored. While retightened borrower-based

### 31.      Debt servicing capacity should be monitored. While retightened borrower-based

### Debt-servicing risks and borrower-based measures
- Close monitoring of debt-servicing is warranted, especially if further increases in interest rates materialize or continued increases in the cost of living further limit the ability to service debt.
- Further calibration of tools should be made conditional on sector specific developments, including risk-taking behavior and sectoral financial conditions (Annex IX).
- Borrower-based measures could be fine-tuned also to protect buffers and support new credit provision.

### Housing supply, property tax, and local incentives
- Continued increases in the supply of housing could alleviate real estate price and affordability pressures.
- Staff supports the authorities’ plan to revise the property tax structure to boost housing supply.
- Local governments have a fiscal incentive to grant more building permits to business than to residential housing (because of favorable tax rates).
- To reduce this incentive, the government plans to establish a housing incentive fund, which will be allocated to the local authorities based on residential building permits. This fund will be financed by the business property tax and a supplement from the budget.
- Measures should be supported by investment in complementary infrastructure in areas where residential building is needed.
- Recent measures designed to encourage faster issuance of building permits and completion of projects should help reduce historically very long lags from planning to completion of construction.

### Financial sector conditions and key statistics
- Staff assesses the banking sector to be broadly robust.
- Capital ratio in the sector was about 14 percent at 2023:Q3 with Tier I capital beyond minimum requirements.
- Liquidity coverage remained comfortably above the 100 percent minimum requirement with LCR at 125 percent in 2022:Q3.
- The net stable funding ratio was 126 percent for the average bank in 2022:Q3.
- Banks’ profits rebounded strongly in 2021 and 2022 with ROE and ROA well above pre-pandemic levels, driven by banks’ surplus of CPI-linked assets over liabilities and improvements in operational efficiency.
- The ratio of nonperforming loans to total loans in 2022:Q3 fell to a decade low.
- Bank loans for residential and commercial real-estate combined reached 54 percent of total in 2022:Q3, up by approximately 10 percentage points in the last five years.
- While BOI stress tests indicate that banks have sufficient capital to absorb shocks under a severe adverse scenario, lending to the private sector could be curtailed with spillovers to aggregate demand.

### Supervisory and macroprudential recommendations
- Staff welcomes BOI implementation of liquidity alerts and retightening of capital requirements and minimum leverage ratios during the post-pandemic rebound.
- Recent BOI measures to strengthen credit risk management (adopted in March 2022), including a requirement to allocate additional capital against highly leveraged land financing, are welcome.
- Recommendations:
  - Make use of existing credit bureau information to improve supervisory models for measurement of risk at the individual exposure level.
  - Combine proposed microprudential frameworks with macroprudential stress tests to quantify potential losses due to contagion across Israeli financial entities.
  - Develop a legal framework to clearly delineate activities and to clarify what are banks and non-banking institutions, including payment services, to enhance consumer protection and safeguard financial stability.
- Staff cautions against interference in the setting of market interest rates; recent initiatives to impose minimum payments on retail deposits and caps on mortgage rates would distort risk-taking and pricing mechanisms of banks and the transmission of monetary policy.

### AML/CFT and related supervisory actions
- Israel should continue strengthening its AML/CFT framework.
- Authorities have improved the regime by strengthening risk-based supervision of some previously unregulated entities (dealers in precious metals).
- Further inclusion recommended: real estate agents, trusts and company service providers under the AML/CFT framework.
- Banks should continue applying enhanced due diligence and issue sufficiently dissuasive sanctions for failure to implement AML/CFT preventive measures and ensure beneficial ownership information is adequate, accurate and current. The same should apply to other financial institutions.

### Contingent policies if downside risks materialize
- Fiscal policy:
  - Can play a counter-cyclical role.
  - If adverse shocks warrant going above the deficit or expenditure ceiling, clearly communicate reasons and the path for returning to targets to secure medium-term fiscal sustainability and mitigate impact on the country risk premium.
- Monetary policy:
  - Should carefully balance risks to output, inflation and financial stability.
  - BOI should stand ready to further tighten monetary policy if the inflationary effect of the shock (exchange rate) is expected to dominate potential disinflationary effects (output, financial stability).
  - If growth decelerates substantially or inflationary pressures subside faster in a sustained manner, monetary policy can respond with a more accommodative stance.
- Financial sector policies:
  - Adjust to support credit provision while protecting buffers and mitigating risks to financial stability.
  - Calibrated and targeted fine-tuning of sectoral prudential policies may be appropriate to weather a severe downturn, coupled with enhanced supervision and assessment of risks.
- Foreign exchange intervention (FXI):
  - May be appropriate under certain shocks and circumstances; the IMF’s integrated policy framework (IPF) outlines country characteristics and nature of shocks that could warrant use of FXI.

### Structural policies: education, infrastructure, and product market reforms
- Education and infrastructure investment would improve productivity, foster participation and prevent further widening of inequality.
- Skill gaps need addressing, particularly among low-participation populations such as the Haredi and Arab communities, while maintaining gender opportunity equality in higher-education and the workplace.
- Government aims: allocate a significant portion of added hours in Arab schools to Hebrew instruction and increase labor-market-relevant subjects among the Haredi population (literacy, mathematics, problem solving in a computerized environment, and English).
- Active Labor Market Policies should expand vocational training and encourage employers’ involvement in training programs.
- Infrastructure:
  - Infrastructure spending reached about 3 percent of GDP in 2021–22 but is projected to decrease in the 2023–24 budget.
  - Stock of public capital is notably below OECD averages; budget allocations for capital investment need to increase markedly, especially considering population growth.
  - Focus on improving transportation networks in large cities and upgrading digital infrastructure for poor communities.
- Staff analysis: increasing public investment by 30 percent (from 2021 levels) would raise GDP growth in the long run by 10 percent, while reducing labor market inequality. Two risk factors that could mitigate these gains: a sustained increase in global risk premia, and reduced spending efficiency.
- Education complements infrastructure: improving education increases returns to capital spending and amplifies infrastructure’s effect on dampening wage inequality.
- Product market reforms:
  - Continue decreasing trade barriers to reduce the cost of living.
  - Support improvements in product market regulation, including allowing import of products that meet European Union standards, and free trade agreements already signed or negotiated.
  - Support proposals to reduce regulation of parallel imports, remove barriers to entry of service companies, implement health insurance cost reduction reform, and increase financial market competitiveness.

### Authorities’ and staff appraisal positions
- Authorities broadly agree with staff assessment; BOI sees risks as well contained and asset quality as strong. Delinquencies are extremely low, bulk of housing is owner-occupied, and mortgage loans are recourse. BOI will consider staff’s recommendation to further enhance supervisory risk measuring.
- Staff appraisal highlights:
  - Economic growth projected to slow in 2023 as households’ purchasing power falls and firms rein in investment.
  - Inflation forecast to fall to the target range by end 2024.
  - Fiscal stance is appropriate; rebuilt fiscal buffers should be protected while raising growth-enhancing spending, with strengthened revenue measures.
  - Possible additional fiscal governance measures: establish an independent fiscal council, review fiscal framework for binding/flexible/transparent rules, and a mechanism to ringfence allowances for infrastructure and education projects.
  - Monetary policy: central bank has moved to restrictive territory; monetary stance should remain tight until clearer signs that aggregate demand is cooling. Market forces should be allowed to continue to set the price of the shekel.
  - Macroprudential stance is adequate; continued efforts to raise housing supply and supportive infrastructure investment and reduction of fiscal disincentives at local authority level are recommended.

*Source: IMF staff report excerpt (1isrea2023001).*

### 52.      Staff assesses the banking sector to be broadly robust, but pockets of vulnerability

### Staff assesses the banking sector to be broadly robust, but pockets of vulnerability

### Banking sector assessment
- Banks are well capitalized and liquid.
- Overall household and corporate leverage levels are comparatively low.
- Concentration in the real estate sector is high.
- Credit bureau information should be used to strengthen the measurement of risk at individual exposure level (to ensure adequate risk absorbing capacity), as a complement to the macroprudential tool set.

### Structural reform priorities
- Close gaps in skills, stock of infrastructure, and market competitiveness.
- Education reform should aim to expand the provision of cognitive and market-relevant skills.
- Active labor market policies, like the expansion of vocational training, can complement efforts in improving the job prospects of Israeli workers.
- Increasing infrastructure spending is crucial to promote labor reallocation and foster productivity.
- Reducing barriers to product market competition is key to address rising cost of living concerns.

*Source: 1isrea2023001 - 52.*

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

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

### Recent economic developments
- Israel fared well relative to other countries, with a more modest contraction and a stronger recovery, as private consumption, investment and exports recovered.
- High frequency indicators are consistent with strong economic growth and are reflected in consumer confidence and business confidence recovering close to pre-crisis levels.
- Investment has recovered across sectors, with intellectual property products, transport and machinery, and buildings and construction showing increases.

### High‑tech sector
- Investments in the high‑tech sector have declined but remain high; investment is diversified within the sector.
- Employment in the high‑tech sector has been increasing with the sector contributing to export growth.
- The high‑tech sector represents an important part of the economy and Israel has received significant flows to finance the high‑tech sector.

### Inflation and monetary policy
- Inflation breached the target band and remains above the upper bound, with prices of tradable and non‑tradables rising (but PPI inflation falling).
- Contributing factors include external factors and strong domestic demand.
- Inflation expectations (from markets) returned to the target band after policy tightening, with eight consecutive hikes between Apr 2022 and Feb 2023, bringing the ex‑ante RIR above zero and estimated neutral.

### Labor market developments
- As the recovery gained pace, unemployment decreased but started to stabilize by the end of 2022; employment is recovering as in other advanced economies.
- Labor force participation remains below pre‑pandemic levels.
- Employment recovery has been uneven across sectors; the labor market remains tight but job vacancies started easing across all sectors.

### Fiscal developments
- Government revenues are well above pre‑crisis levels, with a sharp increase in direct taxes and strong collection of indirect taxes.
- Government spending declined as pandemic-related spending was wound down.
- Medium‑term consolidation plans are largely based on expenditure restraint; government debt is on a downward path but there is little room to raise priority spending, such as in infrastructure.

### External sector
- Shekel depreciation pushed down the REER.
- The current account balance remains in surplus, driven by service exports despite a large goods trade deficit.
- High‑tech industries drive service exports.
- Portfolio inflows resumed while official FX purchases ceased; the net international investment position remains comfortably positive.

### Banking system and financial indicators
- Capital and leverage ratios exceed regulatory minima; NPLs are the lowest in a decade, supporting bank profitability.
- Lending to households (mortgages) and businesses account for the bulk of credit and are fully covered by core funding.
- The shekel weakened after reaching 20‑year highs in 2021; stock prices and bond prices fell in line with global markets, and sovereign CDS spreads rose but remained stable.

### Investment simulations and policy implications
- Simulation of increased public investment scenarios (zero, fifteen, thirty and forty‑five percent increases from current level; spending peaks in 2024 and is financed with a combination of public debt and tax revenues):
  - The yellow line (30 percent extra) would allow closing the capital stock gap and is presented as the recommended investment increase (up to 30 percent extra).
  - New infrastructure spending initially decreases private consumption and investment through a wealth channel (agents expect higher taxation), which improves the current account.
  - Worked hours increase because the government uses the local non‑tech sector to execute the investments, exerting upward pressure on wages and decreasing wage inequality as the non‑tech sector employs predominantly low‑skilled workers.
- Additional scenario with education reform and higher labor participation:
  - With the economy having already absorbed an education reform (more workers employed), the same investment increases raise GDP further (multiplier effect unchanged; growth still increases by 10 percent) and reduce wage inequality more strongly.
- Adverse scenarios:
  - A sudden increase in sovereign spread leads to a stronger decrease of private consumption and investment, greater reliance on taxation, depressed internal demand, no multiplier effect, and increasing public debt.
  - Reduced spending efficiency (execution bottlenecks lowering efficiency from calibrated 80 percent to 60 percent) yields limited growth dividends and higher public debt, although labor demand remains strong and inequality decreases relative to baseline.

### Projections and selected indicators
- From projections and staff estimates and calculations (high‑level points summarized from figures and tables):
  - Eight consecutive policy rate hikes occurred between Apr 2022 and Feb 2023.
  - The recommended public investment increase is "up to 30 percent extra."
  - Investment simulations indicate growth increases (notably a stated "growth still increases by 10 percent" in the higher participation scenario).
  - Fiscal stance highlights: medium‑term consolidation via expenditure restraint; debt on a downward path but constrained fiscal space for priority spending.

*Source: IMF staff report content as provided in the supplied document.*

### Annex I. External Sector Assessment

### Annex I. External Sector Assessment

### Overall Assessment
- The external position in 2022 is preliminarily assessed as stronger than the level implied by medium-term fundamentals and desirable policies: the current account balance exceeds its estimated norm, the net international investment position is positive, and international reserves are comfortable.
- Due to country specificities only imperfectly captured by the model, the estimated gap (between the actual current account balance and its norm) is likely to overstate the extent to which Israel’s current account represents an excess surplus relative to fundamentals and desired policy settings over the medium term.

### 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.

### Foreign Assets and Liabilities: Position and Trajectory
- Background: The net international investment position (NIIP) has been broadly stable around 32 percent (321 percent in 2022, from 31.7 at end-2021) despite the current account surplus, due to valuation effects.
- Assessment:
  - The NIIP does not represent a major risk.
  - Foreign assets, including international reserves of 37 percent of GDP (end-2022), exceed liabilities and provide a large buffer.
  - FDI is the largest component of external liabilities, and the only (significant) negative net position: NIIPs for portfolio securities and other investment are positive (Table 3).
  - The bulk of FDI liabilities consist of equity claims.
  - Debt assets held abroad exceed debt liabilities to non-residents (and so do sovereign reserves).
- 2022 (percent GDP):
  - NIIP: 32.1
  - Gross Assets: 123.1
  - Reserve Assets: 37.2
  - Gross Liabilities: 91
  - Debt Liabilities: 29.3

### Current Account
- Background:
  - The current account surplus dropped half of a percentage point of GDP, from 4.3 percent of GDP in 2021, to 3.7 in 2022.
  - The decline was mainly due to an increase in the merchandise trade deficit (reflecting high absorption) which exceeded the increase in the services trade surplus.
  - The high-tech sector remains the engine of Israel’s export growth, with receipts from cargo between ports rising.
  - Over the medium term, the CA surplus is projected to decline toward about 3.5 percent of GDP.
- Assessment:
  - The EBA CA model suggests that the cyclically adjusted 2022 CA balance is above the level warranted by fundamentals and appropriate policies by 4 percent of GDP.
  - The cyclically adjusted CA balance includes a multilaterally consistent adjustment for the output gap and terms of trade.
  - Staff assess the CA gap to be 3.3 percent of GDP, after an adjustment to the current account norm for Israel’s high exposure to geopolitical uncertainty.
  - Other country-specific factors not reflected in the CA norm potentially also play a role in Israel’s high savings rate, including its high level of transfer and grant inflows, and mandatory pension contributions.

- Text Table. Israel: Model Estimates for 2022 (Percent of GDP)
  - CA-Actual: 3.7
  - Cyclical Contributions: 1.3
  - Adjusted CA 1/: 5.0
  - CA Norm (from model): 0.9
  - Adjustments to the norm: 0.8
  - Adjusted CA Norm: 1.7
  - EBA CA Gap: 3.3
    - o/w Policy gap: 1.1
  - REER Gap 2/:
    - REER level: -14.3
    - REER index: 17.3
    - REER (other): 11.2

  - Footnotes from source:
    - 1/ Cyclically adjusted, including multilateral consistency adjustments.
    - 2/ Semi-elasticity of CA/GDP to REER assumption is 0.23.

### Real Exchange Rate
- Background:
  - The real exchange rate depreciated in 2022 by about 7 percent, using the CPI-based REER, and by about 4 percent using the ULC-based REER—partly correcting the substantial appreciation during the preceding 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).
  - The falling REER was mainly due to the approximately 9 percent depreciation of the nominal exchange (to the US dollar).
- Assessment:
  - There is a large divergence in the exchange rate valuation estimates from EBA models.
  - The REER-index and REER-level models point to substantial overvaluation, of 11.2 and 17.3 percent, respectively, consistent with the prolonged appreciating trend of the REER in the decade to 2021.
  - However, the REER gap implied by the CA model suggests an undervaluation of 14.3 percent.
  - Overall, IMF staff assess the REER gap to be centered around 1.5 percent (the midpoint of a rather wide range from –14 to 17 percent).

### Capital Flows
- Background:
  - Non-residents were net buyers of Israeli assets through each quarter of 2022, while residents continued to accumulate assets abroad, particularly (non-official) portfolio investment.
- Assessment:
  - Capital outflow risks are low due to low external indebtedness of the private sector, a banking system with very 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 fell to USD 194 in December 2022 (from 213 billion at end-2021), due to valuation effects (FX accumulation ceased).
  - This corresponds to 37 percent of GDP and 14 months of imports.
  - Predetermined net short-term drains on reserves are low as a share of gross reserves (about USD 9 billion).
- 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 the country faces.
  - At the onset of the pandemic, the BOI’s intervention—FX purchases of USD 35 billion, 30 billion of which were pre-announced—helped prevent substantial undershooting of the inflation target band from de-anchoring inflation expectations and supported the package of monetary easing measures (the policy rate was at what the authorities regard as the effective lower bound).
  - Foreign exchange intervention should now be limited to preventing disorderly market conditions.

*Source: Annex I. External Sector Assessment (Content unit: 1isrea2023001) from the provided IMF material.*

### Annex IV. Authorities Responses to Past IMF Policy

### Annex IV. Authorities Responses to Past IMF Policy Recommendations

### Monetary policy
- Recommendation: Begin data-driven monetary policy tightening. Foreign exchange purchases should taper off, allowing the shekel’s value to be determined by market forces.
- Actions taken:
  - "The central bank embarked on a steady tightening cycle, raising the policy rate gradually."
  - "Near-term inflation expectations (one year ahead) fell back to the target range in late 2022, and the rate of overall price growth eased in February and March 2023."

### Macroprudential policy
- Recommendation: Further tightening of macroprudential measures could help stem banks’ exposures to housing market risks and prevent potentially unsustainable borrowing.
- Actions taken: Referenced action — "See Annex II."

### Fiscal policy
- Recommendation: Refocus medium-term policy on reducing public debt and rebuilding pre-pandemic buffers. Increase tax revenues by broadening the tax base and making the tax system more progressive to support growth-enhancing spending.
- Actions and outcomes:
  - "Fiscal consolidation has taken place, with debt reduction happening faster than expected."
  - "Gross public debt in 2022 is 61 percent of GDP, down from 68 percent in 2021, and further reduction is expected in 2023."
  - "Increasing revenues, which was part of the recommended strategy, has played a large role in closing the fiscal deficit."

### Structural reforms and labor market
- Recommendations:
  - Expand vocational training and improve its quality.
  - Adapt education streams to labor market needs.
  - Continue reducing trade barriers and red tape.
  - Accelerate digital and physical infrastructure to improve job accessibility.
- Actions and developments:
  - "The new government has pledged to extend support to schools that do not include core subjects in their curriculum."
  - Knesset measures in June to address the labor market child penalty:
    - "An increase by 40 percent in work grants to induce stronger labor market participation, and an extra income tax credit for parents of each child aged 6–12."
    - "In January, the new government pledged to broaden the tax credit scheme to include parents of children aged 6–18."
  - "The new government confirmed its intention to recognize many EU food standards, but barriers to trade and investment more broadly remain relatively high."

### Exposure to Ukraine and Russia
- Key findings:
  - "Russia and Ukraine cover a tiny fraction of Israel’s trade volumes, such that there has been no direct impact on the demand of Israeli goods and services, nor a shortage of imported intermediate goods that would create issues in Israeli supply chains."
  - "Israel is integrated in global capital markets, and direct investments come predominantly from other OECD countries. ... the share of Russia and Ukraine in Israeli FDI combined is negligible."
  - "Exposure to Russia and Ukraine is small, due to energy self-sufficiency and large diversification of exports, most of which are in the high value-added segment which is less cyclical."
  - The war generated additional demand in subsectors of the tech industry, "as cyber-security and military technology."

### Adverse scenarios — Risk Scenario: Impact of Global Spillover
- Context: Israel, as a small open economy, can be impacted by weaker global outlook, escalation of Russia’s war in Ukraine, higher global energy and commodity prices, fragmentation, and lower global credit supply.
- Channels and effects:
  - Commodities and trade: higher global commodities prices increase domestic inflation, reduce real incomes, weigh on private consumption, and lower external demand reduces exports.
  - Lower global credit supply: tighter global financial conditions and wider corporate spreads raise financing costs, hurting investment and consumption.
- Quantified impacts (relative to baseline):
  - "The adverse scenario assumes growth downgrades in the range of 1.4 and 1.5 percentage points and headline inflation to be higher by 1.7 and 1.0 percent during 2023 and 2024."
  - Implication: "an overall economic growth reduction of about half of what it is expected under the baseline."

### Adverse scenarios — Risk Scenario: Impact of Uncertainty around the Judicial Reform
- Context: Ongoing protests and social confrontation increase economic uncertainty, potentially reducing consumption and investment and triggering relocation of high-tech firms.
- BOI identified channels:
  - Increase in the country’s risk premium: higher yield spreads on Israeli government dollar bonds relative to US bonds, shekel weakening, domestic stock market underperformance; raises financing costs, reduces capital, depreciates the shekel, accelerates inflation, and lowers investment and GDP over time.
  - Negative impact to domestic investment and consumption: reassessment of return-risk lowers willingness to invest (for a given interest rate), with particular vulnerability in the high-tech sector.
  - Impact to exports: trade partners may reduce exposure to Israel, lowering exports and activity.
- BOI scenario assumptions:
  - Timing: results presented over the next three years.
  - Magnitude: shocks similar to early 2000s crisis (2001–02): "cumulative increase in interest rate spreads of about 4.5 percentage points and a depreciation (in the effective exchange rate) of about 18 percent during those two years." "The average negative impact on GDP growth each year during the first two years of the crisis was about 3 percent."
  - Persistence: two scenarios, low persistence and high persistence; higher persistence implies larger economic impact.
- BOI quantified impacts (per first-year deviations and three-year average GDP effects):
  - Impact table (first-year impacts shown as Interest Rate deviation; Inflation deviation; Depreciation (first year impact); Change in GDP (per year, over three years)):
    - Increase in risk premium:
      - 0.5 ; 0.6 ; 1.6 ; -0.04
      - 1.9 ; 3.3 ; 13 ; -1.9
    - Decline in domestic demand (investment and consumption):
      - -0.25 ; -0.2 ; 1.8 ; -0.7
    - Decline in exports:
      - 0 ; 0 ; 0.1 ; -0.03
      - -0.1 ; 0.0 ; 0.7 ; -0.2
    - Total impact for low persistence: -0.8 (per year, over three years)
    - Total impact for high persistence: -2.8 (per year, over three years)
  - Note: "The framework used by the BOI is based on a linear model. Therefore, a twice as large shock will double the negative impact on GDP."
  - Interpretation: under low persistence, "the cumulative effect of the three channels will be a negative impact of an average of 0.8 percent of GDP each year over the next three years." Under high persistence, "an average of about 2.8 percent of GDP is negatively impacted per year over the next three years."

### IMF staff assessment of tightening financial conditions
- Method: two-step quantification—(i) estimate financial conditions in Israel and drivers; (ii) quantify impact of tightening financial conditions on aggregate demand using a reduced form multinomial logit model across a set of European countries and Israel.
- Key results:
  - "IMF staff estimates that a tightening cycle of financial conditions could lower output by approximately 2.6 percent—on average over the next three years—when considering a confidence interval of 98 percent."
  - Under a persistent tight regime, the impact on output could be up to about 1.4, 2.7 and 3.9 percent of GDP during the first, second and third years respectively; averaging up to about 2.6 percent in a 3 year period.

*Source: Annex IV. Authorities Responses to Past IMF Policy Recommendations; Annexes V–VI from the IMF staff report content provided.*

### Annex VII. Risk Assessment Matrix

### Annex VII. Risk Assessment Matrix

### Risks: Political and Social
- Internal political tensions
  - Likelihood: High: "The underlying trend in political polarization of Israeli society is reflected in social confrontation."
  - Impact: High: "continued uncertainty associated with ongoing discussions of judicial reform could impact the economy, as investors reassess risk-return trade off to invest in Israel."
  - Policy response: "Find a durable and politically sustainable solution to lower uncertainty and protect the rule of law."
- Social discontent
  - Likelihood: High: "The underlying trend in political polarization of Israeli society is reinforced by the current configuration of party alliances."
  - Impact: High: "Short term impact on institutions and investment could be smaller, but long run changes in the solidity of Israeli institutions could affect investor sentiment and pressure location decisions that firms, especially in the tech sector, already face."
  - Policy response: "Safeguard the principles of rule of law and reinforce the checks and balances, while achieving the objective of the reform, could be achieved with higher participation in the design of a new proposal."

### Risks: Geopolitical and External
- Intensification of regional conflict(s)
  - Description: "Escalation of Russia’s war in Ukraine or other regional conflicts and resulting economic sanctions disrupt trade (e.g., energy, food, tourism, and/or critical supply chain components), remittances, refugee flows, FDI and financial flows, and payment systems."
  - Likelihood: High. "The system of alliances that Israel built in the Arab world in the recent years has been challenged by other actors, and spillovers from Russia-Ukraine war could affect the region."
  - Impact: Medium. "Israeli institutions are built around persistent existential threats, but the intensification of geopolitical tensions might distract resources from important medium-run structural issues."
  - Policy response: "Allow temporary deviations of defense spending. Rebuild structural and contingent buffers for geopolitical risks."
- Deepening geo-economic fragmentation
  - Likelihood: High. "Following the Russia-Ukraine war, the emergence of alliances across geopolitical blocs pose a higher risk of a process of de-globalization of global trade and investment."
  - Impact: Medium. "While reduced global growth would impact Israel, its main trading partners are in the Western block, and have increased their importance in Israeli economy over time."
  - Policy response: "Diversify economy to mitigate the potential detrimental impact of global trade shocks to the economy."

### Risks: Commodity, Climate, and Cyber
- Commodity price volatility
  - Likelihood: Medium. "While the Israeli economy has achieved substantial energy autonomy, and has oriented its production towards services, supply chain disruptions could still happen."
  - Impact: Low. "High diversification, energy autonomy and a placement of the Israeli economy in the high value-added segment of value chains represent useful shields against these risks."
  - Policy response: "Intensify investments on energy sources that can guarantee lower volatility, maintain a highly diversified economy."
- Extreme climate events
  - Likelihood: Medium. "Israel is naturally exposed to extreme climate events and has a particular concern regarding water supplies."
  - Impact: High. "High population density, together with limited natural water resources, make climate events, especially linked to water shortages, potentially disruptive."
  - Policy response: "Invest in adaptation technologies."
- Cyberthreats
  - Likelihood: Medium. "With global tensions rising and asymmetric warfare capabilities, cyberattacks are likely to expose significant fault lines in infrastructures, with Israel being a likely target from regional competitors."
  - Impact: Medium. "While Israel has been at the forefront of promoting digital security in both the public and private sector, the high digitalization of its economy could expose potentially relevant fault lines."
  - Policy response: "Invest in cybersecurity, especially by focusing on the threats posed by lack of awareness of more senior individuals in critical roles."

### Risks: Economic and Financial
- Abrupt global slowdown or recession
  - Likelihood: Medium. "Higher interest rates in the U.S. results in capital outflows from Israel, a stock market fall and tighter financial conditions."
  - Impact: Medium. "Israel proved to be resilient to global downturns thanks to its positioning in the high value-added segment of value chains but remains a small open economy."
  - Policy response: "Keep monitoring financial conditions. Market forces should be allowed to continue to set the price of the shekel, with interventions limited to addressing disorderly market conditions."
- Monetary policy miscalibration
  - Likelihood: Medium. "Labor markets in Israel remain tight, with inflationary pressures unabated among advanced economies, while financial stability concern put pressures on central bank to slow tightening."
  - Impact: Medium. "Being a small open economy linked to all major advanced economies, Israel is exposed to changes in policies of other countries that could trigger capital outflows as well as instability domestically."
  - Policy response: "Maintaining a credible commitment to monetary policy tightening with coordinated moves with major central banks."
- Systemic financial instability
  - Likelihood: Medium. "Monetary policy tightening is still ongoing, while it might slow down. It happens in a financial environment that has experienced ultra-low nominal rates for over a decade."
  - Impact: Medium. "The Israeli economy, being characterized by highly productive firms which need financing to expand, that are on average younger than in other advanced economies, and a rapid growth fueled by investments, depends heavily on financial stability."
  - Policy response: "Monitoring signals of financial distress in local financial markets to avoid threats to financial stability."

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### Annex VIII. Assessing the Impact of Increased Public Investment

### Background and model
- Key features
  - Framework: Adaptation of the DIGNAR real, multiple sector model of a small open economy (Melina et al. (2015)).
  - Two worker types: low-skilled and high-skilled (j = L, H).
  - Two sectors: tech (T) and traditional/non-tech (NT).
  - Public capital enters production with elasticity 훼G calibrated to "a conservative low level of 0.1."
  - Assumption: "푧푧T,t = 푧푧NT,t for all t."
  - Steady-state public investment to GDP ratio assumed equal to "1.8 percent of GDP."
- Fiscal framework
  - Government can change consumption, investment and transfer policy and finance via "debt, consumption taxes, labor taxes, capital taxes, and other transfers."
  - Financing mix rule: "휒Δb_t = (1−휒) s_t Δd_c,t" with 휒 = 50 percent in the surge simulation.
- Public investment efficiency and absorptive capacity
  - Effective investment function captures inefficiencies with parameters: steady-state efficiency 휖̅∈(0, 1) and marginal efficiency 휖∈(0, 1).
  - Baseline efficiency scenario: "80 percent public investment efficiency."
  - Low-efficiency scenario: "60 percent."

### Baseline dynamics and calibration
- Long-run yearly GDP growth driven by total factor productivity: "3 percent."
- In steady state, tech capital larger than non-tech: "K_T > K_NT."
- Model implication: tech sector share grows over time, widening labor earning gap absent policy.

### Investment surge experiment: design and financing
- Surge size and duration
  - Surge equals "a 33 percent increase in capital spending with respect to the steady state."
  - Increase lasts "three years," with convergence back to steady state "in the eighth year of the simulation."
- Financing assumptions
  - "All tax rates adjust proportionally to finance the increase in investment."
  - Remaining fiscal gap closed with a combination of domestic and commercial borrowing, with "휒=50 percent."
  - Commercial borrowing: higher interest rates and subject to jumps in international risk premia.
  - Domestic borrowing: "shifts domestic resources away from the private sector into the public sector."

### Key simulation findings
- Short-run effects
  - "Increasing public investment temporarily crowds out private investment and consumption."
  - Total public debt increases to accommodate the surge but "does not go on an unsustainable path even in the very aggressive investment scenario (in red)."
  - Higher taxes reduce household disposable income and the share of consumption to output; improved trade balance reduces the current account deficit temporarily.
- Long-run effects
  - "Higher public capital increases growth potential in the long run, in turn reducing wage inequality."
  - Central scenario: long-run output growth is "about 10 percent higher than in the baseline," moving trend growth from "slightly above 3 percent a year to about 3.4 percent."
  - Stronger labor demand increases hours worked for all household types; home bias leads investment to rely disproportionately on the domestic traditional sector, narrowing wage inequality relative to tech.
- Interaction with education reform
  - Education reform modeled as lowering the subjective cost of supplying hours for low-skilled (parameter 휅_j).
  - With education reform, "percentage increase of output is identical to the scenarios in Figure 10," but the richer economy has higher levels of worked hours and output.
  - Distributional impact: "With tighter labor markets, additional demand has an amplified effect on wages... it effectively reduces long-run inequality between low-skilled and high-skilled workers."
- Risk and sensitivity scenarios
  - Capacity constraints / lower efficiency
    - Reducing public investment efficiency from "80 percent" to "60 percent" can "almost completely" wipe out growth returns while increasing the debt to output ratio.
    - Implication: "assumptions regarding the quality of investment projects, or the smoothness of their execution, drive all welfare considerations."
  - Adverse global financial conditions
    - Sovereign risk spreads jump by "30 percent" in a stress scenario; result: long-run output growth can fall "below trend," public debt may follow an explosive path, and the current account deficit grows in the long run.
    - "Increasing borrowing costs also affect the severity of the investment crowding out, with private capital formation staying lower than trend for a considerable number of years."
    - Staff assessment: "All analysis in the present Staff Report indicate the likelihood of such a scenario for Israel to being quite low."

### Policy implications and recommendations
- Prioritize project quality and execution to preserve public investment efficiency; even modest drops in efficiency (from "80 percent" to "60 percent") can nullify growth gains.
- Consider complementary education reform to raise labor supply and marketable skills of disadvantaged groups (lower parameter 휅_j), which amplifies the distributional gains of public investment and can reduce long-run inequality.
- Maintain sound public finances and buffers ahead of ambitious investment plans to mitigate risks from international sovereign risk premia (illustrated by a "30 percent" jump in sovereign spreads scenario).
- Finance mixes matter: balance domestic and commercial borrowing recognizing trade-offs—commercial borrowing provides additional resources but is costlier and volatile; domestic borrowing is cheaper but crowds out private sector investment.

*Source: Annex VII. Risk Assessment Matrix and Annex VIII. Assessing the Impact of Increased Public Investment (excerpted from provided IMF content).*

### Annex IX. Financial Conditions

### Annex IX. Financial Conditions

### Overview and key finding
- Financial conditions (FC) in Israel started to tighten in 2022 after loosening significantly during the pandemic.
- The Financial Conditions Index (FCI) summarizes availability and affordability of financing to the main sectors of the economy, characterizing credit availability and financing ease in terms of both prices and quantities.
- The FCI shows significant tightening starting in mid-2022.
- The decline in lending growth is milder than during the GFC or European debt crises, but the pace of FC tightening is comparable to that seen in much of Europe.

*Prepared by G. Borraccia, S. Hassan, and M. Segoviano using the methodology in “Financial Conditions in Europe: Dynamics, Drivers and Macroeconomic Implications”, by G. Borraccia. R. Espinoza, V. Guzzo, F Jiang, R. Lafarguette, V. Nguyen, M. Segoviano and P. Wingender, forthcoming IMF Departmental Paper.*

### FCI definition and transmission channels
- FCI defined as the availability and affordability of financing to the main sectors of the economy.
- Indicators are grouped into five key macroeconomic and financial drivers reflecting transmission channels:
  - Credit availability and cost: mortgage and consumer lending rates, corporate lending rates, determinants of real and financial asset valuations (stock prices, bond yields, house prices).
  - The price of risk: risk premia and market volatility across asset classes, including government and corporate bond spreads, interest rate swap spreads, CDS spreads, plus measures of stock and bond market volatility.
  - Funding constraints: banks’ willingness to lend or restrictions to financial intermediation proxied by financial soundness indicators (including NPL and capital ratios, interest margins, return on assets and on equity).
  - The policy stance: central bank rates and indicators more directly affected by monetary and financial policy (e.g., interbank and deposit rates, short-term government bond yields).
  - External conditions: select variables outside domestic financial systems, including exchange rates, policy rates and yields in global financial centers.

### Sectoral developments
- Financing conditions are tightening across government, households, and non-financial corporates (NFCs), but at different speeds.
- Conditions remain looser—and started to tighten later—for non-financial corporations, partly reflecting healthy profitability.
- Government FC contrasts with household and non-bank financial corporations (NBFC) FC (figure material indicates differing paths across sectors).

### Dominant drivers of tightening
- Higher risk—its price and quantity—and the policy stance are the dominant contributing factors to the ongoing tightening of conditions.
- The higher price of risk reflects increased market volatility and higher required returns by investors.
- For the household sector, the policy stance, in addition to the price of risk, appears to be a primary driver of tightening.
- For the NBFC sector, credit availability also appears to be influencing financial conditions.

### Comparative context and dynamics
- While FC in Israel have been looser than in Europe historically, Israeli FC started tightening in the last quarter (text indicates last quarter prior to publication).
- The pace of tightening is comparable to much of Europe despite milder decline in lending growth relative to major crises (GFC, European debt crises).
- FCI is not scaled (note from figure captions).

### Relationship with liability growth and FCI variability
- The FCI has an observable relationship with liability growth (figure material shows FCI and liability growth, right-hand side reversed), indicating tightening corresponds with shifts in liability growth.
- Figures indicate contributions to quarter-over-quarter first differences of FCI by driver and sector (household, nonfinancial corporations), underscoring the evolving role of drivers over time.

*Source: Annex IX. Financial Conditions, Israel — Staff Report for the 2023 Article IV Consultation.*

### 2018. The Fund has also provided TA for capacity development, particularly in the areas of Anti-

### 1isrea2023001 - 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 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 office for the WBG established in July 1995.

### Statistical issues and data adequacy for surveillance
- General assessment:
  - Macroeconomic statistics are of generally high quality and broadly adequate for surveillance, with some shortcomings in monetary and government finance statistics.
  - A Report on the Observance of Standards and Codes—Data Module, a Detailed Assessment Using the Data Quality Assessment Framework (DQAF), and a Response by the Authorities were published 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 overall fiscal balance data submitted by the Central Bureau of Statistics (CBS) cover all General Government units and are compiled according to the GFSM2014 methodology.
  - Interest expense series implemented on an accrual basis.
  - Quarterly data for consolidated budgetary central government and social security fund are accrual-based and broadly follow GFSM2014.
  - Financial assets and liabilities: only transaction data currently submitted; a financial balance sheet (stocks) is under preparation.
  - In-year monthly reports on central government operations—compiled by the MOF on a cash basis—cover only 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) are reported for the central bank, other deposit takers, and other financial corporations.
- Financial access and sector surveillance:
  - Israel reports some key series and indicators of the Financial Access Survey (FAS), including commercial bank branches per 100,000 adults and ATMs per 100,000 adults (UN SDG Target 8.10 indicators).
  - Financial soundness indicators (FSIs) compiled and reported quarterly, covering deposit takers, other financial corporations, nonfinancial corporations and households.
- External sector:
  - Balance of payments and international investment position data compiled quarterly and follow the sixth edition of the Balance of Payments Manual.
  - Country participates in Coordinated Direct Investment Survey and in Coordinated Portfolio Investment Survey.
- Data standards and reporting:
  - Participant in the Special Data Dissemination System (SDDS) since April 1996, in full observance of SDDS prescriptions.
  - Data ROSC published on March 24, 2006.
  - Data are regularly reported for publication in the Government Finance Statistics Yearbook and in the IFS.

### Common indicators and data frequencies (As January 31, 2023)
- 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: April-23
  - Date received: April-23
  - Frequency: M / M / M
- Reserve/Base Money
  - Date of latest observation: April-23
  - Date received: April-23
  - Frequency: M / M / M
- Broad Money
  - Date of latest observation: April-23
  - Date received: April-23
  - Frequency: M / M / M
- Central Bank Balance Sheet
  - Date of latest observation: April-23
  - Date received: April-23
  - Frequency: M / M / M
- Consolidated Balance Sheet of the Banking System
  - Date of latest observation: April-23
  - Date received: April-23
  - 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: April -23
  - Date received: May-23
  - Frequency: M / M / M
- Revenue, Expenditure, Balance and Composition of Financing – General Government
  - Date of latest observation: 2022
  - Date received: May 2023
  - Frequency: A / A / A
- Revenue, Expenditure, Balance and Composition of Financing – Central Government
  - Date of latest observation: April 23
  - Date received: May-23
  - Frequency: M / M / M
- Stocks of Central Government and Central Government-Guaranteed Debt
  - Date of latest observation: Q4-22
  - Date received: May-23
  - Frequency: Q / Q / Q
- External Current Account Balance
  - Date of latest observation: Q4-2022
  - Date received: Q4-2022
  - Frequency: Q / Q / Q
- Exports and Imports of Goods and Services
  - Date of latest observation: Q4-2022
  - Date received: Q4-2022
  - Frequency: Q / Q / Q
- GDP/GNP
  - Date of latest observation: Q1-23
  - Date received: May-23
  - Frequency: Q / Q / Q
- Gross External Debt
  - Date of latest observation: Q4-22
  - Date received: May-23
  - Frequency: Q / Q / Q
- International Investment Position
  - Date of latest observation: Q4-2022
  - Date received: Q4-2022
  - Frequency: Q / Q / Q

### Macroeconomic performance and policy stance
- Growth and labor market:
  - The Israeli economy grew 6.5 percent in 2022, driven by rebound in domestic demand and strong exports.
  - Unemployment rates declined to historically low levels.
- Inflation and monetary policy:
  - Inflation currently at 5 percent and decelerating.
  - Inflation over past 6 months decelerated to 4.8 percent (compared to the previous 6 months) and reached 3.9 percent over the last 3 months (compared to the previous quarter).
  - BOI actions:
    - Gradual reduction of bond purchases in 2021 and termination of FX purchases in January 2022.
    - BOI started raising interest rates in April 2022 when inflation stood at 3.5 percent and policy rate was 0.1 percent.
    - In May 2023 the Monetary Policy Committee increased the key rate for the 9th consecutive time to 4.75 percent.
    - One-year breakeven inflation around 3 percent.
    - BOI anticipates inflation to return to its target range of 1-3 percent by the second quarter of 2024, absent significant changes in economic activity, exchange rates or the inflation landscape.
- Fiscal outcomes and debt:
  - Deficit reduced from 11.2 percent in 2020 to 4.3 percent in 2021.
  - 2022 recorded a surplus of 0.6 percent of GDP.
  - Debt-to-GDP ratio declined to 60.9 percent in 2022, close to pre-COVID level of 59 percent.
  - 2023-2024 budget framework designed to strengthen fiscal credibility amid elevated uncertainty and accounts for potential cyclical and temporary tax revenue growth.
- Financial stability:
  - BOI considers financial sector risks well-controlled and asset quality robust.
  - BOI measures during recovery included liquidity alerts, retightened capital requirements and minimum leverage ratios, and March 2022 measures to enhance credit risk management (additional capital against highly leveraged land financing).
  - Stress tests indicate banks can withstand all stress scenarios while maintaining capital above the minimum requirement.
  - BOI will evaluate staff's recommendations to further improve supervisory measures.

### Structural reforms, inclusivity, competition, and climate
- Judiciary and political context:
  - Ongoing national dialogue, led by the President, aims for broad agreement to maintain strong and independent institutions while considering proposed judicial reforms.
- Cost of living and competition:
  - Measures to reduce cost of living include aligning product regulations with European standards, optimizing tax payment mechanisms for small businesses, and easing licensing in manufacturing.
  - BOI issued a new bank license in December 2022 (previous license in 2019); further initiatives planned to enhance competition in the financial sector and improve accessibility for additional participants.
  - UK-Israel FTA negotiations aim to ensure efficient trade in financial services.
- Infrastructure:
  - Ministry of Finance introduced the "National Infrastructure Acceleration Bill" to remove barriers in planning, utility coordination, bureaucracy, and regulations.
  - Significant transportation projects (electrification of buses and heavy railways, Jerusalem and Tel-Aviv light rail networks) will reach peak in upcoming years.
  - Government committed to preserving investment scope through multi-year budgeting and ensuring steady future project flows while protecting the fiscal envelope and buffers.
- Labor inclusion:
  - Employment of Arab women rose by 13 percentage points over the past decade; current employment rate for Arab women is 43 percent.
  - Haredi male labor force participation is a long-term challenge due to political, social, and economic factors; addressing employment obstacles should preserve gender opportunity equality in higher education and the workplace.
- Climate and emissions targets:
  - Government targets a 27 percent reduction in emissions by 2030 (compared to 2015 levels) and a 30 percent reduction in the electricity sector.
  - Policies to integrate renewables and support private sector innovation include collaboration with private projects for production and storage, exploring renewable energy imports from neighboring countries, regulations for wide-scale Pumped Storage Hydropower, and examining offshore renewable energy possibilities.
  - Authorities recognize challenges highlighted in the staff report that achieving the overall target without reductions in other sectors is challenging and encourage private sector innovation supported by the Israel Innovation Authority to mitigate emissions in transportation, manufacturing, and agriculture sectors.

*IMF staff report content unit 1isrea2023001 (excerpts provided).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1isrea2023001.pdf_