Israel: Staff Concluding Statement of the 2022 Virtual Article IV Mission

IMF News, February 6, 2022

Source details

Canonical URL: Israel: Staff Concluding Statement of the 2022 Virtual Article IV Mission

Israel “managed the pandemic exceptionally well,” with a “world-leading vaccination campaign” that boosted confidence and mitigated pandemic impact.
Government and central bank support were “prompt and ample,” including fiscal measures of “7.6 percent of GDP in 2020 and 4 percent of GDP in 2021.”
The Bank of Israel (BOI) provided liquidity and measures to keep credit flowing; programs included government and corporate bond purchases and lending incentives.
After a mild downturn in 2020, “Real GDP exceeded its pre-pandemic level,” with “growth around 6.5 percent in 2021.”
High-tech sector led the recovery; private consumption gained speed. Unemployment declined significantly; job vacancies are high across all sectors.
Inflation surged due to global factors and a rebound in domestic demand but “remained within the BoI’s target range.”

“The economic recovery is projected to solidify in 2022 and over the medium term.”
Growth drivers: strong private consumption, investment, and net exports.
Inflation expectation: “With temporary factors winding down, inflation is projected to ease and stay within the BOI’s target band over the medium term.”
Key downside risks identified:
- New COVID-19 variants posing a threat to growth.
- Geopolitical risks causing socioeconomic and political disruption.
- Tightening global financial conditions potentially causing a stock market fall, lower government revenues, and a rise in the cost of capital.
- Long-standing challenges: productivity, labor force participation, and human and physical capital gaps.

“The 2022 fiscal stance is appropriate,” and the medium-term path aims to put debt on a downward path.
Short-term: pandemic support in 2022 should “target the most affected sectors and vulnerable population groups.”
Medium-term: refocus on reducing public debt and rebuilding pre-pandemic buffers.
Concerns and recommendations:
- Planned consolidation “relies on future expenditure restraint that may be challenging given Israel’s already low civil spending.”
- Conduct a review of public spending efficiency.
- Scope to increase tax revenues: make the tax system more progressive and broaden the tax base, including by “reducing pension tax exemptions and personal and corporate tax incentives for selected groups.”
- Increase spending on active labor market policies, education reform, infrastructure, and climate goals.
- Strengthen the fiscal framework: review fiscal rules, size of fiscal buffers, ability to face exceptional events, and consider establishing an independent fiscal council.

BOI measures during the pandemic:
- Ample liquidity provision “near 8 percent of GDP” through bond purchases and SME lending incentives.
- In January 2021, deployed a “sizeable pre-announced program of foreign exchange intervention (6.5 percent of GDP).”
Recent actions: halting of liquidity support programs and end of the preannounced foreign exchange purchases.
Inflation concerns and guidance:
- Although inflation is “contained” and “remains within the BOI’s target range,” rising service prices, “a high rate of capacity utilization,” and rising wages in some sectors indicate incipient underlying inflationary pressures.
- One- and two-year ahead inflation expectations have “risen quickly in line with consumer price growth.”
- Recommendation: “continued close monitoring of inflation developments. If underlying upward pressures become more salient, the BOI should be ready to tighten monetary policy.”
- If tightening is needed, foreign exchange purchases should taper off to allow the shekel to be determined by market forces, “without precluding future purchases” if appreciation pressures threaten to move inflation or inflation expectations below the target band.

Financial system performance:
- Macroprudential easing, BOI measures, and solid bank balance sheets allowed banks to expand credit, with robust business and mortgage lending growth in 2021.
- Rapid recovery improved asset quality and profitability; unwinding of COVID-19 support and removal of dividend restrictions were timely.
Housing market concerns:
- “Housing prices and affordability are a significant concern.”
- Rapid rise in housing prices raises concerns of price misalignment; “house price‑to‑income and price-to-rent ratios” are at high levels.
- BOI actions: reversed easing of the loan-to-value limit and the capital requirement for housing loans.
- Recommendation: consider further tightening of macroprudential measures (for example, lowering the debt-service-to-income limit) to reduce banks’ exposures to housing market risks and prevent potentially unsustainable borrowing.
Regulatory architecture:
- Israel’s conservative regulatory approach has protected the financial system, but greater competition and financial innovation will test this approach.
- Establishment of a committee to review the financial supervision architecture is “welcome.”

Objective: boost productivity, facilitate labor reallocation, and prevent widening inequality.
Labor market and skills recommendations:
- Expand vocational training for disadvantaged adults and encourage private support and improved training quality.
- Greater adaptation of education streams to digitalized labor market needs.
- Specific measures: improve core curriculum of Haredi students; greater Hebrew knowledge among Arab students; greater investment in basic education; strengthen teacher quality in disadvantaged communities.
Product market reforms:
- Reduce tariff and non-tariff trade barriers to promote resource allocation, investment, innovation, competition, and lower trade costs for smaller firms.
Infrastructure:
- “Infrastructure spending needs to accelerate further if Israel is to close the infrastructure stock gap relative to other OECD countries.”
- Priority: transportation to ease congestion and improve job accessibility; upgrade digital infrastructure to expand access in poor communities to support labor reallocation.

Authorities have strengthened commitment to climate change and made progress on policies and targets.
Specific measures:
- Gradual phase-in of excises on coal and other fuels between “2023–28.”
- Phase-out of coal energy production by “2025.”
Additional recommended options: larger increases in carbon prices and greater regulatory and fiscal support for Israel’s innovative green technologies.

The IMF team thanked interlocutors at the Bank of Israel, the Ministry of Finance, the National Economic Council, the Ministry of Energy, the Ministry of Environmental Protection, the Ministry of Health, the National Insurance Institute, the Israel Tax Authority, the Capital Markets, Insurance and Savings Authority, the Israel Securities Authority, labor unions, think tanks, and other private sector representatives for constructive and fruitful discussions.

Source: Israel: Staff Concluding Statement of the 2022 Virtual Article IV Mission