## 1. The Long View, 1996–2013

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### Context and recent performance
- Israel exposed to a series of shocks, including the global crisis and heightened geopolitical tensions in the Middle East, yet GDP growth has averaged 4 percent over the past 5 years, compared with 0.7 percent on average for OECD countries.
- Per capita real GDP has grown more rapidly than in other OECD countries.
- Economy’s resilience underpinned by:
  - large foreign reserves;
  - a dynamic high-tech export sector;
  - absence of economy-wide deleveraging pressures.
- Stock market indices have gradually risen, while credit spreads of Israeli sovereign and banks remain stable.

### Key indicators and trends
- GDP growth moderated to 3½ percent in 2012 and 2013; excluding natural gas, growth was about 2½ percent in 2013.
- Natural gas production at Tamar came on stream in the second quarter of 2013.
- Inflation:
  - Headline CPI, underlying CPI (excluding energy), and market-based inflation expectations have all remained at around the mid-point of the 1–3 percent target range.
- Unemployment remains low at about 6 percent.
- House prices:
  - Nominal house prices have increased by 80 percent since 2007.
  - Staff analysis suggests house prices in Israel are about 25 percent above their long-term fundamental value.
- External position:
  - Foreign reserves have risen to $82 billion (192 percent of short-term external debt).
  - Surplus on the net international investment position is about 22 percent of GDP.
  - The US government guarantee program for Israeli sovereign bonds was extended to 2016 in July 2012; $3.8 billion of the total of $9 billion is untapped.
- Exchange rate:
  - The shekel has appreciated some 12 percent in real effective terms over the past 15 months.

### Short-term and medium-term outlook
- Staff expects growth (excluding contribution of gas) to increase to 3 percent in 2014, reflecting some recovery in investment.
- Baseline projections:
  - Output gap (excluding gas) expected to widen slightly.
  - Unemployment to edge up to just above 6½ percent.
  - Inflation to remain within the 1–3 percent target range.
- Beyond 2014, medium-term growth projected at around 3½ percent annually (excluding gas), down from an annual average of 4¼ percent over the past 10 years, partly reflecting anticipated reduction in labor force growth as baby boomers reach retirement ages.
- Israel: Short-term projection table highlights (Staff est./proj. series):
  - GDP growth entries: e.g., "2012 Q3 GDP 4.2", "2013 Q4 GDP 3.5", "2014 Staff proj. 3.4".

### Financial and monetary conditions
- Since October 2011, the Bank of Israel has lowered the policy rate in several steps to 1 percent.
- Monetary stance has been accommodative.
- Macroprudential measures introduced since 2009:
  - “Indirect” measures: capital surcharges and additional provisioning to reduce banks’ incentives to extend mortgage loans.
  - “Direct” measures: loan-to-value (LTV) and debt-service-to-income (DTI) limits more recently implemented.
- These measures have strengthened financial resilience; direct measures appear to have reduced speculative behavior and the volume of housing transactions, though it is too early to fully assess their effectiveness.

### Risks to the outlook
- External downside risks:
  - Protracted sluggish growth in Europe and the United States;
  - Growth disappointments in emerging economies.
- Domestic risks:
  - Further weakening of competitiveness of the tradable sector due to shekel appreciation;
  - A correction in the housing market with attendant fiscal and financial sector implications;
  - Reemergence of regional geopolitical tensions affecting sentiment.
- Upside risks:
  - Faster-than-expected recovery in Israel’s major trading partners;
  - Larger-than-anticipated spillovers from the natural gas sector.
- Capital flows:
  - FDI inflows have surged since 2009 and remain dominant in the capital account.
  - Portfolio inflows rose rapidly in 2010 but declined sharply thereafter, remaining volatile.

### Policy challenge (overview)
- Key policy challenge: maintain near-term growth at potential while preventing build-up of imbalances, strengthening resilience to shocks, and pursuing structural reforms to ensure long-term sustainability.

### Monetary policy guidance
- Keep monetary policy on hold in the near term given drag from shekel appreciation and planned fiscal tightening.
- Tighten macroprudential measures further if house prices continue to rise.
- If global growth improves sharply or domestic demand strengthens appreciably, gradually normalize monetary policy.
- Ensure foreign currency purchase program introduced by the BoI in May 2013 to offset impact of natural gas production is pre-announced and well-communicated; continue to prepare for the proposed Sovereign Wealth Fund expected in 2018.

### Structural and supply-side recommendations (housing focus)
- Consider tightening property taxation (for example, raising temporarily the property purchase tax for non-primary residences).
- Accelerate supply-side measures to address housing shortages, including implementing the Housing Committee’s recommendations:
  - reform planning process to expedite supply of planned land and issuance of building permits;
  - introduce compensation scheme to accelerate evacuation of land used for agricultural purposes.

### Fiscal policy guidance (overview)
- Pursue fiscal consolidation beyond measures embedded in the 2013–14 Budget to anchor sustainability for 2015 and beyond, and strengthen fiscal institutions.
- Firm adherence to expenditure ceiling and announced tax revenue measures is imperative to ensure credibility of the fiscal framework.

---

### Fiscal consolidation program (2013–14 budget) and outturn

### Fiscal consolidation program (overview)
- The 2013–14 budget included large discretionary consolidation measures totaling 2¾ percent of GDP, with the aim of reducing the deficit to 3 percent of GDP in 2014.
- The target deficit of 3 percent of GDP in 2014 is described as "both broadly appropriate and realistic" and a foundation for further medium-term consolidation.

### Announced revenue measures
- (i) raising the VAT rate from 17 percent to 18 percent;
- (ii) increasing the excise tax on tobacco and beer;
- (iii) introducing environmental taxes;
- (iv) increasing personal income (a measure that was subsequently rolled back) and corporate taxes (including a 2 percent surtax on the wealthiest);
- (v) one-time corporate tax amnesty for companies subject to tax exemptions under an investment law (“trapped profits” collections).

### Announced expenditure measures
- (i) freezing previously planned public sector wage hikes;
- (ii) cutting the defense budget;
- (iii) reducing child allowances and education expenditure (including for religious study);
- (iv) postponing infrastructure projects.

### Budget implementation and outturn (2013)
- Revenues in 2013 were higher than forecast due largely to one-off measures and a rebound in the stock market.
- Expenditures were lower-than-expected due to tight spending controls.
- The overall deficit outturn for 2013 is expected to be 3.5 percent of GDP, about ¾ percentage point below the target.
- Without these measures, the deficit was projected to further widen to 5¾ percent of GDP in 2014.
- As currently projected, the fiscal adjustment would amount to a cumulative of 1¼ percentage points of GDP over 2013–14.
- Assuming a multiplier in the range of 0.5–0.8 (based on BoI estimates), the adverse impact on growth would be around ¾–1 percentage points of GDP.

### 2013–14 Budget expenditure measures (selected exact figures)
- 2013 / Billions of NIS / Percent of GDP: Wage bill freeze 0.5 0.0
- 2014 / Billions of NIS / Percent of GDP:
  - Wage bill freeze 1.0 0.1
  - Defense budget 3.0 0.3
  - Child allowances 2.7 0.2
  - Postponing agreed wage hike 1.0 0.1
  - Education 2.0 0.2
  - Postponing infrastructure projects 2.0 0.2
  - Yeshiva (religious study) 0.5 0.0
  - Reducing other specific items 2.5 0.2
  - Flat cuts across all ministries 1.4 0.1
  - Others 3.2 0.3
- Total 2013: 0.5 0.0
- Total 2014: 19.2 1.7
- Source: Israeli Authorities.

### 2013–14 Budget revenue measures (selected exact figures)
- Announced prior to 2013 (2013 / Billions of NIS / Percent of GDP):
  - VAT from 16 to 17 percent 3.5 0.3
  - Income taxes 4.0 0.4
  - Customs, excises and wealth 0.8 0.1
  - Others -0.2 0.0
  - Total 8.1 0.8
- Announced prior to 2013 (2014 / Billions of NIS / Percent of GDP):
  - Income taxes -3.1 -0.3
  - Customs, excises and wealth 0.5 0.0
  - Others -0.5 0.0
  - Total -3.0 -0.3
- 2013-2014 Budget (2013 / Billions of NIS / Percent of GDP):
  - VAT to 18% 2.3 0.2
  - Excise 0.7 0.1
  - Luxury tax 0.00 0.00
  - Others 0.2 0.0
  - Total 3.3 0.3
- 2013-2014 Budget (2014 / Billions of NIS / Percent of GDP):
  - VAT to 18% 2.3 0.2
  - Excise 0.4 0.0
  - Luxury tax 0.1 0.0
  - Income tax 3.9 0.3
  - Company tax 1.0 0.1
  - Others 1.2 0.1
  - Total 8.9 0.8
- Source: Israeli Authorities.

### Risks to the fiscal outlook and medium-term targets
- Downside risks: revenue could be lower than expected, especially if there is a correction in the housing market or planned measures are not fully implemented.
- After the 2013–14 Budget was approved, projection for interest expense was lowered due to lower-than-assumed interest rates; the government rolled-back the planned increase in personal income tax for 2014. These two changes are intended to be deficit neutral, but will lead to a structural revenue loss.
- Spending pressures could arise, especially pertaining to defense spending.
- Authorities committed to gradually reducing the deficit target from 3 percent in 2014 to 1.5 percent of GDP in 2019, a path that would help reduce debt to about 60 percent of GDP.
- An even more ambitious path of deficit reduction is warranted to provide a greater buffer against shocks, including a sharp correction in the housing market.

### Required adjustment from 2015 onwards
- Additional adjustment will be needed from 2015 onwards to meet deficit targets.
- This requires both reducing expenditure growth by modifying the expenditure rule and introducing additional revenue measures.
- Given low levels of non-interest civilian expenditures in Israel, relying solely on reducing expenditure growth would compromise long-term growth and sustainability.
- Expenditure recommendations:
  - Protect expenditure on priority items that boost productive capacity and reduce the social gap—education, job training, employment services, and infrastructure.
  - Avoid large unfunded expenditure commitments.
  - Annual budgets should provide sufficient contingent reserves in anticipation of shocks.
- Revenue recommendations:
  - Broadening the tax base, including by eliminating tax exemptions (e.g., for advanced study funds and the VAT exemptions on fruit and vegetables, on tourist services, and in the resort town of Eilat).
  - Further increasing indirect taxes (e.g., VAT).
  - Introducing new taxes that reduce externalities (such as a congestion or a pollution tax) or inequality (such as raising the property tax).

### Fiscal institutions and governance
- Need for comprehensive review of current fiscal institutions given history of repeated and significant slippages in meeting fiscal deficit targets.
- Fiscal rules should be developed to:
  - have a more clearly defined debt objective;
  - better link the debt objective to deficit and expenditure targets;
  - allow more flexibility to deal with shocks.
- Embed fiscal rules within a medium-term fiscal and expenditure framework:
  - a multi-year overall expenditure ceiling and expenditure allocations to line ministries;
  - multi-year revenue and fiscal forecasts;
  - an analysis of risks to the fiscal outlook.
- Consider establishing an independent and stand-alone fiscal council to discipline policy and evaluate consistency of fiscal policies with the rules.

---

### Financial sector policy and stability

### Financial sector policy: safeguarding stability
- Financial system described as relatively sound and resilient, but further safeguards recommended.
- Key institutional steps:
  - Establish a Financial Stability Committee (FSC), with the Bank of Israel (BoI) taking the lead role.
  - Legislate a new bank resolution framework as soon as practicable.

### Financial system resilience (highlights)
- Banking system is domestically oriented and focused on traditional retail business.
- Mortgage market features: historically low mortgage losses, a limited buy-to-let market, and open-ended personal liability.
- BoI requires all banks to meet a core Tier 1 capital ratio of 9 percent by 2015.
  - Capital ratios at the two largest banks must reach 10 percent by 2017 (under the Basel III capital definition).
  - Banks’ core Tier 1 capital ratios range between 8½ and 9¾ percent.
- Leverage ratios (equity to capital ratios) are relatively high.
- Banks’ operations are fully deposit-funded, loan-to-deposit ratio well below 100 percent.
- January 2013: BoI strengthened liquidity regulations requiring adherence to new Basel III-type minimum liquidity coverage ratios and monitoring of net stable funding ratios.

### Stress test results
- BoI stress tests suggest that even under severe global crisis scenarios (assumed impact more severe than 2008 crisis), all banks would be able to maintain a 6 percent core Tier 1 capital ratio.
- Most severe stress scenario assumptions:
  - GDP assumed to contract for four consecutive quarters (-4 percent growth annually);
  - Unemployment to rise to 12 percent;
  - House prices to fall a cumulative of 15 percent.
- Under that scenario, banks’ ROE would fall sharply from around 8 percent to -1 percent, but all banks would be able to maintain core Tier 1 capital ratio above 6 percent.

### Systemic and tail risks
- Concentration risk: Banks’ lending to mortgage markets and commercial real estate amounts to 40 percent of their total assets.
  - BoI has lowered regulatory exposure limits and strengthened credit risk management.
  - Stress-testing of exposures to large highly-leveraged corporates should be carried out periodically.
- Interest rate risk: If interest rates increase, households with floating-rate mortgages would be hit hard.
  - BoI stress test suggests that with a 20 percent drop in house prices and a sharp increase in unemployment, many mortgage borrowers—especially those with high DTI and LTV ratios and floating-rate mortgages—would default.
  - Overall impact on banks limited because of collateral and open-ended personal liabilities, but a housing market shock could cause a prolonged recession and adverse macro-financial feedback effects.
- Non-bank corporate lending: corporate lending by non-bank institutions increased about 40 percent growth in 2012; level remains low (less than 10 percent of bank loans) but rapid increases could be concerning.
  - Goldschmidt Committee is reviewing regulatory standards and has made preliminary recommendations including tightening corporate governance and strengthening transparency.
- Insurance supervision: A Multilateral Memorandum of Understanding with the International Association of Insurance Supervisors was signed recently.

### Supervisory coordination and the Financial Stability Committee (FSC)
- Authorities instituted regular meetings of BoI, CMISD of the MoF, the Israel Securities Authority (ISA), and the MoF to share information, harmonize practices, and analyze systemic risk factors.
- Two FSC design options discussed:
  - Option 1:
    - FSC focuses on macroprudential policies in normal times.
    - BoI plays leading role, Governor serves as Chairperson.
    - Consider establishing a separate crisis management committee led by the MoF.
    - May include non-executive committee members.
  - Option 2:
    - FSC has dual functions: macroprudential policies in normal times and crisis management when necessary.
    - Minister of Finance would chair the FSC (or Minister and BoI Governor as co-chairs).
    - Membership could be expanded to include other important government agencies but exclude non-executive members.
- Staff preference: Option 1 is favored to ensure clear mandates, operational independence, accountability, and to avoid undermining macroprudential effectiveness in normal times.

### Legal and resolution framework
- Legal reforms to strengthen BoI’s toolkit for early intervention and resolution, clarify emergency liquidity assistance policy, and protect the bank from quasi-fiscal activity should proceed apace.
- A draft law has been prepared with technical assistance from the Fund; remaining issues should be addressed expeditiously with the aim of submitting the draft law to the Knesset as soon as practicable.

---

### Structural policy and social inclusion

### Structural policy: longer-term sustainable and inclusive growth
- Further action required to improve business climate and boost competition in the non-tradable sector.
- Enhance participation of rapidly growing Haredi and Israeli-Arab populations to bolster long-term potential and reduce poverty and inequality.

### Poverty, demographics, and labor force participation
- Poverty rate in Israel is "near 20 percent" and "remains among the highest in OECD countries."
- Much of the high poverty incidence is accounted for by Haredi and Arab-Israeli communities.
- Demographic projection: "in 20 years, the population of these two groups is projected to exceed 40 percent of the total population."
- BoI staff analysis: unless demographic and educational problems are appropriately addressed, "Israel’s long-term growth potential would be reduced by about 1–1½ percentage points of GDP."

### Structural constraints and policy priorities
- Structural factors limiting integration and human capital:
  - Many Arab-Israeli communities live in underdeveloped rural and remote areas, raising the costs of supplying labor.
  - Many Haredi and Arab-Israeli children follow different education systems with fewer years of formal schooling, lowering human capital acquisition.
  - Low participation in military or civic services isolates them from social networks that facilitate employment opportunities.
- Ongoing initiatives: expansion of Haredi units in the defense forces; opening of public employment centers in Arab-Israeli towns; preliminary evidence shows participation is rising, albeit slowly.
- Policy recommendations:
  - Education, including access to higher education and enforcement of core curriculum.
  - Rural infrastructure and transportation.
  - Enforcement of labor laws.
  - National service arrangements.
  - Encourage private initiatives to enhance efficient use of talents across populations.

### Business environment weaknesses
- World Bank Doing Business Survey identifies weaknesses in:
  - "property registration,"
  - "construction permits,"
  - "contract enforcement."
- Policy priorities:
  - Tackle Doing Business weaknesses;
  - Continue addressing infrastructure gaps (railroad, port, air transport);
  - Enhance competition in non-tradable sectors, following the Committee on Increasing Competitiveness recommendations (2012).

---

### External sector assessment (Annex I) — exchange rate, reserves, and Dutch disease

### Exchange rate and competitiveness
- Since mid-2007, Israel’s REER has appreciated to about 10 percent above its longer-term average, amid high volatility.
- CPI and ULC-based REER have appreciated by 20 percent since July 2007.
- Nominal effective exchange rate has appreciated by nearly 20 percent since 2007.
- Trend appreciation has weakened external competitiveness, leading to sluggish export and output growth in the manufacturing sector.

### Model-based valuations and current account
- Different models give mixed results:
  - ERER suggests an overvaluation of 10 percent.
  - Macro Balance (MB) suggests undervaluation by 7 percent.
  - External Stability (ES) suggests undervaluation by 8 percent.
- IMF’s External Balance Assessment (EBA) suggests the norm for the current account balance for Israel is about zero.
- In 2013, the current account balance is projected at about ¾ percent of GDP; in cyclically adjusted terms this is about 1¾ percent of GDP.
- Deviation of the cyclically adjusted current account from the norm estimated at about 2 percent of GDP, largely attributable to emerging natural gas production.

### Reserves and Sovereign Wealth Fund (SWF) considerations
- Israel’s net international investment position improved and stabilized in positive territory, underpinned by increase in foreign reserves and decline of portfolio liabilities.
- Authorities’ analysis indicates adequate level of reserves is somewhere between $65–$90 billion.
- May 2013: BoI launched an additional intervention program with announced purchases of foreign currency to offset effects of gas production on the current account.
- Government decided to establish a Sovereign Wealth Fund (SWF) to invest gas levy receipts abroad; SWF expected in 2018.

### Natural gas and Dutch disease concerns
- Production from the Tamar field began on April 2013; gas sector estimated to improve current account by 1–1¼ percentage points of GDP in 2013 and 2014.
- Israel expected to start exporting gas by 2018, strengthening the current account and putting appreciation pressures on the shekel.
- Until SWF is established, BoI will offset current account effects of gas production through reserves accumulation; BoI announced yearly purchase amounts and executes purchases regularly.
- Start-up company exits and ICT/high-tech FDI can resemble portfolio investments and contribute to exchange rate appreciation that undermines competitiveness of more labor-intensive industries.

---

### Debt Sustainability Analysis (Annex IV) — baseline, risks, and stress tests

### Baseline findings and assumptions
- Public debt-to-GDP ratio decreased from 98 percent in 2003 to 68 percent in 2012.
- Under staff’s baseline, public debt-to-GDP ratio projected to decline to about 61 percent of GDP in 2018, consistent with authorities’ implicit goal of reducing public debt to 60 percent of GDP by 2020.
- Baseline assumptions:
  - Real GDP projected to grow at about 3.5 percent annual average.
  - CPI inflation expected to remain constant at 2 percent.
  - Budget deficit expected to improve from 3.5 percent of GDP in 2013 to about 3 percent of GDP in 2014. Thereafter projected to remain at about 2 percent.
  - Effective interest rate forecast to slowly decline from 5.5 percent in 2013 to 4.5 percent in 2018.
  - Gross financing needs would hover around 12 percent of GDP under the baseline.

### Stress tests and shock scenarios (selected exact outcomes)
- Growth shock (1 standard deviation lower real GDP growth for 2 years starting 2014):
  - Financing needs would increase to 15 percent of GDP by 2018.
  - Debt-to-GDP would rise to 70 percent in 2015 and then decline slowly to 66 percent by 2018.
- Interest rate shock (borrowing costs increase by 200 basis points):
  - Financing needs would jump to 15 percent of GDP by 2018.
  - Public debt would stay broadly constant at 65 percent of GDP over the projection period.
- Combined macro-fiscal shock:
  - Financing needs would rise to 17 percent of GDP and debt would reach 70 percent of GDP by 2018.

### Tail risk: house price shock combined with geopolitical shock
- Scenario assumptions:
  - Interest rates increase by 200 basis points.
  - Real exchange rates depreciate by about 13 percent.
  - House prices drop by 20 percent.
- Moderate impact on growth variant:
  - Growth decline spread over three years (about 0.7 percent less than the baseline in 2014 and 2.3 percent less in 2015–16).
  - Gross financing needs would expand to 20 percent of GDP.
  - Public debt would reach 79 percent of GDP by 2018.
- Severe impact on growth variant:
  - Growth decline concentrated in 2015, with growth rates lower than the baseline by 1.5 percent in 2014, 5 percent in 2015, and 2.9 percent in 2016.
  - Gross financing needs would rise to 25 percent of GDP.
  - Public debt would reach about 89 percent of GDP by 2020.

### Historical and projection indicators (selected exact figures)
- Nominal gross public debt (% of GDP): 2011: 83.3; 2012: 69.7; 2013: 68.2; 2014: 67.5; 2015: 66.6; 2016: 65.3; 2017: 63.8; 2018: 62.4.
- Public gross financing needs (% of GDP): 2011: 6.0; 2012: 12.8; 2013: 13.2; 2014: 12.3; 2015: 12.4; 2016: 11.6; 2017: 12.1; 2018: 13.7; 2019: 14.2.
- Real GDP growth projections (2013–2018): 3.4, 3.4, 3.4, 3.5, 3.5, 3.5 (percent).
- Effective interest rate projections (2013–2018): 5.5, 5.5, 4.7, 4.6, 4.5, 4.5 (percent).
- Primary balance projections (2013–2018): -0.6, -0.2, -0.2, 0.1, 0.0, 0.0 (percent of GDP).

---

### IMF Executive Board appraisal, selected macro indicators, and recommendations

### Macroeconomic snapshot (selected exact indicators)
- Real GDP growth:
  - 2009: 1.2
  - 2010: 5.7
  - 2011: 4.6
  - 2012: 3.4
  - 2013 (Staff est.): 3.4
  - 2014 (Staff proj.): 3.4
- Output gap (percent of potential):
  - 2009: -1.3; 2010: 0.3; 2011: 1.0; 2012: 0.6; 2013 (Staff est.): 0.2; 2014 (Staff proj.): 0.1
- Unemployment rate (percent):
  - 2009: 8.8; 2010: 7.9; 2011: 6.9; 2012: 6.9; 2013 (Staff est.): 6.4; 2014 (Staff proj.): 6.7
- Inflation (Overall CPI, end period):
  - 2009: 3.9; 2010: 2.7; 2011: 2.2; 2012: 1.6; 2013 (Staff est.): 1.8; 2014 (Staff proj.): 2.0

### External sector (selected figures)
- Current account balance (percent of GDP, memorandum): 2010: 3.1; 2011: 1.3; 2012: 0.3; 2013 (Staff est.): 0.6; 2014 (Staff proj.): 0.7
- Current account balance (billions of U.S. dollars, Table 2 staff est./proj.): 2010: 7.2; 2011: 3.3; 2012: 0.8; 2013: 1.8; 2014: 2.1; 2015: 4.4; 2016: 4.4; 2017: 4.5; 2018: 4.4; 2019: 4.7
- Foreign reserves (end period, selected series): Table 3 (reserve assets, end-period, billions of US dollars): 2009: 60.6; 2010: 70.6; 2011: 74.9; 2012: 75.9.

### Public finances (selected exact figures)
- General government overall balance (percent of GDP): 2009: -6.3; 2010: -4.6; 2011: -4.2; 2012: -3.9; 2013 (Staff est.): -3.5; 2014 (Staff proj.): -3.0
- Public debt (percent of GDP): 2009: 75.3; 2010: 71.5; 2011: 69.7; 2012: 68.2; 2013 (Staff est.): 67.5; 2014 (Staff proj.): 66.6

### Housing and household balance-sheet indicators (selected)
- House prices about 25 percent above their historical averages.
- Household net worth position stayed at 5 times their disposable income.
- Population-to-Dwelling Stock Ratio series highlights 3.30–3.50 (figure axis points).
- Household debt (percent of GDP, 2013Q2) by country shows Israel relatively low in international comparison.

### Financial sector metrics (selected exact figures)
- Regulatory Tier I capital to risk-weighted assets: 2006: 7.6; 2007: 7.7; 2008: 7.6; 2009: 8.3; 2010: 8.5; 2011: 8.4; 2012: 9.2
- Regulatory capital to risk-weighted assets: 2006: 10.9; 2007: 11.0; 2008: 11.3; 2009: 13.7; 2010: 14.1; 2011: 14.0; 2012: 14.9
- Capital as percent of assets (leverage ratio): 2006: 8.5; 2007: 9.0; 2008: 9.1; 2009: 10.6; 2010: 11.1; 2011: 10.6; 2012: 10.8
- Liquid assets as percent of short-term liabilities: 2010: 102.4; 2011: 100.7; 2012: 101.2; 2012 (alternate row): 99.2
- Customer deposits as percent of total (non-interbank) loans: 2006: 118.3; 2007: 113.7; 2008: 107.2; 2009: 110.4; 2010: 104.7; 2011: 111.3; 2012: 113.1
- Nonperforming loans to total gross loans (2012): 2.8 (Table 7) and elsewhere NPLs reported as 3.1 percent of total loans in some summaries.
- Return on average assets (before tax): 2006: 1.0; 2007: 1.2; 2008: 0.0; 2009: 0.9; 2010: 0.9; 2011: 0.8; 2012: 0.8
- Return on average equity (before tax): 2006: 17.3; 2007: 19.5; 2008: 0.7; 2009: 14.1; 2010: 13.8; 2011: 12.3; 2012: 12.2

### IMF policy guidance (selected)
- Monetary policy: with inflation anchored and growth momentum at risk, "monetary policy should remain on hold for now." Risks from rapid house price inflation should be addressed with further tightening of "direct" macroprudential measures.
- Fiscal policy: firm adherence to the expenditure ceiling and announced revenue measures to meet "the deficit target for 2014." For 2015 and beyond, require efforts on both expenditure and revenue to put public debt on a downward trend while preserving long-term growth and sustainability. Strengthen fiscal framework and consider establishing an independent fiscal council.
- External and exchange rate policies: macroeconomic policy mix (accommodative monetary and tight fiscal) plus structural reforms to boost productivity will help alleviate shekel appreciation pressures. Pursue "a pre-announced and well-communicated program of intervention" to offset natural gas effects on external accounts, complemented by discretionary intervention to stem exchange rate volatility.
- Financial sector: expedite progress on issues identified by the FSAP Update, intensify efforts to establish an FSC with a clear macroprudential focus led by the BoI, and consider a separate Crisis Management Committee with the MoF leading. Submit the draft bank resolution law to the Knesset "as soon as practicable."
- Structural reforms: improve business climate and boost competition, especially in the non-tradable sector; address low labor participation rates of Haredi and Israeli-Arab communities to bolster productive capacity, long-term growth, and to reduce poverty and inequality.

---

*Source: IMF staff report chapter "1. The Long View, 1996–2013" and related annexes and sections as provided in the supplied PDF excerpt.*

### 1. The Long View, 1996–2013 ____________________________________________________________________ 20

### 1. The Long View, 1996–2013

### Context and recent performance
- Israel has been exposed to a series of shocks, including the global crisis and heightened geopolitical tensions in the Middle East, yet GDP growth has averaged 4 percent over the past 5 years, compared with 0.7 percent on average for OECD countries.
- Per capita real GDP has grown more rapidly than in other OECD countries.
- Economy’s resilience underpinned by:
  - large foreign reserves;
  - a dynamic high-tech export sector;
  - absence of economy-wide deleveraging pressures.
- Stock market indices have gradually risen, while credit spreads of Israeli sovereign and banks remain stable.

### Key indicators and trends
- GDP growth moderated to 3½ percent in 2012 and 2013; excluding natural gas, growth was about 2½ percent in 2013.
- Natural gas production at Tamar came on stream in the second quarter of 2013.
- Inflation:
  - Headline CPI, underlying CPI (excluding energy), and market-based inflation expectations have all remained at around the mid-point of the 1–3 percent target range.
- Unemployment remains low at about 6 percent.
- House prices:
  - Nominal house prices have increased by 80 percent since 2007.
  - Staff analysis suggests house prices in Israel are about 25 percent above their long-term fundamental value.
- External position:
  - Foreign reserves have risen to $82 billion (192 percent of short-term external debt).
  - Surplus on the net international investment position is about 22 percent of GDP.
  - The US government guarantee program for Israeli sovereign bonds was extended to 2016 in July 2012; $3.8 billion of the total of $9 billion is untapped.
- Exchange rate:
  - The shekel has appreciated some 12 percent in real effective terms over the past 15 months.

### Short-term and medium-term outlook
- Staff expects growth (excluding contribution of gas) to increase to 3 percent in 2014, reflecting some recovery in investment.
- Baseline projections:
  - Output gap (excluding gas) expected to widen slightly.
  - Unemployment to edge up to just above 6½ percent.
  - Inflation to remain within the 1–3 percent target range.
- Beyond 2014, medium-term growth projected at around 3½ percent annually (excluding gas), down from an annual average of 4¼ percent over the past 10 years, partly reflecting anticipated reduction in labor force growth as baby boomers reach retirement ages.
- Israel: Short-term projection table highlights (Staff est./proj. series):
  - GDP growth entries: e.g., "2012 Q3 GDP 4.2", "2013 Q4 GDP 3.5", "2014 Staff proj. 3.4" (preserve the structure and exact figures in source table).

### Contributions to growth (selected)
- Trading partners’ real GDP affects exports; Israel’s real GDP excluding gas shows more moderate growth than headline.
- Contributions to annual real GDP growth show variable contributions from private consumption, public consumption, fixed investment, exports, imports, inventory and residuals across 2009–2013 quarters as in original figures.

### Financial and monetary conditions
- Since October 2011, the Bank of Israel has lowered the policy rate in several steps to 1 percent.
- Monetary stance has been accommodative; various macroprudential measures introduced since 2009:
  - “Indirect” measures: capital surcharges and additional provisioning to reduce banks’ incentives to extend mortgage loans.
  - “Direct” measures: loan-to-value (LTV) and debt-service-to-income (DTI) limits more recently implemented.
- These measures have strengthened financial resilience; direct measures appear to have reduced speculative behavior and the volume of housing transactions, though it is too early to fully assess their effectiveness.

### Risks to the outlook
- External downside risks:
  - Protracted sluggish growth in Europe and the United States;
  - Growth disappointments in emerging economies.
- Domestic risks:
  - Further weakening of competitiveness of the tradable sector due to shekel appreciation;
  - A correction in the housing market with attendant fiscal and financial sector implications;
  - Reemergence of regional geopolitical tensions affecting sentiment.
- Upside risks:
  - Faster-than-expected recovery in Israel’s major trading partners;
  - Larger-than-anticipated spillovers from the natural gas sector.
- Capital flows:
  - FDI inflows have surged since 2009 and remain dominant in the capital account.
  - Portfolio inflows rose rapidly in 2010 but declined sharply thereafter, remaining volatile.

### Policy challenges and recommendations (overview)
- Key policy challenge: maintain near-term growth at potential while preventing build-up of imbalances, strengthening resilience to shocks, and pursuing structural reforms to ensure long-term sustainability.
- Broad policy directions emphasized in the source:
  - Keep monetary policy on hold in the near term given drag from shekel appreciation and planned fiscal tightening, while tightening macroprudential measures further if house prices continue to rise.
  - Consider tightening property taxation (for example, raising temporarily the property purchase tax for non-primary residences).
  - Accelerate supply-side measures to address housing shortages, including implementing the Housing Committee’s recommendations (reform planning process to expedite supply of planned land and issuance of building permits; introduce compensation scheme to accelerate evacuation of land used for agricultural purposes).
  - If global growth improves sharply or domestic demand strengthens appreciably, gradually normalize monetary policy.
  - Ensure foreign currency purchase program introduced by the BoI in May 2013 to offset impact of natural gas production is pre-announced and well-communicated; continue to prepare for the proposed Sovereign Wealth Fund expected in 2018.
  - Fiscal policy: pursue fiscal consolidation beyond measures embedded in the 2013–14 Budget to anchor sustainability for 2015 and beyond, and strengthen fiscal institutions.

### Monetary and exchange rate specifics
- Monetary policy trade-offs:
  - On one hand, absence of inflationary pressures and uncertain external outlook argue for maintaining accommodative stance.
  - On the other hand, rampant house price increases and potential fiscal slippages argue for tighter policy measures.
- Exchange rate assessment:
  - Various model estimates (CGER-type and EBA) suggest no obvious sign of exchange rate misalignment, but appreciation has hurt the tradable sector.
  - The mix of tight fiscal and accommodative monetary policy, together with structural reforms, should help reduce appreciation pressures and improve competitiveness.
  - In the event of disorderly exchange rate movements, policy should seek to mitigate the risk of an exchange rate overshoot.

### Fiscal policy specifics
- Fiscal performance:
  - Fiscal consolidation stalled in 2012, with the deficit expanding to 4 percent of GDP, well above the initial target of 2 percent.
  - In mid-2012 the government announced some consolidation measures (e.g., raising the VAT rate from 16 to 17 percent), but could not agree on a budget for 2013 and elections were brought forward to early 2013.
- Recommendation:
  - Bold fiscal consolidation measures in the 2013–14 Budget are welcome, but further adjustment will be required for 2015 and beyond to anchor sustainability, along with strengthening of fiscal institutions.

*Source: IMF staff report chapter "1. The Long View, 1996–2013" (excerpts as provided).*

### 19.      Following the election, the new government announced an ambitious fiscal consolidation

### _cr1447 - 19.      Following the election, the new government announced an ambitious fiscal consolidation

### Fiscal consolidation program (2013–14 budget)
- The 2013–14 budget included large discretionary consolidation measures totaling 2¾ percent of GDP, with the aim of reducing the deficit to 3 percent of GDP in 2014.
- The target deficit of 3 percent of GDP in 2014 is described as "both broadly appropriate and realistic" and a foundation for further medium-term consolidation.

### Revenue measures (announced)
- (i) raising the VAT rate from 17 percent to 18 percent;
- (ii) increasing the excise tax on tobacco and beer;
- (iii) introducing environmental taxes;
- (iv) increasing personal income (a measure that was subsequently rolled back) and corporate taxes (including a 2 percent surtax on the wealthiest);
- (v) one-time corporate tax amnesty for companies subject to tax exemptions under an investment law (“trapped profits” collections).

### Expenditure measures (announced)
- (i) freezing previously planned public sector wage hikes;
- (ii) cutting the defense budget;
- (iii) reducing child allowances and education expenditure (including for religious study);
- (iv) postponing infrastructure projects.

### Budget implementation and outturn (2013)
- Revenues in 2013 were higher than forecast due largely to one-off measures and a rebound in the stock market.
- Expenditures were lower-than-expected due to tight spending controls.
- The overall deficit outturn for 2013 is expected to be 3.5 percent of GDP, about ¾ percentage point below the target.
- Without these measures, the deficit was projected to further widen to 5¾ percent of GDP in 2014.
- As currently projected, the fiscal adjustment would amount to a cumulative of 1¼ percentage points of GDP over 2013–14.
- Assuming a multiplier in the range of 0.5–0.8 (based on BoI estimates), the adverse impact on growth would be around ¾–1 percentage points of GDP.

### 2013–14 Budget Expenditure Measures (as presented)
- 2013 / Billions of NIS / Percent of GDP: Wage bill freeze 0.5 0.0
- 2014 / Billions of NIS / Percent of GDP: Wage bill freeze 1.0 0.1
- Defense budget 3.0 0.3
- Child allowances 2.7 0.2
- Postponing agreed wage hike 1.0 0.1
- Education 2.0 0.2
- Postponing infrastructure projects 2.0 0.2
- Yeshiva (religious study) 0.5 0.0
- Reducing other specific items 2.5 0.2
- Flat cuts across all ministries 1.4 0.1
- Others 3.2 0.3
- Total 2013: 0.5 0.0
- Total 2014: 19.2 1.7
- Source: Israeli Authorities.

### 2013–14 Budget Revenue Measures (as presented)
- Announced prior to 2013 (2013 / Billions of NIS / Percent of GDP): VAT from 16 to 17 percent 3.5 0.3; Income taxes 4.0 0.4; Customs, excises and wealth 0.8 0.1; Others -0.2 0.0; Total 8.1 0.8
- Announced prior to 2013 (2014 / Billions of NIS / Percent of GDP): VAT from 16 to 17 percent ......; Income taxes -3.1 -0.3; Customs, excises and wealth 0.5 0.0; Others -0.5 0.0; Total -3.0 -0.3
- 2013-2014 Budget (2013 / Billions of NIS / Percent of GDP): VAT to 18% 2.3 0.2; Excise 0.7 0.1; Luxury tax 0.00 0.00; Income tax ......; Company tax ......; Others 0.2 0.0; Total 3.3 0.3
- 2013-2014 Budget (2014 / Billions of NIS / Percent of GDP): VAT to 18% 2.3 0.2; Excise 0.4 0.0; Luxury tax 0.1 0.0; Income tax 3.9 0.3; Company tax 1.0 0.1; Others 1.2 0.1; Total 8.9 0.8
- Source: Israeli Authorities.

### Risks to the fiscal outlook (2014 and beyond)
- Downside risks: revenue could be lower than expected, especially if there is a correction in the housing market or planned measures are not fully implemented.
- After the 2013–14 Budget was approved, projection for interest expense was lowered due to lower-than-assumed interest rates; the government rolled-back the planned increase in personal income tax for 2014.
  - These two changes are intended to be deficit neutral, but will lead to a structural revenue loss.
- Spending pressures could arise, especially pertaining to defense spending.
- Policy guidance: strict adherence to the expenditure ceiling and announced tax revenue measures is imperative to ensure credibility of the fiscal framework.
- If growth underperforms, automatic stabilizers should be allowed to operate fully, and the deficit target relaxed.

### Public debt and medium-term targets
- Public debt declined from over 95 percent of GDP a decade ago to 68 percent in 2012.
- The projected fiscal deficit of 3.5 percent in 2013 is characterized as high, especially given the output gap is close to zero and revenues have benefited from large one-off measures.
- Authorities committed to gradually reducing the deficit target from 3 percent in 2014 to 1.5 percent of GDP in 2019, a path that would help reduce debt to about 60 percent of GDP.
- The text notes that an even more ambitious path of deficit reduction is warranted to provide a greater buffer against shocks, including a sharp correction in the housing market.

### Required adjustment from 2015 onwards
- Additional adjustment will be needed from 2015 onwards to meet deficit targets.
- This requires both reducing expenditure growth by modifying the expenditure rule and introducing additional revenue measures.
- Given low levels of non-interest civilian expenditures in Israel, relying solely on reducing expenditure growth would compromise long-term growth and sustainability.
- Policy recommendations on expenditures:
  - Protect expenditure on priority items that boost productive capacity and reduce the social gap—education, job training, employment services, and infrastructure.
  - Avoid large unfunded expenditure commitments.
  - Annual budgets should provide sufficient contingent reserves in anticipation of shocks.
- Policy recommendations on revenues:
  - Additional measures should be less distortionary and aim at:
    - (i) broadening the tax base, including by eliminating tax exemptions (e.g., for advanced study funds and the VAT exemptions on fruit and vegetables, on tourist services, and in the resort town of Eilat);
    - (ii) further increasing indirect taxes (e.g., VAT);
    - (iii) introducing new taxes that reduce externalities (such as a congestion or a pollution tax) or inequality (such as raising the property tax).

### Fiscal institutions and governance
- A comprehensive review of current fiscal institutions is needed, given history of repeated and significant slippages in meeting fiscal deficit targets.
- Fiscal rules should be developed to:
  - have a more clearly defined debt objective;
  - better link the debt objective to deficit and expenditure targets;
  - allow more flexibility to deal with shocks.
- Fiscal rules should be embedded within a medium-term fiscal and expenditure framework including:
  - a multi-year overall expenditure ceiling and expenditure allocations to line ministries;
  - multi-year revenue and fiscal forecasts;
  - an analysis of risks to the fiscal outlook.
- Consideration should be given to establishing an independent and stand-alone fiscal council to discipline policy and evaluate consistency of fiscal policies with the rules.

---

### Financial sector policy: safeguarding financial sector stability
- The financial system is described as relatively sound and resilient, but further safeguards are recommended.
- Key institutional steps recommended:
  - Establish a Financial Stability Committee (FSC), with the Bank of Israel (BoI) taking the lead role.
  - Legislate a new bank resolution framework as soon as practicable.

### Financial system resilience (highlights)
- Israel’s banking system is domestically oriented and focused on traditional retail business.
- Mortgage market features: historically low mortgage losses, a limited buy-to-let market, and open-ended personal liability.
- Banks have increased capital ratios through retained earnings; BoI requires all banks to meet a core Tier 1 capital ratio of 9 percent by 2015.
  - Capital ratios at the two largest banks must reach 10 percent by 2017 (under the Basel III capital definition).
  - Banks’ core Tier 1 capital ratios range between 8½ and 9¾ percent.
- Leverage ratios (equity to capital ratios) are relatively high.
- Banks’ operations are fully deposit-funded, loan-to-deposit ratio well below 100 percent.
- In January 2013, the BoI strengthened liquidity regulations requiring adherence to new Basel III-type minimum liquidity coverage ratios and monitoring of net stable funding ratios.

### Stress test results
- BoI stress tests suggest that even under severe global crisis scenarios (assumed impact more severe than 2008 crisis), all banks would be able to maintain a 6 percent core Tier 1 capital ratio.
- Under the most severe stress scenario: GDP assumed to contract for four consecutive quarters (-4 percent growth annually), unemployment to rise to 12 percent, and house prices to fall a cumulative of 15 percent. Banks’ ROE would fall sharply from around 8 percent to -1 percent, but all banks would be able to maintain the capital ratio of above 6 percent.

### Systemic and tail risks
- Concentration risk: Banks’ lending to mortgage markets and commercial real estate amounts to 40 percent of their total assets.
  - BoI has lowered regulatory exposure limits and strengthened credit risk management.
  - Stress-testing of exposures to large highly-leveraged corporates (holding companies, real estate and construction firms) should be carried out periodically.
- Interest rate risk: If interest rates increase, households with floating-rate mortgages would be hit hard.
  - BoI stress test suggests that with a 20 percent drop in house prices and a sharp increase in unemployment, many mortgage borrowers—especially those with high DTI and LTV ratios and floating-rate mortgages—would default.
  - Overall impact on banks limited because of collateral and open-ended personal liabilities, but a housing market shock could cause a prolonged recession and adverse macro-financial feedback effects.
- Non-bank corporate lending: Corporate lending by non-bank institutions (insurance, pension, and provident funds) increased about 40 percent growth in 2012; level remains low (less than 10 percent of bank loans) but rapid increases could be concerning.
  - Goldschmidt Committee is reviewing regulatory standards and has made preliminary recommendations including tightening corporate governance and strengthening transparency; regulations should be strengthened after the committee finalizes its report.
- Insurance supervision: A Multilateral Memorandum of Understanding with the International Association of Insurance Supervisors was signed recently to facilitate cooperation and information exchange.

### Supervisory coordination and the Financial Stability Committee (FSC)
- Authorities have instituted regular meetings of the BoI, the Capital Markets, Insurance, and Savings Division (CMISD) of the MoF, the Israel Securities Authority (ISA), and the MoF to share information, harmonize practices, and analyze systemic risk factors.
- Two FSC design options discussed:
  - Option 1:
    - FSC focuses on macroprudential policies in normal times.
    - BoI plays leading role, Governor serves as Chairperson.
    - Consider establishing a separate crisis management committee led by the MoF.
    - May include non-executive committee members.
  - Option 2:
    - FSC has dual functions: macroprudential policies in normal times and crisis management when necessary.
    - Minister of Finance would chair the FSC (or Minister and BoI Governor as co-chairs).
    - Membership could be expanded to include other important government agencies (such as the Prime Minister Office) but exclude non-executive members.
- Staff preference: Option 1 is favored to ensure clear mandates, operational independence, accountability, and to avoid undermining macroprudential effectiveness in normal times.

### Legal and resolution framework
- Legal reforms to strengthen BoI’s toolkit for early intervention and resolution, clarify emergency liquidity assistance policy, and protect the bank from quasi-fiscal activity should proceed apace.
- A draft law has been prepared with technical assistance from the Fund; remaining issues should be addressed expeditiously with the aim of submitting the draft law to the Knesset as soon as practicable.

---

### Structural policy: longer-term sustainable and inclusive growth
- Further action is required to improve the business climate and boost competition in the non-tradable sector.
- Enhance participation of rapidly growing Haredi and Israeli-Arab populations to bolster long-term potential and reduce poverty and inequality.

### Business environment weaknesses and priorities
- World Bank Doing Business Survey identifies weaknesses in:
  - "property registration,"
  - "construction permits,"
  - "contract enforcement."
- Policy priorities:
  - Tackle Doing Business weaknesses, continue addressing infrastructure gaps (railroad, port, air transport).
  - Enhance competition in non-tradable sectors, following the Committee on Increasing Competitiveness recommendations (2012).

*Source: IMF staff report text as contained in the provided chapter.*

### 37.      Despite rapid growth, the poverty rate in Israel

### _cr1447 - 37.      Despite rapid growth, the poverty rate in Israel

### Poverty incidence and demographic projection
- The poverty rate in Israel is "near 20 percent" and "remains among the highest in OECD countries."
- Much of the high poverty incidence is accounted for by Haredi and Arab-Israeli communities.
- Demographic projection: "in 20 years, the population of these two groups is projected to exceed 40 percent of the total population."
- BoI staff analysis cited: unless demographic and educational problems are appropriately addressed, "Israel’s long-term growth potential would be reduced by about 1–1½ percentage points of GDP."

### Structural constraints to integration and human capital
- Structural factors identified as contributing to low participation and human capital:
  - Many Arab-Israeli communities live in underdeveloped rural and remote areas, "thus raising the costs of supplying labor."
  - Many Haredi and Arab-Israeli children follow different education systems with fewer years of formal schooling, "thus lowering human capital acquisition."
  - Low participation in military or civic services "thus isolating them from the social networks that facilitate employment opportunities."

### Ongoing initiatives and preliminary outcomes
- Initiatives under way:
  - Expansion of Haredi units in the defense forces.
  - Opening of public employment centers in Arab-Israeli towns.
- Preliminary evidence: participation of these populations in the labor force "is rising, albeit slowly."

### Policy recommendations to achieve inclusive growth
- Areas requiring "more forceful and concerted action by all stakeholders":
  - Education, including access to higher education and enforcement of core curriculum.
  - Rural infrastructure and transportation.
  - Enforcement of labor laws.
  - National service arrangements.
- Role for private initiatives: "enhancing the efficient use of talents across all different populations to fully reap Israel’s productivity potential."

### Authorities' views (summary)
- Authorities broadly concurred with staff assessment of economic developments, risks and contours of policy response, while emphasizing the need to support near-term growth and preserve long-term sustainability.
- On fiscal policy:
  - Reducing public debt over the medium-term "would remain one of the top policy priorities."
  - MoF view: fiscal adjustments should come mainly from expenditure cuts; revenue efforts should focus on broadening the tax base rather than raising tax rates.
  - MoF did not see the case for an explicit debt target; preferred laying out a medium-term deficit target and developing a comprehensive medium-term fiscal and expenditure framework.
  - Authorities not fully convinced of merits of establishing a fiscal council; priority is strengthening capacity within the MoF.
- On financial sector and institutional arrangements:
  - BoI broadly agreed staff preference for an FSC focused on macroprudential policies in normal times, with BoI in the lead and its chairmanship assigned to the Governor, plus a separate crisis management committee.
  - MoF favors a single committee covering both macroprudential policy in normal times and crisis management, chaired by the Minister of Finance.
- Authorities agreed on "the need for more concerted efforts aimed at integrating Arab-Israeli and Haredi communities in economic activity."

### Staff appraisal: macroeconomic context and policy guidance
- Macroeconomic snapshot:
  - Economy "is growing at a moderate pace."
  - Inflation and inflation expectations are "squarely within the 1–3 percent target band."
  - Unemployment "is low."
  - External position "is strong" and financial markets "have remained relatively calm."
- Key challenges identified:
  - Public debt and the fiscal deficit "remain high."
  - House price inflation poses risks of a boom-bust cycle.
  - Appreciation of the shekel raises competitiveness concerns.
  - Medium-term growth potential "is likely to be lower than in the past."
- Policy guidance:
  - Monetary policy: with inflation anchored and growth momentum at risk, "monetary policy should remain on hold for now." Risks from rapid house price inflation should be addressed with further tightening of "direct" macroprudential measures; BoI should respond nimbly to changes.
  - Fiscal policy: minimize risk of slippages by firm adherence to the expenditure ceiling and announced revenue measures to meet "the deficit target for 2014." For 2015 and beyond, require efforts on both expenditure and revenue to put public debt on a downward trend while preserving long-term growth and sustainability. Strengthen fiscal framework and consider establishing an independent fiscal council.
  - External and exchange rate policies: macroeconomic policy mix (accommodative monetary and tight fiscal) plus structural reforms to boost productivity will help alleviate shekel appreciation pressures. To reduce Dutch disease risk from gas-related capital inflows, pursue "a pre-announced and well-communicated program of intervention" to offset natural gas impact on external accounts, complemented by discretionary intervention to stem exchange rate volatility.
  - Financial sector: expedite progress on issues identified by the FSAP Update, intensify efforts to establish an FSC with a clear macroprudential focus led by the BoI, and consider a separate Crisis Management Committee with the MoF leading. Submit the draft bank resolution law to the Knesset "as soon as practicable."
  - Structural reforms: improve business climate and boost competition, especially in the non-tradable sector; address low labor participation rates of Haredi and Israeli-Arab communities to bolster productive capacity, long-term growth, and to reduce poverty and inequality.

*Source: _cr1447 - 37.      Despite rapid growth, the poverty rate in Israel*

### 55.      It is recommended that the next Article IV consultation with Israel be held on a standard 12-

### _cr1447 - 55.      It is recommended that the next Article IV consultation with Israel be held on a standard 12-

### Recommendation
- It is recommended that the next Article IV consultation with Israel be held on a standard 12-month cycle.

### Macroeconomic performance and near-term prospects
- Real GDP growth:
  - 2009: 1.2
  - 2010: 5.7
  - 2011: 4.6
  - 2012: 3.4
  - 2013 (Staff est.): 3.4
  - 2014 (Staff proj.): 3.4
- Output gap (percent of potential):
  - 2009: -1.3
  - 2010: 0.3
  - 2011: 1.0
  - 2012: 0.6
  - 2013 (Staff est.): 0.2
  - 2014 (Staff proj.): 0.1
- Unemployment rate (percent):
  - 2009: 8.8
  - 2010: 7.9
  - 2011: 6.9
  - 2012: 6.9
  - 2013 (Staff est.): 6.4
  - 2014 (Staff proj.): 6.7
- Inflation (Overall CPI, end period):
  - 2009: 3.9
  - 2010: 2.7
  - 2011: 2.2
  - 2012: 1.6
  - 2013 (Staff est.): 1.8
  - 2014 (Staff proj.): 2.0
- Monetary policy:
  - Bank of Israel policy rate (percent, end year): 2009: 1.00; 2010: 2.00; 2011: 2.75; 2012: 2.00
  - Real policy rate defined as policy rate minus inflation expectations; monetary policy stance described as accommodative.

### External sector and reserves
- Current account balance (percent of GDP, memorandum): 2010: 3.1; 2011: 1.3; 2012: 0.3; 2013 (Staff est.): 0.6; 2014 (Staff proj.): 0.7
- Current account balance (billions of U.S. dollars, Table 2 staff est./proj.):
  - 2010: 7.2
  - 2011: 3.3
  - 2012: 0.8
  - 2013: 1.8
  - 2014: 2.1
  - 2015: 4.4
  - 2016: 4.4
  - 2017: 4.5
  - 2018: 4.4
  - 2019: 4.7
- Foreign reserves (end period, billions of U.S. dollars, Table 2 & Table 3):
  - Table 2 staff est./proj.: 2010: 7; 2011: 17; 2012: 17; 2013: 5? (table displays 7,17,17,57,68... — primary listed series in Table 2: 7 17 17 76 82 85 86 86 87 87 87; memo)
  - Table 3 (Israeli assets abroad, reserve assets, end-period, billions of US dollars): 2004: 27.1; 2005: 28.1; 2006: 29.2; 2007: 28.6; 2008: 42.5; 2009: 60.6; 2010: 70.6; 2011: 74.9; 2012: 75.9
- Gross external debt (percent of GDP, Table 2 memorandum):
  - 2010: 46.5
  - 2011: 40.8
  - 2012: 37.6
  - 2013: 32.0
  - 2014: 28.2
  - 2015: 24.4
  - 2016: 20.4
  - 2017: 16.5
  - 2018: 12.8
  - 2019: 9.3

### Public finances
- General government overall balance (percent of GDP, Table 1 and Table 4):
  - Table 1 (General government overall balance): 2009: -6.3; 2010: -4.6; 2011: -4.2; 2012: -3.9; 2013 (Staff est.): -3.5; 2014 (Staff proj.): -3.0
- Central government:
  - Revenues and grants (percent of GDP): 2009: 26.5; 2010: 25.7; 2011: 26.0; 2012: 24.9; 2013 (Staff est.): 25.6; 2014 (Staff proj.): 25.7
  - Total expenditure (percent of GDP): 2009: 31.5; 2010: 29.2; 2011: 29.0; 2012: 28.9; 2013 (Staff est.): 29.1; 2014 (Staff proj.): 28.5
  - Overall balance (percent of GDP): 2009: -5.0; 2010: -3.6; 2011: -3.0; 2012: -4.1; 2013 (Staff est.): -3.5; 2014 (Staff proj.): -2.8
- Public debt (percent of GDP, Table 1 and Table 5):
  - Table 1 (Debt): 2009: 75.3; 2010: 71.5; 2011: 69.7; 2012: 68.2; 2013 (Staff est.): 67.5; 2014 (Staff proj.): 66.6
  - Table 5 (Public debt to GDP, memorandum): 2007: 74.6; 2008: 72.9; 2009: 75.3; 2010: 71.5; 2011: 69.7; 2012: 68.2

### Housing markets, household balance sheet, and credit
- Housing valuation:
  - House prices about 25 percent above their historical averages (figure caption).
- Mortgage and debt indicators:
  - Mortgage debt service payment (percent of disposable income) increased (figure).
  - Population-to-Dwelling Stock Ratio (1996Q1–2013Q2): series ranges shown 3.30–3.50 (figure axes highlight 3.30, 3.35, 3.40, 3.45, 3.50).
  - Household debt (percent of GDP, 2013Q2) by country shows Israel relatively low in international comparison (figure caption).
  - Household net worth ratio: households' net worth position stayed at 5 times their disposable income (figure caption).
- House price metrics:
  - Price-to-income and Price-to-rent measures increased rapidly since 2007 (figure caption).

### Financial sector performance and risks
- Banking sector capital and liquidity:
  - Regulatory Tier I capital to risk-weighted assets (Table 7): 2006: 7.6; 2007: 7.7; 2008: 7.6; 2009: 8.3; 2010: 8.5; 2011: 8.4; 2012: 9.2
  - Regulatory capital to risk-weighted assets (Table 7): 2006: 10.9; 2007: 11.0; 2008: 11.3; 2009: 13.7; 2010: 14.1; 2011: 14.0; 2012: 14.9
  - Capital as percent of assets (leverage ratio) (Table 7): 2006: 8.5; 2007: 9.0; 2008: 9.1; 2009: 10.6; 2010: 11.1; 2011: 10.6; 2012: 10.8
  - Liquid assets as percent of short-term liabilities (Table 7): 2010: 102.4; 2011: 100.7; 2012: 101.2; 2012 (alternate row): 99.2 (table presents both sets)
  - Customer deposits as a percent of total (non-interbank) loans (Table 7): 2006: 118.3; 2007: 113.7; 2008: 107.2; 2009: 110.4; 2010: 104.7; 2011: 111.3; 2012: 113.1
- Asset quality and profitability:
  - Nonperforming loans to total gross loans (Table 7): 2012: 2.8
  - Return on average assets (before tax) (Table 7): 2006: 1.0; 2007: 1.2; 2008: 0.0; 2009: 0.9; 2010: 0.9; 2011: 0.8; 2012: 0.8
  - Return on average equity (before tax) (Table 7): 2006: 17.3; 2007: 19.5; 2008: 0.7; 2009: 14.1; 2010: 13.8; 2011: 12.3; 2012: 12.2
  - Noninterest expenses as percent of gross income (Table 7): 2006: 66.3; 2007: 64.5; 2008: 82.2; 2009: 64.0; 2010: 68.4; 2011: 70.3; 2012: 69.8
- Market indicators:
  - Shekel exchange rates and financial market trends:
    - NIS/EUR and NIS/USD series show continued appreciation of the shekel against the US dollar (figure caption).
    - Tel Aviv 100 Index and Tel Aviv Financial 15 Index rose relative to FTSE 100 (figure caption).
  - Sovereign and interbank spreads:
    - 10-Year Government Bond Yields: Israeli sovereign bond yields remain stable (figure caption).
    - 5-Year sovereign CDS spreads and spreads of 3-month interbank rates over 3-month T-bill rates remain stable (figure captions).
  - One-Year Expected Default Frequency for banks: market indicators for bank default probabilities have gradually fallen (figure caption).

### Non-bank financial sector and corporate/household sectors
- Pension and insurance:
  - Growth rate of pension fund assets picked up since mid-2012 (figure caption).
  - Life insurance asset growth also picked up (figure caption).
  - Insurance Return on Equity recovered by 2012 (figure caption).
- Corporate sector:
  - Corporate profitability remains lower than pre-crisis levels (figure caption).
  - Corporate leverage (Debt-to-Equity) ratio on a downward trend (figure caption).
  - One-year Expected Default Probability for corporates declined through 2013 (figure caption).
- Household borrowing:
  - Household sector borrowing continues to grow broadly in line with nominal GDP growth rate (figure caption).
  - Bank credit to business sector continues to fall, while credit to households continues to grow (figure caption).

### Key statistics and memoranda (selected)
- GDP per capita (2012): $32,265
- Population density (2011): 359 people per sq. km
- Poverty rate (2008): 19.9 percent
- Fertility rate (2009): 3.0 per woman
- Life expectancy at birth (2009): 79.7 (male) and 83.5 (female)
- Infant mortality rate (2009): 3.4 per 1,000 births
- Physicians (2007): 3.6 per 1,000 people
- CO2 emissions (tons per capita, 2007): 9.3

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

### Annex I. Israel’s External Sector Assessment

### Annex I. Israel’s External Sector Assessment

### The appreciation of the real exchange rate
- Since mid-2007, Israel’s real exchange rate (REER) has appreciated to about 10 percent above its longer-term average, amid high volatility.
- Israel’s CPI and ULC-based real effective exchange rates (REER) have appreciated by 20 percent since July 2007.
- The nominal effective exchange rate has appreciated by nearly 20 percent since 2007, while prices and wages in Israel have not grown faster than in other countries.
- Growth has averaged 3.7 percent since 2008, compared with 0.7 percent on average in OECD countries.
- Since 2003, Israel has maintained a current account surplus of around 2.3 percent of GDP.
- High-tech manufacturing and services represent about 50 percent of total industry exports.
- Net FDI inflows have remained strong; in 2012 FDI inflows were largely explained by reinvestments owing to a considerable increase in retained profits of foreign companies operating in Israel.
- Production from the Tamar field began on April 2013; the gas sector is estimated to contribute to improving the current account balance by 1–1¼ percentage points of GDP in 2013 and 2014.
- Portfolio inflows surged in 2010 and the first half of 2011 driven by interest rate differentials; these flows receded after the Bank of Israel’s interest rate cut, removal of the tax exemption on capital gains for foreign investors, and an increase in the economy’s risk premium.
- In 2012 and 2013, portfolio flows turned negative as domestic institutional investors made sizeable portfolio investments abroad; institutional investors increased hedging by selling dollars forward to Israeli banks.

### Model-based current account and exchange rate valuations
- Different equilibrium exchange rate assessment models give mixed results:
  - Equilibrium Real Exchange Rate (ERER) measure suggests an overvaluation of 10 percent.
  - Macro Balance (MB) measure suggests undervaluation by 7 percent.
  - External Stability (ES) measure suggests undervaluation by 8 percent.
- The IMF’s External Balance Assessment (EBA) suggests the norm for the current account balance for Israel is about zero.
- In 2013, the current account balance is projected at about ¾ percent of GDP; in cyclically adjusted terms this is about 1¾ percent of GDP.
- The deviation of the cyclically adjusted current account from the norm is estimated at about 2 percent of GDP, largely attributable to emerging natural gas production.

### Foreign reserves and international investment position
- Israel’s net international investment position (IIP) has improved and stabilized in positive territory, underpinned by an increase in foreign reserves and a decline of portfolio liabilities.
- The stock of foreign liabilities is low by international standards; a part is denominated in shekels.
- The Bank of Israel (BoI) modified its exchange rate policy in 2009 to engage in discretionary intervention to counteract excessive volatility or affect the level of the exchange rate.
- In May 2013, the BoI launched an additional intervention program with announced purchases of foreign currency to offset the effects of gas production on the current account.
- Authorities’ analysis indicates the adequate level of reserves is somewhere between $65–$90 billion.
- Standard metrics suggest foreign reserves may have grown beyond adequate level, but by international standards reserves accumulation in Israel does not appear to have been excessive.

### The impact of the exchange rate appreciation on the tradable sector
- The appreciation of the shekel is undermining competitiveness: revenues and profit margins in the tradable sector have declined.
- Labor income share in manufacturing has an upward trend, in contrast with a stable share for the economy as a whole.
- Export volumes have been falling continuously since mid-2011 despite stable global demand; contraction in trade with the US and Europe (about 50 percent of Israeli export market) contributes to this weakness.
- Trend appreciation of the shekel has weakened external competitiveness, leading to sluggish export and output growth in the manufacturing sector.

### Dutch disease concerns: natural gas and start-up companies
- Impact of gas discoveries on the current account has been relatively limited so far; reduction in fuel imports has been lower than anticipated because refineries are still importing energy fuels (partly to fulfill previous contracts); these imports have been exported subsequently, improving the current account balance.
- Expectations about future gas production have caused disorderly movements in the foreign exchange market; in June 2013 the exchange rate overreacted, prompting BoI discretionary intervention.
- Israel is expected to start exporting gas by 2018, which will strengthen the current account and put appreciation pressures on the shekel.
- The government decided to establish a Sovereign Wealth Fund (SWF) to invest gas levy receipts abroad and contribute to fair distribution of gas revenues.
- Until the SWF is established, the BoI will offset current account effects of gas production through reserves accumulation; the BoI announced a foreign currency purchase program in May 2013 as an interim measure, announcing yearly amounts and executing purchases regularly throughout the year.
- Start-up companies are an important supplier of foreign currency via venture capital financing and “exits” (sale of Israeli firms to foreign companies); about 60 Israeli companies are currently traded in NASDAQ.
- About 50 percent of the stock and flow of inward FDI is accounted for by the ICT and high-tech manufacturing industries; the ICT sector represents 30 percent of exports, but contributes to 10 percent of the economy’s GVA and to 6 percent of employment.
- Start-up exits can resemble portfolio investments and may contribute to exchange rate appreciation that undermines competitiveness of more labor-intensive industries; Israel’s goods export market share has declined while services exports share has increased.

*Source: Annex I. Israel’s External Sector Assessment.*

### Annex IV. Israel: Debt Sustainability Analysis 2013

### Annex IV. Israel: Debt Sustainability Analysis 2013

### Key findings on public debt and debt profile
- Public debt-to-GDP ratio decreased from 98 percent in 2003 to 68 percent in 2012.
- Debt maturity averages 7 years.
- Debt held by non residents amounts to 18 percent of the total.
- Gross financing needs would hover around 12 percent of GDP under the baseline.
- Although most indicators are below early warning benchmarks, Israel’s debt profile appears to be highly vulnerable to growth shocks.
- The DSA covers debt of the general government (public sector defined as general government).

### Baseline scenario and underlying assumptions (staff)
- Under staff’s baseline scenario, public debt-to-GDP ratio is projected to decline to about 61 percent of GDP in 2018, consistent with the authorities’ implicit goal of reducing public debt to 60 percent of GDP by 2020.
- Baseline assumptions:
  - Real GDP is projected to grow at about 3.5 percent annual average. The output gap is expected to be broadly closed through the projection period.
  - CPI inflation is expected to remain constant at 2 percent.
  - The budget deficit is expected to improve from 3.5 percent of GDP in 2013 to about 3 percent of GDP in 2014. Thereafter, it is projected to remain at about 2 percent.
  - The primary expenditure is projected to remain constant as percentage of GDP.
  - The effective interest rate is forecast to slowly decline from 5.5 percent in 2013 to 4.5 percent in 2018.
  - The US debt guarantee program constitutes about 15 percent of external debt until 2016.
  - As interest payments remain elevated throughout the projection period, gross financing needs would hover around 12 percent of GDP.

### Risks to the baseline
- Risks to the baseline remain to the downside, reflecting an ambitious adjustment plan relative to historical fiscal performance; fiscal slippages would result in higher debt levels.

### Stress tests and shock scenarios
- A range of stress tests indicate particular susceptibility to growth, interest rate, and combined macro-fiscal shocks.

- Growth shock:
  - Assumption: Lower real GDP growth rates (by 1 standard deviation for 2 years starting in 2014).
  - Effects: Slower improvement in the primary balance as revenues fall while expenditure remains unchanged.
  - Financing needs would increase to 15 percent of GDP by 2018.
  - Debt-to-GDP ratio would rise to 70 percent in 2015 and then decline only slowly to 66 percent by 2018.

- Interest rate shock:
  - Assumption: Borrowing costs increase by 200 basis points (e.g., from a geopolitical shock).
  - Effects: Financing needs would jump to 15 percent of GDP by 2018.
  - Public debt would stay broadly constant at 65 percent of GDP over the projection period (average), aided by high maturity of new borrowing.

- Combined macro-fiscal shock:
  - Assumption: Exchange rate depreciation, an expansion of the primary deficit, and a decline in real GDP.
  - Effects: Financing needs would rise to 17 percent of GDP and debt would reach 70 percent of GDP by 2018.

### Tail risk: house price shock combined with geopolitical shock (customized scenario)
- Scenario assumptions:
  - Interest rates increase by 200 basis points.
  - Real exchange rates depreciate by about 13 percent.
  - House prices drop by 20 percent.
- Results presented for two growth-impact variants:

  - Moderate impact on growth:
    - Growth decline spread over three years (about 0.7 percent less than the baseline in 2014 and 2.3 percent less in 2015–16).
    - Gross financing needs would expand to 20 percent of GDP.
    - Public debt would reach 79 percent of GDP by 2018.

  - Severe impact on growth:
    - Growth decline concentrated in 2015, with growth rates lower than the baseline by 1.5 percent in 2014, 5 percent in 2015, and 2.9 percent in 2016.
    - Gross financing needs would rise to 25 percent of GDP.
    - Public debt would reach about 89 percent of GDP by 2020.

### Historical and projection indicators (selected exact figures from DSA tables)
- Nominal gross public debt: 2011: 83.3; 2012: 69.7; 2013: 68.2; 2014: 67.5; 2015: 66.6; 2016: 65.3; 2017: 63.8; 2018: 62.4; (percent of GDP).
- Public gross financing needs: 2011: 6.0; 2012: 12.8; 2013: 13.2; 2014: 12.3; 2015: 12.4; 2016: 11.6; 2017: 12.1; 2018: 13.7; 2019: 14.2 (percent of GDP as shown in table).
- Real GDP growth (projections): 2013–2018: 3.4, 3.4, 3.4, 3.5, 3.5, 3.5 (percent).
- Inflation (GDP deflator projections): 2013–2018: 1.8, 2.6, 2.4, 1.9, 2.1, 2.1 (percent).
- Primary balance (baseline projections): 2013–2018: -0.6, -0.2, -0.2, 0.1, 0.0, 0.0 (percent of GDP).
- Effective interest rate (projections): 2013–2018: 5.5, 5.5, 4.7, 4.6, 4.5, 4.5 (percent).
- Cumulative change in gross public sector debt (2002–2018 projections row): -6.9 (percent of GDP cumulative change reported).
- Identified debt-creating flows (2013–2018 cumulative in table): -2.3 (percent of GDP).
- Residual, including asset changes (2013–2018 cumulative in table): -4.6 (percent of GDP).

### Composition and maturity/currency structure (projections)
- By maturity: projections show share of medium and long-term and short-term debt (percent of GDP) across 2011–2018 with short-term and medium/long-term components illustrated in the original figures.
- By currency: projections show local currency-denominated and foreign currency-denominated shares (percent of GDP) across 2011–2018.

### Financial-sector oversight recommendations and implementation status (Annex V, selected)
- Strengthen institutional framework for macroprudential oversight by formally establishing a Financial Stability Committee (FSC):
  - Status: The BoI, the CMISD, and the ISA signed a Memorandum of Understanding (MoU) setting principles for coordination. A team comprising government ministries and the BoI is working on a formal framework for coordination and information sharing. Extensive work in progress on drafting a new law to establish an FSC. Views differ among authorities on exact setup.

- Further improve stress testing techniques (systemic risks, credit risk, liquidity risk):
  - Status (BoI): Ongoing work. BoI employs models to estimate credit losses for four sectors (real estate and construction, other corporate, housing and retail). Developed econometric models and loan-level methodologies. Work in progress on construction risks and liquidity stress tests. BoI conducts stress tests based on a uniform scenario with banks and completed a stress test on banks’ mortgage portfolios using loan-level data. BoI has constructed indices to assess systemic risk and plans to integrate them into stress testing and macro models.
  - Status (CMISD): Running monthly stress testing of insurance companies' capital against investment risk including credit and market risks. Uses an early warning system (Compass) and tracks market indicators (spreads of deferred capital notes, credit ratings).

- Eliminate gaps and overlaps in supervisory responsibilities:
  - Status: Regular coordination among regulators continues. A joint BoI–ISA team was set up to address regulatory gaps and overlaps in the broker-dealer sector and to form foundational requirements under future regulation. Oversight of underwriters remains an ISA duty, with the Supervisor of Banks able to set regulations for banks and their subsidiaries.

- Undertake systematic cost-benefit analysis of regulatory changes and streamline regulations where possible:
  - Status (BoI): Systemic cost-benefit analysis of significant regulatory changes is performed case by case.
  - Status (CMISD): Increased transparency measures: draft regulations published in two rounds for public and industry feedback; publication of “green papers” before major amendments; public committees review broad capital market issues with published reports.

*Source: Annex IV. Israel: Debt Sustainability Analysis 2013 (IMF staff).*

### 4. The Commissioner publishes positions papers reflecti

### _cr1447 - 4. The Commissioner publishes positions papers reflecti

### Commissioner publications, CMISD codification, and principle-based supervision
- The Commissioner publishes position papers reflecting policies and expectations regarding implementation of special regulations, and documents reflecting findings of reviews that include appropriate and faulty implementation of the policies.
- The CMISD has been consolidating all regulations as part of recent reforms into a comprehensive codex of regulation.
- As part of this process, all regulations are re-examined to ensure internal consistency and congruency with the CMISD's long-term objectives for the regulated activity.
- These initiatives reflect the goal of the CMISD to rely on principle-base supervision.

### AML/CFT legal and regulatory framework; DNFBPs
- September 2012: the ISA published for public comments a detailed list of possible reliefs to supervised entities; some reliefs were implemented, many forwarded for parliamentary approval, likely to be received in 2014.
- May 7, 2012: the Knesset approved an amendment to the Prohibition on Money Laundering Law applying the AML/CFT regime to dealers in the precious stones sector; the sector will be supervised by the Ministry of Industry, Trade and Labor and will be subject to Administrative sanctions. An AML/CFT order has yet to be enacted for the amendment to come into force and specify the obligations.
- May 11, 2012: a draft bill concerning application of AML/CFT obligations on DNFBPs was approved in first reading by the Knesset Plenary but has not been enacted yet.
- A draft order applying AML/CFT obligations on DNFBP’s has been disseminated to representatives of relevant sectors (Lawyers, trusts service providers, accountants, tax consultants and real estate agents); meetings were held to improve cooperation and reach agreed understandings.

### Transparency of beneficial ownership
- Information on beneficial ownership is retained by AML/CFT regulated businesses as part of their compliance obligations.
- AML/CFT Orders determine the obligation to receive from the customer a declaration stating whether he is acting on his behalf or on behalf of another (a beneficial owner declaration), and to state the name and identity number of the beneficiary.
- The Orders (including the Banking Order that was approved by the Knesset Committee in October 2013 and shall enter into force in a few months) also oblige taking reasonable measures to verify the identity of the beneficial owner, using relevant information or data obtained from reliable sources.
- The Corporations Authority has submitted to the legislation department and the Ministry of Justice a draft amendment to the Companies Regulations aiming at enhancing transparency with respect to the reporting requirements of private companies including, inter alia, provisions regarding beneficial ownership, subject to the current legal measures.
- The Corporations Authority undertook measures in the past two years to ensure compliance with annual reporting requirements for private companies, including implementation of sanctions against “violating companies” and public campaigns to increase compliance and public awareness; reported information is available to the public and most of it is publicly accessible on the website of the Corporation Authority.

### Banking oversight: interest-rate, market, and liquidity risk; staffing
- Interest-rate risk: a new directive regarding interest-rate risk management was issued in May 2013.
- Liquidity risk: an updated directive regarding liquidity risk management was issued in January 2013 as an interim step towards implementing Basel III liquidity requirements; the BoI is in progress of adopting the Basel III Liquidity Coverage Ratio requirement, and a joint working group with banks has been established. Liquidity risk monitoring is being strengthened, subject to resource limitations.
- Personnel management: the Banking Supervision Department lacks flexibility to hire mid-career professionals and managerial prerogative regarding staff incentives and retention; it continues to hire workers beginning their careers and hires external advisors to make up for lack of experienced specialists.

### Insurance sector oversight
- The CMISD joined the Multilateral MoU with the International Association of Insurance Supervisors.
- The CMISD supervises groups with insurers, provident and pension funds; banks and insurance companies cannot exist in the same group.
- August 2011: the Insurance Supervision Law was amended to enhance the CMISD’s powers—now authorized to demand or confiscate documents and computer data, and the law allows for administrative penalties, including financial sanctions on officers.
- 2012: restrictions on inter-group transactions were introduced, limiting transactions with related parties such as companies that hold more than 20 percent of the institutional entity’s shares or cases where the insurer holds more than 10 percent of the shares of a related financial institution; inter-group transactions allowed only if approved by the group entities and the CMISD.
- On consolidated supervision, minimal capital requirements need to be consolidated on a group basis for insurer, provident, or pension funds in the same group.

### Securities markets oversight and development
- The ISA is emphasizing two wide-scale projects: simplifying and shortening reports (mainly the annual report); and reviewing and evaluating advantages and disadvantages of introducing new financial instruments to be offered to the public and traded on the TASE.
- Fit and proper criteria for underwriters: the issue has not been carried forward because of administrative reasons; relevant draft legislation is planned to be resent to the Knesset in 2014.
- Broker-dealers: the ISA has established an internal working group to examine and propose a legislative framework to regulate the broker-dealer activity in Israel; a joint team with the BoI has been set up to ensure consistency and comprehensiveness of future regulation; the joint team is forming foundational requirements for broker-dealers.
- A new joint working group among TASE, ISA, and BoI has been set up to ensure consistency of supervisory practice.
- Repo market development: the Israeli Tax Authority de facto recognizes repo transactions as lending (for tax purposes); the Tax Authority and other regulatory bodies are still working to resolve the issue.

### Payments and securities systems oversight
- Business continuity: the BoI continues to implement the business continuity plan for the payment systems it operates, including conducting periodic emergency preparedness tests.
- Finality of settlements: The Payment Systems Law, 5768–2008, establishes the finality of payments transmitted via the Zahav system, including finality of the net payments sent to the system from other payment systems (the Tel Aviv Stock Exchange clearing houses, Masav (ACH), and the Paper-based (Checks) Clearing House).
- Amendments: TASE clearing houses advanced an amendment to the Securities Law to arrange finality of occasional payments transmitted through the TASE Clearing House connected to the Zahav system.
- 2013: the BoI declared the Masav system to be a “controlled system”, and thus subject to its payment systems oversight.
- BoI oversight now formally oversees the Zahav (RTGS) system, the Masav (ACH) system, and the Shva (ATM SWITCH) system. Oversight of the TASE clearing houses (SSS) is carried out by the ISA; the BoI has signed a MoU with the ISA for transferring data on clearing house operations.

### Crisis management and bank resolution
- Extensive work has been in progress in drafting a new law on bank resolution.
- Establish a policy framework for ELA: work in progress; a policy framework for ELA has yet to be established.
- Establish by law and make operational: a full set of early intervention tools; and a special framework for going-and-gone concern resolution—BoI has drafted a work plan for dealing with bank resolution subject, including early identification and measures for different stages.
- Establish mechanism for solvency support and funding bank resolution, protecting the BoI from quasi-fiscal activities: a resolution fund scheme and a deposit insurance scheme are still being discussed; once the new bank resolution law is adopted, the BoI will update internal procedures and establish a MOU with relevant regulators.
- Agree on a protocol for coordination and assignment of responsibilities for system-wide crisis management: still under discussions; views differ among authorities on how exactly a crisis management committee should be set up.

### Fund relations — key figures (as of January 24, 2013 / January 24, 2014 references retained as in source)
- Membership: Israel became a member of the Fund on July 12, 1954.
- General Resources Account (SDR Million Percent Quota):
  - Quota 1,061.10                      100.00
  - Fund holdings of currency  700.57 66.02
  - Reserve position in Fund 360.53 33.89
  - New arrangements to Borrow 65.01 
- SDR Department (SDR Millions Percent Allocation):
  - Net cumulative allocations 883.39 100.00
  - Holdings 999.47                      113.14
- Outstanding Purchases and Loans: None
- Financial Arrangements: None
- Projected Payments to Fund (SDR Million; based on existing use of resources and present holdings of SDRs): Total 0.00 for 2013, 2014, 2015, 2016, 2017 as reported.
- Exchange rate arrangement:
  - De jure: “free floating.”
  - De facto: classified as “floating” as the BoI has intervened more than three times over the last six months.
  - Israel accepted the obligations of Article VIII, Sections 2, 3, and 4 on September 21, 1993.
- Last Article IV Consultation: concluded on March 27, 2012; Israel is on the standard 12-month consultation cycle.

### Statistical issues — assessment and data dissemination
- General: Macroeconomic statistics are of generally high quality and broadly adequate for surveillance, with some shortcomings particularly in monetary and government finance statistics.
- Government finance statistics: reported overall annual fiscal balance methodology not in conformity with internationally accepted best practice, as interest expenditure excludes the inflation component; authorities are gradually moving toward standard methodology.
- Monetary statistics: banking statistics are not based on balance sheet reporting but on a selection of data reported by banks to regulatory authorities; current information does not permit full sectorization.
- Balance of payments: compiled on a quarterly basis and follow the fifth edition of the Balance of Payments Manual.
- Data ROSC published on March 24, 2006.
- Participation in SDDS: Participant since April 1996, and in full observance of the SDDS’s prescriptions for data coverage, periodicity and timeliness, and for the dissemination of advance release calendars.

### Table of Common Indicators — selected observations/dates (preserve source format)
- International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Dec-13            14-Jan-14             M            M            M
- Reserve/Base Money: Dec-13            14-Jan-14             M            M            M
- Broad Money: Nov-13            14-Jan-14             M            M            M
- Central Bank Balance Sheet: Nov-13           18-Dec-13            M           M           M
- Consolidated Balance Sheet of the Banking System: Q3-2013                    ...                    Q                    Q                     Q
- Consumer Price Index: Dec-13 15-Jan-14 M M M
- GDP/GNP: Q3-2013 16-Jan-14 Q Q Q
- External Current Account Balance: Q3-2013          18-Dec-13            Q          Q          Q

*Source: IMF staff report informational annex and related sections as provided in the content unit.*

### 1.      The budget performance for 2013 is projected to be better than previously

### _cr1447 - 1.      The budget performance for 2013 is projected to be better than previously

### Budget performance for 2013: outturn and drivers
- Overall fiscal deficit for 2013: projected at 3¼ percent of GDP (December data on budget execution).
- Improvement relative to earlier expectations:
  - Budget Law expected: 4¼ percent of GDP.
  - Staff Report projected: 3½ percent of GDP.
- Main drivers of better-than-expected performance:
  - Lower expenditures: around 0.5 percent of GDP, owing to tighter spending control.
  - Higher revenues: around 0.7 percent of GDP, owing largely to greater-than-anticipated revenue collections from one-off measures (examples given: taxes collected on “trapped” profits of multinationals and from the sale of start-up companies in the high-tech sector).
  - Additional revenue boosts: rebound in the stock market and higher real estate taxes.

### Revised expenditure rule submitted to the Knesset
- New formula characteristics:
  - Based on a target debt ratio of 50 percent of GDP (10 percentage points less than what is used in the prevailing rule).
  - Caps real expenditure growth at population growth (currently 1.7 percent) plus one percent.
- Implication: the new formula implies lower real expenditure growth, consistent with deficit targets set through 2020.

### Government debt issuance (January 22, 2014)
- Amount raised: €1.5 billion in new debt issuance.
- Auction details:
  - Initial offering aimed at raising €1 billion; investor bids totaled €5.7 billion, inducing the Government to increase the amount sold.
  - Maturity: 10 years.
  - Yield: 2.932 percent.

### IMF Executive Board assessment — macroeconomic context and policy guidance
- Macroeconomic snapshot and risks:
  - Israel's economic fundamentals: described as strong — GDP growth solid, unemployment low, inflation within 1–3 percent target range, financial sector in good health, external position strong.
  - Growth outlook excluding new large-scale natural gas production: expected to remain moderate due to planned fiscal tightening and further strengthening of the currency, offsetting some pick-up in external demand.
  - Key challenges highlighted: public debt remains high despite recent decreases; rapid house price inflation poses financial stability risks; large employment and productivity gaps between general Jewish population, Ultra-Orthodox Jewish (Haredi) and Israeli-Arab communities could undermine long-run growth.
- Policy prescriptions endorsed by the Board:
  - Monetary policy: with uncertain global environment and headwinds from fiscal tightening and exchange rate appreciation, monetary policy should "stay the course"; Bank of Israel should respond nimbly to changes; if growth prospects improve more than anticipated, the monetary stance should be gradually normalized.
  - Macroprudential policy: further tightening may be needed to alleviate risks of a boom-bust cycle in the housing market.
  - Fiscal policy:
    - Minimize likelihood of slippages in meeting deficit target via firm adherence to the expenditure ceiling and full implementation of announced revenue measures.
    - Further adjustment required in 2015 and beyond to put public debt on a firmly downward trend, alongside strengthening fiscal institutions.
    - Embedding current fiscal rules within a fully-fledged medium-term fiscal and expenditure framework would strengthen institutions; most Directors supported establishing an independent fiscal council to enhance credibility and transparency (some Directors viewed current framework as adequate).
  - Structural reforms: boost productivity, increase competition in non-tradable sector, and promote labor force participation of Haredi and Israeli-Arab populations to reduce poverty and inequality and bolster long-run productive capacity.
  - Financial sector: establish a Financial Stability Committee led by the Bank of Israel focused on macroprudential policies in normal times; legislate legal reforms to strengthen the bank resolution framework as soon as practicable.

### Selected quantitative indicators and fiscal/financial balances (as presented)
- Growth and labor market:
  - Real GDP growth: 3.4 percent (2012); Staff est. 3.4 percent (2013); Staff proj. 3.4 percent (2014).
  - Unemployment rate: 6.9 percent (2012); Staff est. 6.4 percent (2013); Staff proj. 6.7 percent (2014).
  - Output gap (percent of potential): 0.6 percent (2012); Staff est. 0.2 percent (2013); Staff proj. 0.1 percent (2014).
- Prices and external:
  - Overall CPI (end period): 1.6 percent (2012); Staff est. 1.8 percent (2013); Staff proj. 2.0 percent (2014).
  - Current account: 0.3 percent of GDP (2012); Staff est. 0.6 percent of GDP (2013); Staff proj. 0.7 percent of GDP (2014).
- Public finance (percent of GDP):
  - Central government revenues and grants: 24.9 percent (2012); Staff est. 25.6 percent (2013); Staff proj. 25.7 percent (2014).
  - Central government total expenditure: 28.9 percent (2012); Staff est. 29.1 percent (2013); Staff proj. 28.5 percent (2014).
  - Central government overall balance: -4.1 percent (2012); Staff est. -3.5 percent (2013); Staff proj. -2.8 percent (2014).
  - General government overall balance: -3.9 percent (2012); Staff est. -3.5 percent (2013)3/; Staff proj. -3.0 percent (2014).
  - General government debt: 68.2 percent of GDP (2012); Staff est. 67.5 percent (2013); Staff proj. 66.6 percent (2014).
  - Note: "The preliminary outturn for the fiscal deficit in 2013 is estimated at 3¼ percent of GDP." (footnote 3/)
- Financial sector metrics:
  - Core capital ratio (pre-2015 gradual Basel III adoption): improved to 9.3 percent.
  - Nonperforming loans (NPLs): 3.1 percent of total loans.
  - Deposits equal 89 percent of outstanding credit.
  - Foreign currency external debt (general government): 10.6 percent of GDP (2012); Staff est. 7.8 percent (2013); Staff proj. 7.0 percent (2014).
- Exchange rate and reserves:
  - Foreign reserves (end period, billions of U.S. dollars): 76 (2012); Staff est. 82 (2013); Staff proj. 85 (2014).
  - Bank of Israel policy rate (percent, end year): 2.00 (2012); 1.00 (2013).
  - 10-year government bond yield (percent, average): 4.33 (2012); Staff est. 3.85 (2013).
  - January 22, 2014 bond auction: average yield of 2.932 percent; bid-to-cover ratio implied by bids of €5.7 billion against initial €1 billion offer.

### Monetary policy, exchange-rate intervention, and macroprudential measures (authorities' account)
- Monetary policy stance:
  - Policy rate reduced during 2013 from 2 percent to 1 percent to support activity, ease appreciation pressures, and support private consumption and investment.
  - Market-based inflation expectations remained close to midpoint of 1–3 percent inflation target band.
- Exchange rate intervention policy (two pillars):
  - Non-discretionary program: purchases communicated in advance to offset effect on current account of lower energy costs from local natural gas production; October 2013 announcement that 2014 purchases will amount to US$ 3.5 billion.
  - Discretionary intervention: used occasionally to curb excessive appreciation beyond fundamentals.
- Macroprudential measures to address housing market risks:
  - Direct measures: cap LTV at 70 percent; cap debt service to income at 50 percent; limit mortgage repayment period to 30 years.
  - Indirect measures: a series aimed at reducing risks associated with mortgage lending to banks and households.
  - Assessment: too early for full impact evaluation; initial evidence and staff assessment point to effectiveness of direct measures; BoI stands ready to tighten if insufficient.

### Financial stability and institutional reforms
- Financial system characterization: solid, conservative, banks stable, liquid, and profitable.
- Key indicators:
  - NPLs: 3.1 percent of total loans.
  - Deposits equal 89 percent of outstanding credit.
  - Direct exposure to international markets is low.
- Institutional actions and recommendations:
  - Establish a formal Financial Stability Council / Financial Stability Committee with clear mandate and operational independence.
  - Progress on bank resolution framework: draft law for early intervention and resolution in process; authorities expect to resolve remaining issues soon and appreciated TA support.

*IMF Executive Board Concluding Statement and related staff and authorities' remarks (February 10, 2014).*

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