## 1. Israel: Energy Shocks ## Source details **Canonical URL:** [1. Israel: Energy Shocks](https://www.imf.org/-/media/files/publications/cr/2026/english/1isrea2026001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2026/english/1isrea2026001.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2026/english/1isrea2026001.pdf.json) --- ### Context and main challenges - Elevated regional tensions over the past three years: the 2023-25 Gaza conflict, the June 2025 escalation with Iran, and the war beginning February 28, 2026. - Output remains about 9 percent below its pre-October 2023 trend. - Repeated disruptions have yielded elevated defense spending, higher debt and interest costs, and persistent labor supply constraints from military mobilization and reduced availability of Palestinian workers. - Structural challenges: low labor force participation and skill levels for some groups (particularly Haredi men and Arab-Israelis), a dual economy with world-class high-tech sectors alongside lower productivity industries, and exposure as a small, open economy to global trade tensions and trading partner growth. - Political context: General elections due by late October 2026; fragmented landscape and possibility of early elections if the Knesset fails to pass key legislation. ### Recent economic developments (selected) - Output and growth - Output contracted sharply after October 2023 (−21 percent, annualized q/q) and recovered through 2023-25; GDP growth rose from 1 percent in 2024 to 2.9 percent in 2025. - Real GDP contracted by 3.3 percent (q/q, annualized) in Q1 2026 (war impact). - Labor market - Temporary mobilization of about 100,000 reservists (2.2 percent of the labor force in early March 2026). - Compensation of non-public sector employees increased by 6.8 percent y/y in 2025, up from 2.3 percent in 2024. - Employment, unemployment, and vacancy indicators pointed to continued tightness into early 2026. - Inflation and monetary developments - Inflation accelerated through 2024 and peaked in January 2025 (headline 3.8 percent y/y; core 3.6 percent y/y). - By fall 2025 inflation returned to the 1-3 percent target range; headline and core inflation were 2 percent y/y and 2.2 percent y/y, respectively, in February 2026. - Headline inflation accelerated by 0.6 percent m/m (seasonally adjusted) in April 2026, with annual inflation at 1.9 percent; core inflation 0.2 percent m/m and 1.4 percent y/y in April 2026. - Financial markets and banking system - Shekel: depreciated to NIS 4.1 per US$ after October 7, 2023 shock; by mid-February 2026 strengthened to around NIS 3.1 per US$; by mid-May 2026 around NIS 2.9 per US$. - 5-year CDS widened above 140 basis points after October 7, 2023; narrowed to about 70 basis points by late-February 2026 and declined to pre-war levels by mid-May 2026. - Q3 2025 banking indicators: non-performing loans below 1 percent of total loans; return on equity around 16 percent; leverage ratio 7 percent; liquidity coverage ratio 130 percent. - External sector and reserves - Current account surplus narrowed from 2.8 percent of GDP in 2024 to 1.5 percent in 2025. - Net international investment position estimated at 43 percent of GDP (end-2025). - Gross reserves at 37.5 percent of GDP; international reserves US$229.5 billion at end-2025 (about 37.5 percent of GDP). - Fiscal developments and public debt - Central government balance: surplus of 0.6 percent of GDP in 2022 → deficits of 4.1 percent in 2023 and 6.8 percent in 2024; central government deficit narrowed to 4.7 percent of GDP in 2025 (below the 5.2 percent of GDP budgeted). - General government balance: surplus of 0.3 percent of GDP in 2022 → deficits of 5.4 percent in 2023 and 8.1 percent in 2024; GG deficit declined to 5.2 percent of GDP in 2025. - Public debt rose from 60 percent of GDP at end-2022 to 68 percent of GDP at end-2025. ### Outlook and key risks - Baseline assumptions - Ceasefires since mid-April largely hold; no sustained escalation or material progress toward regional peace agreements; elevated geopolitical uncertainty persists. - Reservists expected to gradually return but mobilization remains above pre-October 2023 levels; reduced foreign workers continue to constrain labor supply. - Baseline incorporates global oil price futures as of May 12 and assumes limited headwinds from tighter global financial conditions. - Projections - Real GDP growth: 3.5 percent in 2026; 4.4 percent in 2027. - Inflation: headline inflation projected to rise from 1.9 percent in Q1 2026 to 2.5 percent in Q4 2026, then ease to around 2 percent by Q4 2027. - Medium-term: potential growth projected at around 3½ percent (down from an average of 4 percent in 2013-22, excluding 2020-21); general government deficit projected to remain around 5 percent of GDP over the medium term; GG debt projected to reach 74 percent of GDP by 2031; current account surplus expected to be around 2¼ percent of GDP. - Downside scenario (illustrative) - Assumes intensified hostilities and a severe global recession from commodity market disruptions. - Under this scenario: growth would decelerate to 2¾ percent in 2026 and to 1½ percent in 2027; defense spending would rise to 9 percent of GDP; absent policy adjustment, GG deficit would widen to 7½ percent of GDP in 2027; public debt could rise by over 4 percentage points of GDP. - Contingent policy advice: strictly target fiscal support so conflict-related relief outlays remain temporary; reprioritize non-defense spending; introduce new revenue measures; tighten monetary policy; safeguard FX market functioning through prudent reserve use; closely monitor financial sector risks. - Upside scenario (illustrative) - Progress toward durable peace and expanded Abraham Accords participation; large-scale demobilization and improved sentiment. - Contingent policy advice: reallocate peace dividends to growth-enhancing reforms (higher infrastructure and education spending) alongside some fiscal consolidation; new revenue measures still needed to create fiscal space. ### Box 1 — Energy shocks: structure, pass‑through, and scenario impact - Energy supply mix - Natural gas: about 45 percent; petroleum: 37 percent; other sources: 18 percent (including renewables 7 percent). - Natural gas consumption is fully domestically supplied, with prices set under long-term pricing arrangements. - Over 90 percent of petroleum and refined products are imported and priced at global rates. - Energy use and electricity - Electricity generation: about 70 percent natural gas, 16 percent renewables, 14 percent coal; petroleum has largely been phased out. - About 70 percent of petroleum consumption is used in transport. - Gasoline prices increased by 12.5 percent in April month over month (unleaded 95-octane gasoline price is regulated with a monthly price ceiling based on Mediterranean/European market averages and the exchange rate). - Staff estimates on pass-through - A 10 percent increase in oil prices would raise inflation by about 0.25 percentage points. - A 10 percent appreciation of the nominal effective exchange rate would reduce inflation by about 0.6 percentage points. - Severe scenario impact - In a severe scenario where energy supply dislocations extend into 2027 (based on the April 2026 WEO), growth in 2027 would be 0.8 percentage points lower than the baseline and inflation 2.0 percentage points higher, following an already weaker outlook in 2026. ### Fiscal strategy: findings and recommended measures - Fiscal position and projections - Knesset-approved 2026 budget set the deficit at 4.9 percent of GDP (approved March 30); draft 2026 Budget envisaged a CG deficit of 3.9 percent of GDP in 2026. - Staff baseline projects a CG deficit of 5.3 percent of GDP for 2026. - Staff recommend reducing the CG deficit to about 2.5 percent over the next three years to place debt on a firm downward trajectory to 65 percent by the mid-2030s and to 60 percent by 2040. - Under staff baseline, public debt would continue to rise to 74 percent of GDP by 2031 absent further adjustment; debt sustainability analysis indicates a moderate risk of sovereign stress. - Recommended fiscal strategy (high level) - Contain the deficit within the 4.9 percent of GDP ceiling by enforcing strict spending controls, reprioritizing non-priority spending, and introducing new revenue measures if needed. - Make conflict‑related fiscal support temporary and targeted to vulnerable households. - If downside risks materialize, allow automatic stabilizers to operate. - Specific revenue and expenditure options (selected and staff-estimated potential yields) - Revenue options: - Abolish the lower income tax bracket (tax rate, 10 percent) and merge it with the second lowest tax bracket (tax rate, 14 percent). - Rationalize VAT exemptions (e.g., fruits, vegetables, tourism services). - Rationalize preferential treatment of the advanced study fund (Keren Hishtalmut) and corporate income tax exemptions under the Encouragement of Capital Investments Law (ECIL). - Expand taxes on negative externalities (e.g., single-use plastics, sugar sweetened beverages). - Increase VAT rates (noted as relatively low compared to OECD peers). - Staff revenue yield estimates (Percent of GDP): - Align the lowest two personal income tax brackets at 14 percent: 0.3 - Close VAT exemption on tourism services: 0.1 - Close VAT exemption on fruits and vegetables: 0.2 - Rationalize preferential tax treatment of advanced study fund: 0.3 - Rationalize tax incentives in ECIL: 0.3 - Expand taxes on negative externalities: 0.1 - Increase VAT rates by 2 percentage points: 0.8 - Expenditure measures: - Launch a spending review to identify scope to rationalize current spending and reprioritize toward education, active labor market policies, and integration of Haredi and Arab-Israeli populations. - Improve public investment efficiency using frameworks such as the IMF Public Investment Management Assessment. - Institutional reforms: - Improve budget presentation with long-term fiscal sustainability analyses and forecast reconciliations; consider an IMF Fiscal Transparency Evaluation; review fiscal rules and explore independent fiscal oversight. ### Structural reform priorities - Objectives: boost labor supply and productivity, restore pre-conflict growth potential, and support fiscal consolidation. - Labor supply and skills - Employment rates: Haredi men around 55 percent; Arab-Israeli women 45 percent; government 2030 targets are 65 and 53 percent, respectively. - Recommended actions: - For Arab-Israelis: successor program to enhance proficiency in Hebrew and English, education, childcare, and infrastructure. - For Haredi men: enforce core curriculum (mathematics, science, and English), expand vocational and technological training, phase out negative work incentives (e.g., subsidies for full-time yeshiva students). - Productivity-enhancing reforms - Product market reforms: deepen competition-enhancing reforms, streamline regulatory requirements (e.g., company registration), lower entry barriers to professional services while maintaining quality. - Infrastructure investment: scale up, especially public transport; monitor contingent liabilities from public-private partnerships. - Maintain competitive edge in high-tech and AI - Strengths: high-tech sector well-positioned for AI; IMF AI Preparedness Index places Israel among well-positioned economies. - Recent developments: National AI Directorate established October 2025; national AI supercomputer launched January 2026. - Recommended actions: expand STEM education, upgrade curricula, introduce AI education early, adopt a comprehensive lifelong learning strategy for reskilling and upskilling, and narrow access gaps among Haredi and Arab-Israeli groups. ### Monetary and foreign exchange policy guidance - Monetary policy stance and assessment - BOI cut policy rate cumulatively 50 basis points in November 2025 and January 2026 to 4 percent; signaled a pause after the war onset; resumed easing on May 25, lowering the policy rate by 25 basis points to 3.75 percent. - Staff assess the current stance as moderately tight and supportive of price stability. - Staff estimate real neutral rate between 0.5 and 1.5 percent; with inflation at about 2 percent, the nominal neutral rate ranges between 2.5 and 3.5 percent. - Staff recommendations for BOI - Maintain a moderately tight monetary policy under the baseline; remain attentive to war-related labor supply effects, pass-through of higher energy prices and exchange rate movements, and the impact of the latest rate cut on financial conditions and domestic demand. - Stand ready to adjust course if incoming data or heightened risks indicate meaningful deviations; further rate cuts toward neutral would be appropriate if inflation pressures moderate or disinflationary forces strengthen. - Foreign exchange policy - Market forces should continue to determine the FX rate, barring abrupt market disruptions. - BOI FX stabilization program (October 2023) involved up to US$30 billion in FX sales and US$15 billion in swaps; deployed during initial stress and largely unused since (small sales in June 2025). ### Financial stability, real estate risks, and supervisory priorities - Financial sector resilience - Conservative supervisory guidance on dividend retention and loan-loss provisioning strengthened resilience. - Banks remain well-capitalized, liquid, and profitable; Q3 2025 indicators: Tier I capital to RWA 11.5 percent; leverage ratio 7.4 percent; NPLs 0.6 percent; liquidity coverage ratio 130.7; return on average equity (before tax) 15.8 percent. - Real estate sector vulnerabilities - Developers used presales with extended delivery periods and low upfront payments coupled with bank-provided balloon loans. - By 2024-25 house prices and transactions rebounded strongly; bank lending to real estate exceeded half of total credit by early 2025. - Balloon loan origination rose from about 5 percent in early 2022 to over 20 percent by late 2024, then dropped to about 15 percent by reporting date. - BOI measures (April 2025) included capping contractor-subsidized balloon loans at 10 percent of housing loan issuance and higher capital requirements on exposures to risky developer presales; measures slowed issuance of balloon loans. - Supervisory and macroprudential recommendations - Ensure lenders rigorously assess real estate exposures and update provisions. - Maintain and adapt prudential requirements (e.g., exposure limits for real estate) as risks evolve. - Keep macroprudential measures introduced in April 2025 in place through end-2026 and extend if warranted. - Develop liquidity stress testing frameworks and conduct regular system-wide stress tests including liquidity risks. - Monitor nonbank financial institutions (NBFIs), consider extending borrower-based measures to NBFIs, and ensure adequate liquidity buffers and oversight of foreign-currency derivative exposures. - Caution against subsidizing existing mortgages given low delinquencies and potential moral hazard and fiscal costs. - Capital framework and crisis management - Careful calibration of Basel III capital buffers recommended; consider setting the neutral counter-cyclical capital buffer at a positive level. - Expedite legal amendments strengthening BOI’s resolution powers and address remaining crisis management gaps (escalation powers, legal triggers, early intervention tools). - Banking competition and tiered licensing - New three-tiered licensing regime (legislation approved April 2026) to facilitate entry and allow combination of banking and other financial services under a holding company. - Proceed cautiously to mitigate risks from entrants with limited risk management capacity, regulatory arbitrage, and competition-stability trade-offs; maintain BOI supervision for all deposit-taking institutions. - Financial integrity (AML/CFT) - Progress on real estate sector legislation and strengthening beneficial ownership regime (before the Knesset). - Update of the National Risk Assessment expected by end of year; enhance risk-based approach, apply dissuasive sanctions, complete confiscation legislative reform, and ensure beneficial ownership registries are adequate and up to date. ### Selected headline macro‑financial indicators (as reported) - Real GDP (percent change): 2024 = 1.0; 2025 = 2.9; 2026 = 3.5; 2027 = 4.4; 2028 = 3.7. - Unemployment rate (percent): 2024 = 3.0; 2025 = 3.0; 2026 = 3.0; 2027 = 3.1. - Overall CPI (percent change, average): 2024 = 3.1; 2025 = 3.0; 2026 = 2.3; 2027 = 2.1. - Public debt (percent of GDP): 2024 = 67.7; 2025 = 68.4; 2026 = 70.1; 2027 = 70.7; 2028 = 71.5. - Central government overall balance (percent of GDP): 2024 = -6.8; 2025 = -4.7; 2026 = -5.3; 2027 = -4.4. - Central government total expenditure (percent of GDP): 2025 = 30.8; 2026 = 31.1. - Nominal GDP (in billions of NIS): 2025 = 2,111; 2026 = 2,246; 2027 = 2,398; 2028 = 2,545. - Current account balance (percent of GDP): 2024 = 2.9; 2025 = 1.5; 2026 = 1.3; 2027 = 1.8. - Foreign reserves (end‑of‑period, US$ billions): 2025 = 229.5. *Source: IMF staff report excerpt — "1. Israel: Energy Shocks."* ### 1. Israel: Energy Shocks __________________________________________________________________________ 12 ### 1. Israel: Energy Shocks ### Context—Challenges - Elevated regional tensions over the past three years have tested the economy’s resilience, including: the 2023-25 Gaza conflict, the June 2025 escalation with Iran, and the war in the Middle East that began on February 28, 2026. Output remains about 9 percent below its pre-October 2023 trend. - Repeated disruptions have led to elevated defense spending, higher debt and interest costs, and persistent labor supply constraints from military mobilization and reduced availability of Palestinian workers. - Structural challenges: low labor force participation and skill levels for some groups (particularly Haredi men and Arab-Israelis), dual economy with world-class high-tech sectors alongside lower productivity industries, and exposure as a small, open economy to global trade tensions and trading partner growth. - Political context: General elections are due by late October 2026; the political landscape is fragmented and early elections are possible if the Knesset fails to pass key legislations. Government policies during recent conflicts broadly aligned with past staff recommendations, while structural reform progress has been mixed. ### Recent Economic Developments - Output and growth - Output contracted sharply after October 2023 (−21 percent, annualized q/q) and recovered through 2023-25; GDP growth rose from 1 percent in 2024 to 2.9 percent in 2025. - Activity strengthened into 2025 with brief interruption from the June 2025 Iran escalation and a strong rebound in H2 2025. - Labor market - Military mobilization, displacement, and the loss of Palestinian workers reduced labor supply significantly in Q4 2023; labor supply gradually recovered through 2024-25 as reservists returned and foreign workers replaced Palestinians. - Compensation of non-public sector employees increased by 6.8 percent y/y in 2025, up from 2.3 percent in 2024. - Employment, unemployment, and vacancy indicators pointed to continued tightness into early 2026. - Inflation and monetary developments - Inflation accelerated through 2024 and peaked in January 2025 (headline 3.8 percent y/y; core 3.6 percent y/y). - By fall 2025, inflation returned to the 1-3 percent target range; headline and core inflation were 2 percent y/y and 2.2 percent y/y, respectively, in February 2026. - Financial markets and banking system - After October 7, 2023 shock shekel depreciated to NIS 4.1 per US$, 5-year CDS widened above 140 basis points, and equities fell sharply; by mid-February 2026 shekel strengthened to around NIS 3.1 per US$, equities more than doubled, and CDS narrowed to about 70 basis points by late-February. - Banking system indicators (Q3 2025): non-performing loans below 1 percent of total loans; return on equity around 16 percent; leverage ratio 7 percent; liquidity coverage ratio 130 percent. - External sector and reserves - Current account surplus narrowed from 2.8 percent of GDP in 2024 to 1.5 percent in 2025. - Net international investment position estimated at 43 percent of GDP (end-2025). - Gross reserves at 37.5 percent of GDP. - Fiscal developments and public debt - Central government balance: surplus of 0.6 percent of GDP in 2022 → deficits of 4.1 percent in 2023 and 6.8 percent in 2024; 2025 budget included about 1.2 percent of GDP in consolidation measures; central government deficit narrowed to 4.7 percent of GDP in 2025 (below the 5.2 percent of GDP budgeted). - General government balance: surplus of 0.3 percent of GDP in 2022 → deficits of 5.4 percent in 2023 and 8.1 percent in 2024; GG deficit declined to 5.2 percent of GDP in 2025. - Public debt rose from 60 percent of GDP at end-2022 to 68 percent of GDP at end-2025. - Impact of the war beginning February 28, 2026 - State of emergency declared; large-scale mobilization of reservists reportedly about 100,000 (2.2 percent of the labor force in early March). - Temporary loan payment deferral program reintroduced in early March. - Real GDP contracted by 3.3 percent (q/q, annualized) in Q1 2026. - Headline inflation accelerated by 0.6 percent m/m (seasonally adjusted) in April 2026, with annual inflation at 1.9 percent; core inflation 0.2 percent m/m and 1.4 percent y/y in April 2026. - Financial markets by mid-May 2026: shekel around NIS 2.9 per US$; 5-year CDS declined to pre-war levels; 10-year government bond yields around 4 percent (about 20 basis points above pre-war levels). - High-frequency indicators suggest a pick-up in consumption in April-May 2026; employment recovered partially and labor market remained tight in April 2026. ### Outlook and Risks - Baseline assumptions - Ceasefires since mid-April largely hold, no sustained escalation or material progress toward regional peace agreements, and elevated geopolitical uncertainty persists. - Reservists expected to gradually return but mobilization remains above pre-October 2023 levels; reduced foreign workers continue to constrain labor supply. - Baseline incorporates global oil price futures as of May 12 and assumes limited headwinds from tighter global financial conditions. - External drag from slower trading partner growth expected to be modest, reflecting resilient high-tech exports and strong linkages with the U.S. economy. - Projections - Real GDP growth: 3.5 percent in 2026; 4.4 percent in 2027. - Inflation: headline inflation projected to rise from 1.9 percent in Q1 2026 to 2.5 percent in Q4 2026, then ease to around 2 percent by Q4 2027. - Medium-term: potential growth projected at around 3½ percent (down from an average of 4 percent in 2013-22, excluding 2020-21); general government deficit projected to remain around 5 percent of GDP over the medium term; GG debt projected to reach 74 percent of GDP by 2031; current account surplus expected to be around 2¼ percent of GDP. - Downside scenario (illustrative) - Assumes intensified hostilities directly involving Israel and a severe global recession triggered by deeper, prolonged commodity market disruptions. - Under this scenario: growth would decelerate to 2¾ percent in 2026 and to 1½ percent in 2027; defense spending would rise to 9 percent of GDP; absent policy adjustment, GG deficit would widen to 7½ percent of GDP in 2027; public debt could rise by over 4 percentage points of GDP. - Contingent policy advice: strictly target fiscal support so conflict-related relief outlays remain temporary; reprioritize non-defense spending; introduce new revenue measures; tighten monetary policy; safeguard FX market functioning through prudent reserve use; closely monitor financial sector risks. - Upside scenario (illustrative) - Progress beyond the ceasefire toward durable peace and expanded participation in the Abraham Accords; large-scale demobilization and stronger sentiment spur investment and growth. - Contingent policy advice: reallocate peace dividends to growth-enhancing reforms (higher infrastructure and education spending) alongside some fiscal consolidation; new revenue measures still needed to create fiscal space. ### Box 1 — Energy Shocks - Energy supply mix - Natural gas: about 45 percent; petroleum: 37 percent; other sources: 18 percent (including renewables 7 percent). - Natural gas consumption is fully domestically supplied, with prices set under long-term pricing arrangements. - Over 90 percent of petroleum and refined products are imported and priced at global rates. - Implications - Global energy price shocks primarily affect transport. - Electricity generation: about 70 percent natural gas, 16 percent renewables, 14 percent coal; petroleum has largely been phased out. - About 70 percent of petroleum consumption is used in transport. - Gasoline prices increased by 12.5 percent in April month over month (unleaded 95-octane gasoline price is regulated with a monthly price ceiling based on Mediterranean/European market averages and the exchange rate). - Severe scenario impacts - In a severe scenario where energy supply dislocations extend into 2027 (based on the April 2026 WEO), growth in 2027 would be 0.8 percentage points lower than the baseline and inflation 2.0 percentage points higher, following an already weaker outlook in 2026. - Staff estimates on pass-through - A 10 percent increase in oil prices would raise inflation by about 0.25 percentage points. - A 10 percent appreciation of the nominal effective exchange rate would reduce inflation by about 0.6 percentage points. *Source: IMF staff report excerpt — "1. Israel: Energy Shocks."* ### 11. In addition, trade disruptions, and disorderly AI correction pose additional risks (Annex ### 11. In addition, trade disruptions, and disorderly AI correction pose additional risks (Annex IV) ### Risks to growth and stability - Protectionism and trade tensions, including possible new tariffs on previously exempt sectors (e.g., semiconductors), and further trade diversion could weigh on growth and investment, and amplify inflation. - As Israel is well-integrated into the AI supply chain, a disorderly AI correction could cause a decline in its exports and foreign direct investment, and lead to job and wealth losses via institutional investors’ exposure to global equity markets. - Domestically, political tensions could rise, raising uncertainty and risk premia, and weakening consumption and investment. ### Policy discussions — overarching guidance - Priority: rebuild fiscal buffers by pursuing fiscal consolidation through growth-friendly revenue measures, while stepping up structural reforms to help potential growth regain momentum and support the fiscal adjustment. - Near term: a policy mix of gradual fiscal tightening and a moderately tight monetary policy stance remains appropriate under the baseline, where capacity constraints persist and inflation rises temporarily. - Financial supervisors: remain vigilant in monitoring real estate risks. ### A. Restoring Fiscal Buffers Amid Persistently Higher Defense Spending Findings and projections - The draft 2026 Budget envisaged a CG deficit of 3.9 percent of GDP in 2026, down from 4.7 percent in 2025, mainly reflecting lower defense spending. - The Knesset approved the budget on March 30, setting the deficit at 4.9 percent of GDP, over 1 percentage point above the pre-war draft. Revenue projections were revised up on stronger-than-expected tax collection in Q1. However, expenditure increased more, driven by higher defense spending (about 1½ percentage points of GDP). - Staff baseline: Staff project a CG deficit of 5.3 percent of GDP as revenue overperformance in Q1 is unlikely to persist. Defense spending may exceed allocations, but could be accommodated within the overall envelope through contingency reserves. - Public debt: Under the staff’s baseline, the fiscal deficit narrows only modestly to around 4 percent in 2029 as defense spending remains elevated. Absent further adjustment, the public debt would continue to rise to 74 percent of GDP by 2031, with risks tilted upward. The debt sustainability analysis indicates a moderate risk of sovereign stress (Annex VI). Recommended fiscal strategy - Aim to contain the deficit within the 4.9 percent of GDP ceiling by enforcing strict spending controls, reprioritizing non-priority spending, and introducing new revenue measures if needed. - If downside risks to growth materialize, automatic stabilizers should operate to cushion the impact on the economy. - In the event of heightened energy price pressures, fiscal support should remain temporary and targeted to vulnerable households, avoiding broad-based measures that are fiscally costly and weaken price signals. - Staff recommend reducing the CG deficit to about 2.5 percent over the next three years to place debt on a firm downward trajectory to 65 percent by the mid-2030s and to 60 percent by 2040. Adjustment should prioritize revenue measures, given already low social and infrastructure spending relative to OECD peers. Specific revenue and expenditure options - Revenue measures (efficient options with limited growth impact): - Abolish the lower income tax bracket (tax rate, 10 percent) and merge it with the second lowest tax bracket (tax rate, 14 percent). - Rationalize tax exemptions—for example, VAT exemptions on fruits, vegetables, and tourism services, preferential treatment of the advanced study fund (Keren Hishtalmut), and corporate income tax exemptions under the Encouragement of Capital Investments Law (ECIL). - Expand taxes on negative externalities—for example, taxes on single-use plastics, and sugar sweetened beverages. - Increase VAT rates, which remain relatively low compared to other OECD countries. - Tax system reviews: undertake a comprehensive review of the tax system, including tax expenditures, to enhance simplicity, efficiency, and equity. - Expenditure measures: - Launch a spending review to identify scope to rationalize current spending, including administrative expenditures and social benefit programs, and to reprioritize resources toward growth enhancing programs—such as education, active labor market policies, and policies to support integration of Haredi and Arab-Israeli populations in the labor market. - Improve the efficiency of public investment, through strengthening the planning, allocation, and execution, possibly by leveraging the IMF Public Investment Management Assessment framework. - Institutional reforms: improve budget presentation by including analyses of long-term fiscal sustainability and forecast reconciliations; consider undertaking the IMF Fiscal Transparency Evaluation; review effectiveness of fiscal rules and explore options for independent fiscal oversight. Selected exact figures from budget tables and staff estimates - Revenue and grants: 55 1.9 26.1 57 1.5 25.4 58 7.0 26.1 58 0.2 25.8 (Note: table text as in source). - Expenditure: 65 0.5 30.8 65 9.3 29.3 69 8.2 31.1 69 8.2 31.1 (Note: table text as in source). - Defense: 16 5.5 7.8 13 8.5 6.1 16 9.9 7.6 16 9.9 7.6 (Note: table text as in source). - Balance examples: -9 8.6 -4.7; -8 7.8 -3.9; -11 1.2 -4.9; -11 8.0 -5.3 (Note: table text as in source). - Memorandum: Selected discretionary revenue measures: Wiz......10.00.4 10.00.4 10.00.4 (Note: table text as in source). - General government net lending: -110.0 -5.2 ... -142.6 -6.3 (Note: table text as in source). - Nominal GDP (authorities): 2,111 2,253 2,247 2,246 (Note: table text as in source). - Nominal GDP (percentage change): 6.7 6.4 6.4 (Note: table text as in source). Potential revenue yields (IMF staff estimates) - Align the lowest two personal income tax brackets at 14 percent: 0.3 (Percent of GDP) - Close VAT exemption on tourism services: 0.1 (Percent of GDP) - Close VAT exemption on fruits and vegetables: 0.2 (Percent of GDP) - Rationalize preferential tax treatment of advanced study fund: 0.3 (Percent of GDP) - Rationalize tax incentives in ECIL: 0.3 (Percent of GDP) - Expand taxes on negative externalities: 0.1 (Percent of GDP) - Increase VAT rates by 2 percentage points: 0.8 (Percent of GDP) ### B. Advancing the Longstanding Structural Reform Agenda Objectives - Accelerate structural reforms urgently to boost labor supply and productivity, restore pre-conflict growth potential, and support fiscal consolidation. - Reform priorities include: (i) expanding labor supply and addressing skill mismatches; (ii) strengthening productivity through product market reforms and infrastructure investment; and (iii) preserving Israel’s competitive edges in high-tech and AI. Boosting labor supply and addressing skills mismatches - Substantial gaps in labor participation and skills persist among Haredi and Arab-Israeli groups: Employment rates for Haredi men (around 55 percent) and Arab-Israeli women (45 percent) remain well below those of other groups and the government’s 2030 targets (65 and 53 percent, respectively). - Education outcomes are weaker, reflecting curriculum gaps in Haredi schools and resource constraints and language barriers in Arab-Israeli communities. Generous fiscal support for Haredi men enrolled in yeshiva weakens incentives to enter the labor market. - Recommended actions: For Arab-Israelis, build on recent progress with a successor program to enhance proficiency in Hebrew and English, education, childcare, and infrastructure. For Haredi men, enforce core curriculum (mathematics, science, and English), expand vocational and technological training, and phase out negative work incentives (e.g., generous subsidies for full-time yeshiva students). Enhancing productivity - Product market reforms: deepen reforms to strengthen competition and business dynamism. Israel underperforms on several OECD product market indicators, suggesting scope to improve efficiency. Steps taken include aligning import procedures with EU standards. There is scope to further streamline regulatory requirements (e.g., company registration) and lower entry barriers to professional services (while maintaining quality). - Infrastructure investment: scale up infrastructure investment, particularly public transport. The World Bank’s Logistics Performance Index indicates Israel’s trade and transport infrastructure lags behind many advanced economies. The National Infrastructure Promotion Law (enacted June 2023) aims to accelerate planning, approval, and execution of large-scale national infrastructure projects. Given reliance on public-private partnerships, contingent liabilities require careful monitoring and management. Maintain competitive edge in high-tech and AI - Israel’s high-tech sector remains a key strength and is well-positioned to expand AI development activities. Broader AI diffusion would offer significant productivity gains across traditional industries and the public sector. The IMF’s AI Preparedness Index places Israel among well-positioned economies to harness these gains. - Risks: rapid technological change could outpace the supply of skilled workers and data infrastructure, while gaps in the policy framework could undermine sustained global leadership. - Recent developments: establishment of a National AI Directorate within the Prime Minister’s office in October 2025; launch of a national AI supercomputer in January 2026. - Recommended actions: expand STEM education, upgrade mathematics and science curricula, introduce AI education at early stages, narrow gaps in access to AI-related skills and opportunities among Haredi and Arab-Israeli groups (in line with the 2022 Perlmutter Committee’s recommendations). Adopt a comprehensive lifelong learning strategy encompassing reskilling, upskilling, and mid-career training to support workers facing potential job displacement from AI adoption. ### C. Ensuring Price Stability Monetary policy stance and assessment - Before the war, the BOI cut its policy rate by a cumulative 50 basis points in November 2025 and January 2026 to 4 percent, amid easing inflation pressures and reduced risk premia. Following the onset of the Middle East war, it signaled a pause in the easing cycle. On May 25, the BOI resumed easing, lowering the policy rate by 25 basis points to 3.75 percent, amid contained inflation expectations and shekel appreciation. Staff assess that the current stance remains moderately tight and supports price stability. - Staff estimate that the real neutral rate ranges between 0.5 and 1.5 percent. With inflation expectations at about 2 percent, the nominal neutral rate ranges between 2.5 and 3.5 percent. Staff recommendations for the BOI - Maintain a moderately tight monetary policy. Under the baseline, inflation is expected to rise temporarily due to higher energy prices and supply constraints. Given substantial uncertainty, the BOI should remain attentive to evolving risks and continue to closely monitor: war-related effects on labor supply, the pass-through of higher energy prices and exchange rate movements, and the impact of the latest rate cut on financial conditions and domestic demand. - Stand ready to adjust course if incoming data or the heightened risk environment indicate meaningful deviations from the baseline. Further rate cuts toward the neutral rate would be appropriate if inflation pressures moderate or disinflationary forces—such as oil price stabilization or sustained exchange rate appreciation—become more pronounced. Foreign exchange policy - Market forces should continue to determine the FX rate, barring abrupt market disruptions. The BOI implemented its foreign exchange stabilization program in October 2023—involving up to US$30 billion in FX sales and US$15 billion in liquidity via swaps—aimed at ensuring market functioning. It was deployed during the initial stress period but has since remained largely unused—the last, small FX sales occurred in June 2025 during the Iran escalation. ### D. Safeguarding Financial Stability Financial sector resilience and supervision - Financial stability has been supported by prudent and proactive supervision and timely policy measures. Conservative supervisory guidance—particularly on dividend retention and loan-loss provisioning—has helped banks strengthen resilience, while tightly parametrized borrower-based measures contained excessive mortgage credit growth (Annex VII). - Banks remain well-capitalized, liquid, and profitable. *Source: IMF staff analysis in the specified content unit.* ### 27. The real estate sector presents a pocket of vulnerability. At the onset of the ### The real estate sector presents a pocket of vulnerability ### Real estate market developments and immediate risks - Developers boosted demand after the onset of the 2023 conflict through property presales with extended delivery periods and low upfront payments, deferring the balance until delivery via bank-provided balloon loans (Annex VIII). - House prices and transactions rebounded strongly after the dip in late 2023, peaking in late 2024-early 2025 (Annex VIII). - Bank lending to real estate expanded, with exposures exceeding half of total credit by early 2025. - Following prudential measures introduced by the BOI in April 2025, the housing market has begun to cool: price growth and transactions decelerated, and new unit inventories for sale increased. - BOI prudential measures in April 2025 included: - capping contractor-subsidized balloon loans at 10 percent of housing loan issuance; and - imposing higher capital requirements on exposures to developers heavily engaged in risky presales. ### Financial sector vigilance and supervisory recommendations - Bank supervision: supervisors should - ensure that lenders rigorously assess real estate sector exposures and update provisions accordingly; - maintain robust prudential requirements, adjusting them (e.g., exposure limits for real estate) as risks evolve; and - keep macroprudential measures introduced in April 2025 in place through end-2026 and extend them if warranted. - Stress testing: - The BOI is encouraged to develop liquidity stress testing frameworks. - Bank-insurance stress tests recently conducted jointly by the BOI and the Capital Market and Insurance Authority are welcome. - Authorities should regularly conduct system-wide stress tests and broaden their scope to include liquidity risks. - Nonbank financial institutions (NBFIs): - Close monitoring should continue as nonbank mortgage lending—though still small—continues to grow. - Authorities should consider extending borrower-based measures to NBFIs. - Supervisors should closely monitor NBFIs’ growing exposure to foreign-currency derivatives and ensure sufficient liquidity buffers. - Proposed mortgage subsidies: - Staff caution against subsidizing existing mortgages because delinquencies remain low, and subsidies would weaken monetary transmission, entail fiscal costs, be regressive, and raise moral hazard concerns. ### Capital framework, crisis management, and FSAP follow-up - Basel III implementation: - Staff call for careful calibration of capital buffers to (i) ensure that all material risks are adequately captured; (ii) maintain an appropriate balance between simplicity and risk sensitivity; and (iii) preserve the overall level of capital requirements. - Authorities should consider setting the neutral counter-cyclical capital buffer at a positive level to strengthen resilience in normal times and improve usability of buffers in downturns. - FSAP recommendations: - Authorities have implemented numerous 2012 FSAP recommendations, especially in bank and insurance supervision, securities markets oversight and development. - Recent legal amendments strengthening the BOI’s resolution powers address part of the recommendations and should proceed expeditiously. - Remaining gaps include crisis management elements: need for clear escalation of powers, distinct legal triggers for enforcement, and early intervention tools. ### Banking competition and tiered licensing - Authorities’ plan to introduce a tiered bank licensing framework based on proportionality (legislation approved by the Knesset in April 2026) aims to: - facilitate new entries via a three-tiered regime; and - allow a combination of banking and other financial services under a single holding company. - Risks and safeguards: - Potential risks from entrants with limited risk management capacity, regulatory arbitrage, and competition-stability trade-offs. - Efforts to enhance bank competition through new entries should proceed cautiously; robust regulatory and supervisory standards must be maintained. - All deposit-taking institutions should remain under BOI supervision. ### Strengthening financial integrity (AML/CFT) - Progress under way includes legislative changes for the real estate sector and measures to strengthen the beneficial ownership regime for legal persons; these reforms are before the Knesset. - The update of the National Risk Assessment should be finalized by the end of the year. - Authorities should: - further enhance the risk-based approach; - apply dissuasive sanctions for non-compliance with AML/CFT preventive measures; - complete legislative reform regarding confiscation; and - ensure beneficial ownership information in relevant registries is adequate, accurate, and up to date. ### Authorities’ views (selected quantitative and policy points) - Growth forecasts revised from around 5.2 percent (pre-war) to 3.3-3.8 percent in 2026, depending on the duration of the conflict, followed by a rebound to 5.3-6.1 percent in 2027. - BOI projects inflation to rise slightly above 2 percent by Q1 2027, noting elevated uncertainty and that a sustained shekel appreciation would exert downward pressure on inflation in 2026. - MOF aims to restrain the deficit to no more than 4.9 percent of GDP in 2026. - May 2026 BOI policy decision: cut the policy rate to 3.75 percent. - MOF view on nonbank borrower-based measures: premature to extend to NBFIs because the non-banking private credit market is not yet sufficiently developed. - Excess-profit taxes on banks in the 2026 budget intended to bolster state revenues and target windfall profits; BOI cautions they may be counterproductive to competition objectives. - National Risk Assessment update expected to be finalized by end-2026. ### Staff appraisal (selected projections and guidance) - Under staff’s baseline, which assumes the sustained ceasefire in the Middle East: - growth is projected at 3.5 percent in 2026, down from the 4.8 percent pre-war projection, and to rise to 4.4 percent in 2027; - headline inflation is expected to rise temporarily due to higher energy prices in the near term, while core inflation and inflation expectations remain around the midpoint of the target band. - Fiscal guidance: - Fiscal consolidation should steadily continue to rebuild buffers. - Beyond 2027, additional measures will be required to reduce the central government deficit to around 2.5 percent of GDP over the next three years to place public debt on a firm downward trajectory. - Fiscal adjustment should prioritize revenue measures; a comprehensive review of the tax system, including tax expenditures, is needed. - Structural reform priorities: - Intensify reforms to lift medium-term potential growth, focusing on labor force participation and skills (notably among Haredi and Arab-Israeli groups), product-market reforms, and infrastructure investment aligned with population growth. - Strengthen active labor market policies, including a lifelong learning strategy, to facilitate reskilling and labor mobility. - Monetary policy guidance: - A moderately tight monetary policy stance has helped maintain price stability. - The BOI should maintain a moderately tight stance under the baseline and stand ready to adjust if incoming data or heightened risks indicate meaningful deviations. - Financial stability guidance: - Systemic risks are contained, but authorities should remain vigilant. - Continue prudent and proactive supervision, regular system-wide stress tests including liquidity risks, consider extending borrower-based measures to NBFIs, preserve overall capital requirements in Basel III implementation, and expedite legal reform strengthening BOI’s resolution powers while addressing remaining crisis management gaps. - Enhance bank competition cautiously, with due regard to financial stability. *Source: IMF staff report excerpt provided.* ### 48. It is recommended that the next Article IV consultation with Israel be held in the ### It is recommended that the next Article IV consultation with Israel be held in the standard 12-month cycle. ### Recent economic developments - Output growth picked up in 2025; output contracted in Q1 2026 due to the war in the Middle East. - Credit card purchases by private consumers (2002=100, seasonally adjusted) show a contraction in consumption in March, followed by a rebound. - Consumer confidence and business confidence weakened following the war in the Middle East. - Investment in buildings and construction remains below pre-conflict levels. ### Labor market developments - Unemployment fell to historically low levels reflecting a conflict-related labor shortage. - Employment rates have decreased in part reflecting increased mobilization of reservists. - Labor force participation remains below pre-pandemic levels. - Wage and unemployment-vacancy indicators point to a tight labor market with job vacancies uneven across sectors. ### Monetary developments - Inflation breached the target upper band in 2024 but has come within the target range since August 2025. - Prices of tradable goods moderated more rapidly, owing to a strong shekel. - Inflation expectations remain at around 2 percent. - The Bank of Israel (BOI) cut the policy rate in May 2026 after cuts in November 2025 and January 2026. - Financial conditions eased through 2025 and into Q1 2026. ### Selected financial indicators - The shekel appreciated after the October 2023 depreciation. - Stock prices have recently outperformed the global equity market. - Bond yields remain stable; the sovereign 5-year CDS spread has recovered close to pre-2023 conflict levels after the de-escalation. - The yield curve shifted down since October 2023 and remains relatively steep. - Banks’ expected default frequencies remain low. ### Banking system performance - Capital and leverage ratios stable at around 11 percent (Tier I capital to RWA) and 7 percent (leverage ratio). - Nonperforming loans (NPLs) fell to their lowest levels in a decade. - Bank profitability supported by lower NPLs; Tier 1 capital to total assets ratio is around the peer-group median. - Bank lending to the private sector has recovered; banks’ non-interbank loans are fully covered by customer deposits. ### External sector developments - Real effective exchange rate steadily appreciated since mid-2024. - Current account surplus narrowed in 2025. - Share of services exports in world exports increased in 2025 while that of goods exports declined. - High-tech industries remain the main driver of service exports; tourism has yet to recover. - Resident portfolio investment accounts for a large share of foreign accounts. - Net international investment position remains positive at around 40 percent of GDP. ### Fiscal developments and public finances - Government revenues rebounded following the decline at the onset of the conflict in October 2023, with increases in both direct and indirect taxes. - Government expenditure has remained elevated reflecting a sharp increase in defense spending. - Public debt has risen alongside higher interest expense. ### Key projections and indicators (selected from Tables) - Real GDP (percent change): 2024 = 1.0; 2025 = 2.9; 2026 = 3.5; 2027 = 4.4; 2028 = 3.7. - Unemployment rate (percent): 2024 = 3.0; 2025 = 3.0; 2026 = 3.0; 2027 = 3.1. - Overall CPI (percent change, average): 2024 = 3.1; 2025 = 3.0; 2026 = 2.3; 2027 = 2.1. - Gross national saving (percent of GDP): 2024 = 26.7; 2025 = 25.8; 2026 = 26.2. - Public debt (percent of GDP): 2024 = 67.7; 2025 = 68.4; 2026 = 70.1; 2027 = 70.7; 2028 = 71.5. - Central government overall balance (percent of GDP): 2024 = -6.8; 2025 = -4.7; 2026 = -5.3; 2027 = -4.4. - Central government revenues and grants (percent of GDP): 2025 = 26.1; 2026 = 25.8. - Central government total expenditure (percent of GDP): 2025 = 30.8; 2026 = 31.1. - Nominal GDP (in billions of NIS): 2025 = 2,111; 2026 = 2,246; 2027 = 2,398; 2028 = 2,545. - Current account balance (percent of GDP): 2024 = 2.9; 2025 = 1.5; 2026 = 1.3; 2027 = 1.8. - Foreign reserves (end‑of‑period, US$ billions): 2025 = 229.5. ### Financial sector indicators (selected) - Regulatory Tier I capital to risk-weighted assets (percent): 2025Q3 = 11.5. - Capital as percent of assets (leverage ratio): 2025Q3 = 7.4. - Nonperforming loans to total gross loans (end-period, percent): 2025Q3 = 0.6. - Liquidity coverage ratio: 2025Q3 = 130.7. - Return on average equity (before tax): 2025Q3 = 15.8. *Source: IMF staff report on Israel (figures, tables, and projections as provided).* ### Annex I. Authorities’ Responses to Past Article IV ### Annex I. Authorities’ Responses to Past Article IV Recommendations ### Key recommendations and authorities’ actions - Monetary - Recommendation: The monetary policy stance should remain tight until there are clearer signs that aggregate demand is cooling. Market forces should be allowed to continue to set the price of the shekel. - Actions: The BOI has maintained a moderately tight monetary policy stance. The BOI’s FX stabilization program was launched in October 2023 and deployed during the initial stress period but has since remained largely unused. - Macroprudential and Financial System - Recommendation: Further calibration of macroprudential tools should be based on sector-specific developments. Measures to boost housing supply should be supported by complementary infrastructure investment and the reduction of fiscal disincentives to residential construction at the local authority level. Credit bureau information should be used to strengthen the measurement of risk at the individual exposure level. - Actions: Housing construction was disrupted by the onset of the 2023 conflict but rebounded strongly on developer-offered financing incentives. New macroprudential measures implemented in April 2025 aim to curb risky housing finance developments. Some progress on fiscal disincentives on housing supply at the local authority level. The credit bureau began offering a digital reporting service. - Fiscal - Recommendation: Fiscal buffers should be protected while raising growth-enhancing spending, for which the authorities should proactively strengthen revenue measures. Consider establishing an independent fiscal council, review the fiscal framework for rule effectiveness, and a mechanism to ringfence allowances for infrastructure and education projects. - Actions: The fiscal deficit remains high. The debt ratio, which had decreased to about 60 percent of GDP in 2022, increased to 68 percent of GDP in 2025. No consensus was made towards an independent fiscal council or other structural changes to the fiscal framework. - Structural - Recommendation: Education reform to expand cognitive and market-relevant skills; active labor market policies including vocational training; increase infrastructure spending to promote labor reallocation and productivity; reduce barriers to product market competition to address rising cost of living. - Actions: Reforms were partly interrupted by the conflict. The government has increased education funding and protected infrastructure spending, with new light rail or extensions ongoing in major cities. Remaining tariffs on U.S. goods (mainly food and agriculture) have been largely removed, and many EU and U.S. food and product standards have been recognized, but non-tariff barriers remain. *Italic source attribution: Annex I. Authorities’ Responses to Past Article IV (from provided document)* --- ### Annex II. Macroeconomic Developments—From October 2023 to February 2026 ### Overview of shock and recovery - Q4 2023 impact - The outbreak of conflict in October 2023 led to a 21 percent contraction in quarterly annualized GDP in Q4. - Drivers: loss of over 100,000 Palestinian workers, extensive Israeli reservist mobilization, and a month-long school closure. - Sectors especially hard hit: Construction, agriculture, and tourism. - Populations in conflict zones (~2.5 percent of the total along the northern and southern borders) were most severely affected and displaced. - Government and BOI assistance helped mitigate effects. - 2024 partial recovery - GDP grew by 1 percent in 2024, driven by higher government spending. - Business sector GDP contracted and per capita GDP declined. - Private consumption largely rebounded; fixed investment (structures) remained subdued. - Investment in high-tech sector continued strongly. - Inflation exceeded the 3 percent target from August 2024; main contributors: housing, food, tobacco, and volatile airfares. - Current account surplus sustained despite declines in tourism, exports to Palestinian territories, and the Turkey trade embargo. - 2025 developments - Output surpassed its pre-conflict level in Q1 2025; output surged past pre-conflict level again in Q3 2025 after interruption in Q2. - Headline inflation decelerated to 2.6 percent in December 2025, aided by a stronger shekel and eased supply constraints. - Real effective exchange rate appreciated by about 7 percent in 2025. ### Labor and investment dynamics - Non-Israeli employment - Sharp loss of non-Israeli workers at conflict onset; charted pre-war average comparison (figure in source). - Gross fixed investment (quarterly, seasonally adjusted) - Components: Machinery, equipment and other investment; Nonresidential structures; Residential structures. - Residential structures and nonresidential structures severely affected; machinery and equipment less so. - Financial conditions - Risk premia surged at conflict onset but largely reverted to pre-conflict levels after the October 2025 ceasefire. - Sovereign spreads and CDS widened in 2024 during escalations with Iran; narrowed ahead of ceasefires; widened again following renewed hostilities and then fell after ceasefire. - Moody’s and S&P downgraded Israel’s credit ratings in 2024, but recently upgraded the outlook to “stable”. - Financial sector remained resilient and credit continued to flow, supported by BOI interventions at conflict onset. ### Relief and support measures (selected) - Housing and welfare support - At peak around end-2023 (about three months after the conflict began): over 110,000 evacuees were in government funded short-term housing programs—about 45 percent northern residents and about 55 percent southern residents. - Grants and Compensation Fund (estimated claims Oct. 2023 to end-2024; ongoing, extended to June 2025) - Direct damage (physical damage to property, equipment or infrastructure): est. NIS3.5 billion - Indirect damage (losses due to disruption of business operations or direct damage): est. NIS24 billion - Unemployment benefits relaxations - Period of unpaid leave qualifying for unemployment benefits shortened to at least 14 days (from 30 days). - Bank of Israel supported measures - Loan repayment deferral program (launched Oct. 2023, extended every 3-months, ended March 2025): most-affected customers could defer payments for 3 months; mortgage deferments unlimited amount; consumer credit cumulative up to NIS 100,000; business credit up to NIS 2 million. - Most deferred payments ended as customers returned to making repayments (BOI estimates; Nov. 2024: 1 percent of total bank credit vs. Dec. 2023 6.9 percent). - Low-interest BOI loans to banks conditional on providing SME credit. - Banking system relief plans (NIS 3 billion, ongoing from Q2 2025 - Q1 2027): measures include higher rates on short-term deposits, fee exemptions, partial or full exemption from monthly repayment for defined periods, among others. *Italic source attribution: Annex II. Macroeconomic Developments (from provided document)* --- ### Annex III. External Sector Assessment ### Overall assessment and policy implications - Overall assessment: The external position in 2025 is assessed as broadly in line with the level implied by medium-term fundamentals and desirable policies. - Current account (CA) - CA surplus: 1.5 percent of GDP in 2025 (down from 2.9 percent of GDP in 2024). - Projected medium-term CA surplus: 2¼ percent of GDP. - Policy response: Sustained fiscal consolidation over the medium term to raise public savings; structural reforms (product market reforms) to boost private investment and offset higher CA surpluses. - External vulnerabilities mitigants: Israel’s strong net international investment position and sizable international reserves. ### A. Foreign Asset and Liability Position - NIIP background and assessment - NIIP around or above 40 percent of GDP over 2023–2025; increase of about 10 percentage points of GDP compared to 2022. - Drivers: persistent CA surpluses and favorable valuation of foreign assets of Israel’s large institutional funds sector. - Foreign Assets and Liabilities, 2025 (Percent of GDP) - NIIP: 43.0 - Gross Assets: 149.6 - Reserve Assets: 37.5 - Gross Liabilities: 106.5 - Debt Liabilities: 27.0 - Assessment: NIIP expected to improve further, but foreign asset values subject to adverse valuation changes. Composition: one-quarter of assets are reserves; half of non-reserve holdings in equities and bonds; close to half of liabilities are stable direct investments. ### B. Current Account (details and model estimates) - 2025 details - CA surplus: 1.5 percent of GDP in 2025 (2.9 percent in 2024). - Drivers of decline: drop in income balance (higher undistributed profits of foreign companies); narrowing goods deficit offset by smaller services surplus. - Medium-term projection: CA surplus projected to increase to 2¼ percent of GDP as goods and services balance gradually improves. - Assessment via EBA model (2025) - Cyclically adjusted CA: 1.4 percent of GDP - CA Norm (from model): 1.7 percent of GDP - EBA CA Gap: -0.3 percent of GDP - CA gap attribution: -0.3 percentage point of GDP attributed to policy gaps (mainly domestic fiscal policy gap (-0.6 ppt) and health expenditure (0.3 ppt)). - Israel: Model Estimates for 2025 (Percent of GDP) - CA-Actual: 1.5 - Cyclical contributions 1/: 0.1 - Adjusted CA: 1.4 - CA Norm (from model): 1.7 - EBA CA Gap: -0.3 - REER level / REER index: -5.9 / -2.2 - REER Gap (percent) 2/: 1.5 - Additional numbers: 26.6; 10.0 (as reported in source) - Note: Semi-elasticity of CA/GDP to REER assumption is -0.22. - Observations: Other factors contributing to high saving rate include transfers and grant inflows (including US military aid) and mandatory pension contributions (pension law enacted in 2008 increased private saving from 15.3 percent of disposable income prior to 2008 to 20.3 percent in 2019). ### C. Real Exchange Rate - Background: REER appreciated by about 7 percent in 2025 after remaining broadly stable in 2024; appreciation largely reflects NEER appreciation in 2025. - Assessment: CA gap estimate of -0.3 percent of GDP implies a REER gap of about 1.5 percent (elasticity -0.22). REER level and REER index models point to REER gaps of about 26.6 percent and 10.0 percent, respectively. The current account approach better explains recent REER developments given currency appreciation and continued capital inflows. ### D. Capital and Financial Accounts - 2025 flows - Net financial account outflows: 2.9 percent of GDP in 2025 (compared to around 4.2 percent of GDP in 2024). - Net FDI inflows: 1.9 percent of GDP in 2025 (0.9 percent of GDP in 2024). - Net outflows in portfolio and other investment: about 2.0 and 3.0 percent of GDP, respectively, largely reflecting residents’ accumulation of foreign assets. - Assessment: Foreign financial inflows mainly in stable FDI; portfolio inflows small relative to domestic institutional investors’ investment abroad. No new capital flow management measures introduced over the past two years. ### E. FX Interventions and Reserve Level - BOI FX stabilization program - Program scope: up to US$30 billion in FX sales and US$15 billion via swaps. - Interventions: US$8.2 billion in FX sales and US$0.4 billion in swaps in October 2023; US$0.3 billion in FX sales in November 2023; US$0.3 billion in FX sales in June 2025. - Reserves and adequacy - International reserves: US$229.5 billion at end-2025 (about 37.5 percent of GDP). - Reserves adequacy: about 14 months of prospective imports of goods and services or about 220 percent of the IMF’s reserve adequacy metric. - Exchange rate regime classification - De jure: free floating. - De facto: floating. *Italic source attribution: Annex III. External Sector Assessment (from provided document)* --- ### Annex IV. Risk Assessment Matrix (selected risks, likelihoods, impacts, and policy recommendations) - Geopolitical tensions and intensification of conflicts - Likelihood: High. Expected Impact: High. - Expected consequences: High-cost conflict with significant GDP disruption, resurging public debt, infrastructure destruction, higher defense spending, higher demand for reservists, resurging country risk premium, and lower investment. - Policy recommendation: Targeted fiscal support measures, prioritization exercise for nondefense spending, and sustained revenue measures. Make conflict-related spending temporary. Stand ready to raise interest rates and counter disruptions to FX markets if needed. After conflict abates, rebuild fiscal buffers. - Protectionism and further trade disruptions - Likelihood: High. Expected Impact: High. - Expected consequences: Decline in exports, FDI and related employment, tighter financial conditions. - Policy recommendation: Keep monitoring trade, investment and financial conditions, and actively secure favorable trade agreements. Further reduce tariff and non-tariff barriers, and increase export diversification. - Disorderly AI correction - Likelihood: High. Expected Impact: High. - Expected consequences: Decline in exports, FDI, and employment due to high-tech exposure; wealth loss via institutional investor exposure to global equity markets. - Policy recommendation: Intensify assessment of AI correction impacts. If negative output gaps and deflationary risks emerge, ease monetary policy and allow fiscal automatic stabilizers to operate. - Fiscal vulnerabilities and higher interest rates - Likelihood: High. Expected Impact: Medium. - Expected consequences: Upward pressure on long-term interest rates, tightening global financial conditions, amplified by price-sensitive investors and leveraged NBFIs. - Policy recommendation: Market forces should be allowed to continue to set the price of the shekel, with interventions limited to addressing disorderly market conditions. If negative output gaps and deflationary risks arise, ease monetary policy and allow fiscal automatic stabilizers to operate. - Cyberthreats - Likelihood: High. Expected Impact: Medium. - Policy recommendation: Invest in cybersecurity, guided by up-to-date risk assessments. - Housing finance amplifies financial stability risks - Likelihood: Medium. Expected Impact: Medium. - Expected consequences: A bust could lead to contract rescissions, falling house prices, defaults among homebuyers and construction companies, and bank losses. - Policy recommendation: Continue prudent and proactive supervision and close monitoring of financial sector risks, especially banks’ real estate exposures. Consider extending borrower-based measures to nonbank financial institutions. - Progress beyond the ceasefire (opportunity) - Likelihood: Medium. Expected Impact: Medium/High. - Expected consequences: Expanded Abraham Accords participation could boost trade and investment, ease labor shortages with demobilization of reservists. - Policy recommendation: Reallocate peace dividends to growth-enhancing reforms, including infrastructure and education spending, alongside some fiscal consolidation. New revenue measures will still be needed to create fiscal space. *Italic source attribution: Annex IV. Risk Assessment Matrix (from provided document)* ### Annex V. Data Issues ### Annex V. Data Issues ### Data adequacy assessment (summary) - Median Rating: A across National Accounts, Prices, Government Finance Statistics, External Sector Statistics, Monetary and Financial Statistics, Inter-sectoral Consistency. - Overall staff assessment: "Staff assess the overall data quality as broadly adequate for the Fund's surveillance." - Staff note: "Israel's economic and financial statistics are comprehensive, generally of high quality, and are provided to the Fund in a comprehensive manner." - Publication practice: "The authorities regularly publish a full range of economic and financial data, as well as a calendar of dates for the main statistical releases." ### Detailed assessment highlights and data quality characteristics - Coverage: A for all major sectors assessed (National Accounts, Prices, Government Finance Statistics, External Sector Statistics, Monetary and Financial Statistics, Inter-sectoral Consistency). - Consistency: A for the sectors where assessed. - Granularity: - Government Finance Statistics: top cell (government operations data) A; bottom cell (public debt statistics) A as per table note 3/. - Monetary and Financial Statistics: top cell (Monetary and Financial Statistics data) A; bottom cell (Financial Soundness indicators) A as per table note 3/. - Real sector classification: staff note a shortcoming—classification of activities on the production side is "relatively limited (i.e., 16 versus over 40 in many European countries)." - Frequency and Timeliness: - Most sectors: A for frequency and timeliness. - Some lower ratings indicated (table entries include B, C, D for specific subdimensions). - Use of data in Article IV consultations: "Staff do not use data and/or estimates different from official statistics." - Other data gaps: "None." (in Table VIII.1 summary) ### Specific data items and availability - FX intervention data: "Monthly FX intervention data is published, which is adequate for surveillance." - Labor market: "Labor market related data in various forms are also available and adequate." - SDDS Plus participation: "Israel adheres to the Special Data Dissemination Standard (SDDS) Plus since December 2020 and publishes the data on its National Summary Data Page." - SDDS Plus reporting: "The latest SDDS Plus Annual Observance Report is available on the Dissemination Standards Bulletin Board (https://dsbb.imf.org/)." (as stated in the source) ### Changes since the last Article IV consultation - General government data: "More comprehensive data for general government have been received by the team from the statistics agency, improving coverage beyond previously limited central government data and breakdowns available." - Financial balance sheet project: "With regard to the financial balance sheet (stocks of financial assets and liabilities) project, the sectoral balance sheet, debt securities, and other financial corporations survey have been reported on a regular basis under the SDDS plus framework." ### Corrective actions and capacity development priorities - Production-side classification: "The authorities plan to transmit the more detailed classification of activities on the production side for reference year 2025 in due course." - Other corrective actions/capacity development: Noted where applicable in tables; for some sectors, "N/A" is recorded. ### Rationale for staff assessment (key points) - Strengths cited: - Comprehensive coverage and regular publication of a full range of economic and financial data. - High-quality statistics reflecting membership in the OECD: "Israel is a member of the OECD, and its data quality and practices reflect that." - Shortcomings cited: - Limited production-side classification (16 categories versus over 40 in many European countries) which affects some real sector statistics. - Some data provided to the Fund "have some shortcomings that somewhat hamper surveillance" and in other contexts "have serious shortcomings that significantly hamper surveillance"—these phrases appear in the survey legend describing gradations of shortcomings used by staff. *Annex V. Data Issues (1isrea2026001)* ### Annex VI. Figure 5. Israel: Medium-Term Risk Assessment ### Annex VI. Figure 5. Israel: Medium-Term Risk Assessment ### Medium-term mechanical indicators and summary - Debt fanchart module — Value: 58.5; Contrib: 0.8 (percent of GDP) - Probability of debt non-stabilizaiton — Value: 61.6; Contrib: 0.5 (percent) - Terminal debt-to-GDP x — Value: 21.8; Contrib: 0.5 (institutions index) - Debt fanchart index (DFI) — Value: 1.8 - DFI risk signal: Moderate - Gross financing needs (GFN) module: - Average baseline GFN — Value: 12.1; Contrib: 4.1 (percent of GDP) - Initial Banks' claims on the gen. govt — Value: 10.3; Contrib: 3.3 (pct bank assets) - Chg. In banks' claims in stress — Value: 8.0; Contrib: 2.7 (pct banks' assets) - GFN financeability index (GFI) — Value: 10.2 - GFI risk signal: Moderate - Medium-term index (component values): - Debt fanchart index — Value: 1.8 - GFN finaceability index — Value: 10.2 - Medium-term index risk signal: 5/ Final assessment: Moderate - Probabilities (2026–2031): - Prob. of missed crisis, if stress not predicted: 18.2 pct. - Prob. of false alarms, if stress predicted: 27.3 pct. - Thresholds and notes: - Signal is low risk if the DFI is below 1.13; high risk if the DFI is above 2.08; otherwise moderate risk. - Signal is low risk if the GFI is below 7.6; high risk if the DFI is above 17.9; otherwise moderate risk. - Signal is low risk if the GFI is below 0.26; high risk if the DFI is above 0.40; otherwise moderate risk. - Mechanical signals, including the Fanchart and the GFN tool, indicate a moderate risk. - Source: IMF staff estimates and projections. ### Key percentile and stress-test visual indicators (as reported) - Percentile in peer group: ranges shown from 0 to 100; mechanical signals and triggered stress tests mapped across 2021–2031 (visual indicators retained in source). --- ### Annex VI. Figure 6. Israel: Long-Term Risk Assessment ### Long-term projections and amortization assessment - Historical benchmark: Historically, the GFN was approximately 9 percent of GDP. - Projections: - Expected rise to 12 percent of GDP in the next five years. - Reaching 15 percent of GDP in the long term. - Module findings: - Triggered Modules: Large Amortization - Projection variables: GFN-to-GDP ratio; Amortization-to-GDP ratio - Scenarios considered: Medium-term extrapolation; Baseline with t+5; Baseline with t+5 and DSPB; Historical 10-year average. - Overall risk indication: Despite the amortization risks highlighted in the module, all scenarios indicate manageable amortization and stable debt ratios. --- ### Annex VII. Macroprudential and Financial Policy Measures Since the Last Article IV ### COVID-related measures and transitional arrangements - Capital requirement: - Commercial banks’ capital requirements were reduced during the COVID shock period. - Transitional arrangement: minimum bank capital ratios should not be lower than either (1) capital ratios recorded on end-2021, or (2) the compelling minimum capital ratios required prior to the relief. - The transitional arrangement ended on December 31, 2023. - Leverage ratio: - Minimum leverage ratio reduced by 0.5 percentage points (from 6 to 5.5 for large banks, and from 5 to 4.5 for small banks). - Relief period extended until June 30, 2026 (announced December 20, 2023). - Any banking corporation that has not utilized the relief by December 31, 2025, will not be permitted to reduce its leverage ratio below the "regular" minimum ratio after this date. - Other sectoral limits on exposures: - January 2021 COVID relief: limitation on exposure to construction and real estate industry increased by 2 percentage points (from 24 percent to 26 percent of the total credit portfolio when national infrastructure is included; from 20 to 22 excluding infrastructure). - Following the conflict, effective October 29, 2024, these reliefs were extended until December 31, 2027, with an additional two-year period to revert to the original limits. - New relief: total exposure to the "Financial and Insurance" industry set at 25 percent (instead of 20 percent) until December 31, 2027, with an additional two-year period to return to the original limit. ### Conflict-related measures - Loan deferral framework: - Framework introduced to enable customers to defer loan repayments free of interest and fees, particularly in conflict-affected areas. - Temporary relief expired. Bank-level deferrals remain possible under new bank voluntary support framework. - Restrictions on banks’ dividend distributions: - Supervisor of Banks issued guidance to adopt conservative dividend and provisioning policies after the 2023 conflict onset. - Following sustained high profits in 2024, banks were generally allowed to increase dividend payout ratios. ### Housing and structural measures - Housing finance restrictions: - BOI announced regulations to cap promotional financing schemes and increase capital charges for bank lending to developers that heavily use these schemes. - Implemented effective April 6, 2025. - Credit bureau developments: - In May 2023, the BOI launched a digital reporting service enabling customers to view credit liabilities and obtain insights. - During the conflict emergency period, the supervisor of credit data sharing issued temporary orders to mitigate negative credit implications of the war on customers. --- ### Annex VIII. Risks from Housing Finance in Israel ### A. Recent housing market developments - By 2024, transactions and mortgage issuance had surpassed pre-conflict levels; house prices rose by nearly 8 percent despite elevated uncertainty. - Structural supply constraints: - Intensified due to labor shortages and temporary construction site closures. - Replacement of Palestinian workers with Israeli and foreign labor proceeded slowly, creating substantial project backlogs and delaying completions. - By early 2025, construction activity partially recovered but supply bottlenecks persisted. ### B. Banking sector exposures and asset quality - Bank credit concentration: - Bank credit to real estate expanding, with exposures at more than half of total credit as of October 2025. - Asset quality: - Delinquencies, mainly among construction firms, picked up with higher provisioning. - Overall nonperforming loans have remained below 1 percent. - Supporting factors for banking system soundness: - Resilience of economic activity. - Government support during the conflict. - Long-standing macroprudential borrower-based measures (BBMs): limits on loan-to-value (LTV), payment-to-income (PTI), and mortgage maturities. - Temporary payment-deferral programs supported mortgage performance; most borrowers returned to regular payment schedules by early 2025. ### C. Presales, balloon loans, and transmission channels - Structural change in presales: - By 2025, units with delivery beyond two years accounted for the majority of new home sales. - Developers offered contracts with minimal upfront deposits—often 10 to 20 percent of the purchase price—bundled with bank-provided balloon (or bullet) loans covering an additional 30–40 percent. - Balloon loans: interest payments covered by developers until delivery; repayment or conversion to standard mortgage expected on completion (typically two to four years). - Balloon loan origination shares: - Rose from about 5 percent in early 2022 to over 20 percent by late 2024, and dropped to about 15 percent by the reporting date. - Vulnerability channels from presales and balloon loans: - Market overheating and expectations driven by front-loaded demand and perceived time-limited deals. - Speculative activity: low upfront costs relative to expected capital gains incentivize flipping presale contracts. - Project mismanagement and liquidity risks from misallocation of presale proceeds amid delays and cost overruns. - Buyer funding shortfalls and contract rescissions when deposits fall well below LTV-implied downpayment requirements (25–50 percent, depending on purchaser type). - Systemic risks: banks’ substantial exposure to mortgages and construction lending could transmit developer distress into broader financial stress. ### D. Policy response and priorities - BOI supervisory and prudential measures taken in 2024: - Enhanced data and information requirements from banks. - Supervisory reviews of underwriting procedures and prevailing practices. - Requirement for banks to establish dedicated risk frameworks with clear limits and underwriting criteria. - Mandatory analyses of market-development impacts on banks’ portfolios, accompanied by board-level discussions. - Adjustments to credit loss provisions for construction and real estate sectors. - Enhanced disclosure requirements. - Key regulatory measures implemented April 2025: - Cap of 10 percent on balloon loans as a share of new quarterly mortgage origination. - 150 percent risk weight on exposures to construction projects where more than 25 percent of units are presold with reduced deposits during the construction period. - These complemented existing measures: one-percent capital surcharge on housing loans and the 22-percent cap on exposures to construction and real estate businesses. - Measures appear to have slowed issuance of balloon loans. - Remaining challenges and recommended priorities (as indicated by the source): - Potential regulatory leakages because current regulations apply primarily to banks; nonbank lenders have expanded lending to construction and real estate. - Nonbank direct mortgage lending remains limited (less than 2 percent of total mortgages), but their financing role in presales could shift risks outside the banking regulatory perimeter. - Need for broader application of BBMs across lenders, including nonbanks, to limit regulatory arbitrage. - Continued information sharing and coordinated oversight—including through the Financial Stability Committee—are essential to prevent a disorderly market correction and preempt broader financial system risks. *Source: IMF staff estimates and projections.* ### Annex IX. Authorities’ Responses to Past FSAP ### Annex IX. Authorities’ Responses to Past FSAP Recommendations ### Overall financial sector oversight — summary of past FSAP recommendations and status - Strengthen the institutional framework for macroprudential oversight and policy setting by more formally establishing a Financial Stability Committee (FSC) and initiating its operations - Authority: All; Priority: High; Para.: 46; Time-frame: Near-term; Status: Implemented - Further improve stress testing techniques, including the capacity to analyze systemic risks, credit risk, and liquidity risk - Authority: BOI, CMISA; Priority: High; Para.: 20, 23, 24, 47; Time-frame: Near-term; Status: Implemented - Eliminate gaps and overlaps in supervisory responsibilities, ensuring that like activities are subject to equally stringent regulation and supervisions - Authority: BOI, ISA, CMISA; Priority: High; Para.: 28-30; Time-frame: Near-term; Status: Partially implemented - Undertake more systematically cost-benefit analysis of regulatory changes, and streamline regulations where possible - Authority: BOI, ISA, CMISA; Priority: Medium; Para.: 25; Time-frame: Near-term; Status: Implemented - Strengthen the AML/CFT legal and regulatory framework, in particular with regard to the designated non-financial businesses and professions, and the transparency of beneficial ownership - Authority: Government; Priority: High; Para.: 43; Time-frame: Near-term; Status: Implemented ### Banking, insurance, and securities oversight — selected recommendations and status - Banking oversight - Further strengthen regulation and supervision of interest rate risk and market risk - Authority: BOI; Priority: High; Para.: 33; Time-frame: Immediate; Status: Implemented - Develop regulation of liquidity risk as international practice in this area evolves, and intensify monitoring - Authority: BOI; Priority: High; Para.: 32; Time-frame: Near-term; Status: Implemented - Introduce greater flexibility in personnel management and budgets to attract and retain financial sector experts with the required skill mix - Authority: BOI; Priority: Medium; Para.: 27; Time-frame: Near-term; Status: Implemented - Insurance sector oversight - Intensify cross-border supervisory coordination and information-sharing - Authority: CMISA; Priority: High; Para.: 35; Time-frame: Immediate; Status: Implemented - Widen powers to supervise groups connected to insurance companies, and in particular related holding companies - Authority: CMISA; Priority: High; Para.: 36; Time-frame: Near-term; Status: Implemented - Securities markets oversight and development - Enforce uniformly high standards of due diligence in the underwriting of securities issues - Authority: ISA; Priority: High; Para.: 38; Time-frame: Immediate; Status: Implemented - Establish an appropriate licensing and supervisory framework for currently unregulated broker-dealers - Authority: ISA; Priority: Medium; Para.: 37; Time-frame: Near-term; Status: Implemented - Ensure consistency of relevant supervisory practice by TASE, the ISA, and the BOI - Authority: TASE, ISA, BOI; Priority: Medium; Para.: 39; Time-frame: Near-term; Status: Implemented - Remove impediments (including tax treatment) to repo market development - Authority: MOF; Priority: Medium; Para.: 48; Time-frame: Near-term; Status: Partially implemented ### Payments and securities systems oversight — selected recommendations and status - Develop and test more comprehensive business continuity plans - Authority: BOI; Priority: High; Para.: 41; Time-frame: Immediate; Status: Implemented - Protect finality of settlements in payments systems linked to Zahav - Authority: BOI; Priority: Medium; Para.: 39; Time-frame: Immediate; Status: Partially implemented - Complete development of payment system oversight - Authority: BOI; Priority: Medium; Para.: 40; Time-frame: Near-term; Status: Partially implemented ### Crisis management — selected recommendations and status - Establish a policy framework for ELA - Authority: BOI; Priority: High; Para.: 50; Time-frame: Immediate; Status: Implemented - Establish by law and make operational: - a full set of early intervention tools; and - a special framework for going-and-gone concern resolution - Authority: BOI, MOF; Priority: High; Para.: 50-54; Time-frame: Near-term; Status: Partially implemented - Establish mechanism for providing solvency support and for funding bank resolution, protecting the BOI from quasi-fiscal activities - Authority: BOI, MOF; Priority: High; Para.: 55-57; Time-frame: Near-term; Status: Not Implemented - Agree on a protocol for the coordination of, and assignment of responsibilities for system-wide crisis management - Authority: All; Priority: High; Para.: 59-60; Time-frame: Immediate; Status: Implemented ### Authorities’ assessment — Recent economic developments and macroeconomic outlook - Context and resilience - The war that ensued Hamas terror attack on October 7, 2023, has taken a significant human toll and affected the economy. - Elevated regional tensions over the past three years have led to growth below its pre-war trend, but Israel’s economy has continued to demonstrate resilience supported by strong fundamentals, credible policy frameworks, and a dynamic private sector. - Growth projections - BOI projects growth of 3.8 percent in 2026 and 5.5 percent in 2027. - Ministry of Finance projects growth of 4 percent in 2026 and 4.8 percent in 2027. - Near-term indicators - Government tax revenues are above their medium-term trend. - Credit card expenditures are on the rise. - The shekel appreciated against major currencies. - Risks - Renewed hostilities pose downside risk to growth and upside risk to inflation. - Expansion of regional peace accords could support trade, investment, and broader economic integration. ### Authorities’ assessment — Fiscal policy - Fiscal stance and history - Prudent fiscal policy since the mid-1980s reduced public debt below 60 percent pre-COVID. - In 2020, debt surged due to the pandemic; strong growth and prudent policy in 2021-2022 reduced debt back to 60 percent in 2022. - Following October 2023, the deficit widened and public debt increased. - Current and planned fiscal approach - Financing conditions have remained favorable, supported by deep domestic capital markets and significant consolidation measures introduced in the 2025 budget. - Authorities aim to contain the deficit at around 4.9 percent of GDP in 2026 and to pursue a gradual consolidation thereafter. - Emphasis on revenue-based measures to adjust while preserving growth-enhancing expenditures (infrastructure, education, labor market integration). - Authorities are open to a comprehensive review of the tax system to enhance simplicity, efficiency, and equity, and to rationalize current spending and prioritize resources toward growth-enhancing programs. ### Authorities’ assessment — Monetary policy - Inflation and expectations - Headline inflation, core inflation, and inflation expectations are around the midpoint of the BOI’s 1-3 percent target range. - On June 15, the May inflation figure came in at 1.9 percent y/y. - Inflation expectations for the next 12 months from financial markets declined to 1.5 percent. - Policy decisions and rationale - As inflation pressures eased and risk premia declined at the end of 2025, the BOI cut its policy rate by a cumulative 50 basis points. - The BOI paused at the onset of the war, then cut the interest rate by 25 basis points on May 25. - Current interest rate level is 3.75 percent and is assessed by the BOI as reflecting a moderately tight stance supporting price stability. - Future interest rate path will be determined by developments in inflation, economic activity, geopolitical uncertainty, and fiscal developments. - A further decline in inflation expectations towards the lower end of the target range may require a more neutral policy stance. - Exchange rate and external position - BOI concurs that market forces should continue to determine the FX rate, barring abrupt market disruptions. - Staff assessment: the external position in 2025 was broadly in line with the level implied by medium-term fundamentals and desirable policies. - Israel maintains a positive, though narrowing, current account surplus, driven by strong high-tech services exports. - The international investment position and gross reserves are at high levels, providing adequate buffers. ### Authorities’ assessment — Financial sector - System resilience - Banks are well capitalized, liquid, and profitable, with non-performing loans at historical lows. - Authorities recognize banks’ sizeable exposure to real estate as a risk. - Macroprudential and supervisory measures - BOI introduced limits on mortgage loan-to-value ratios, payment-to-income ratios, and the adjustable-rate share of mortgage composition. - In April 2025, BOI capped contractor-subsidized balloon loans and imposed higher capital requirements on exposure to developers heavily engaged in presales, resulting in reduced subsidized presales. - Tel Aviv Stock Exchange transitioned to a Monday–Friday trading schedule at the beginning of 2026. - Establishment of the Financial Stability Committee in 2019 enhanced cooperation between financial regulators. - BOI is working to develop a bank liquidity stress testing framework and, together with CMISA, to regularize joint stress tests for banks and insurance companies. - Recently adopted amendments to the Banking Order strengthen bank resolution capacity by enhancing the BOI’s powers and flexibility in application of resolution tools. - BOI is working to implement the Basel III capital structure while maintaining current capital requirements. - Measures to strengthen banking competition include two new digital banks and new legislation approved by the Knesset in April creating a three-tiered regime based on proportionality. ### Authorities’ assessment — Structural policies and technology - Labor market and infrastructure - Low participation and limited labor-relevant skills among Haredi men, and low participation of Arab women, weigh on potential growth. - Authorities note contribution of past initiatives to enhance Arab-Israelis’ educational and workforce outcomes and the need to improve incentives for Haredi men to enter the labor force. - Government investing heavily in physical infrastructure and AI-related infrastructure. - Product-market reforms pursued to strengthen competition and facilitate trade, including aligning import procedures with EU standards and removing remaining tariffs on U.S. goods. - AI and innovation - IMF’s AI Preparedness Index ranks Israel 18th globally. - Stanford AI index places Israel at the top in AI-related private investment and newly funded AI companies. - CBS data show the share of firms reporting AI use rising to 39 percent in 2026. - A recent survey by the BOI and Israel Democracy Institute shows the share of employees using AI for work purposes in Israel is higher than in any European country included in the Eurostat survey. - Staff’s analysis suggests the Israeli labor force enjoys higher AI complementarity than that of other European countries. - Authorities commit to maintaining leadership in innovation and advanced technologies, including artificial intelligence, through investment in human capital, digital infrastructure, and research and development. - Noted constraints: skill shortages, sectoral disparities, and skill gaps among Arab-Israeli and Haredi populations could constrain economy-wide AI diffusion. *Source: Annex IX. Authorities’ Responses to Past FSAP Recommendations (selected extracts).* --- _Source: https://www.imf.org/-/media/files/publications/cr/2026/english/1isrea2026001.pdf_