Israel -- 2007 Article IV Consultation Concluding Statement of the IMF Mission
IMF News, December 9, 2007
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- Published: December 9, 2007
Mission overview and key judgment
- The economy is performing exceptionally well, requiring continuation of strong economic policies.
- Sound policies and unprecedented global growth have driven the improvement; however, public debt is "not much lower than before the latest recession" and vulnerability to shocks remains high.
- Priority policy needs:
- More public debt reduction to safeguard the government's ability to respond to difficult times.
- Further improvements to the financial sector framework to enhance resilience.
Economic developments and prospects
- Growth outlook:
- Real GDP growth expected "around 4 percent from 2008," compared with "about 5½ percent in 2007."
- Domestic conditions supportive: broad-based GDP growth; rising real incomes including for the poor; improved corporate profitability and balance sheets; good employer–trade union cooperation; solid competitiveness.
- External conditions weakening: global financial turmoil and high oil prices reduce demand in key export markets; risks lie on the downside.
- Inflationary pressures:
- Likely to mount given rising global inflation; slowing productivity; robust labor demand; accelerating housing services prices.
- Offsetting factors: subdued wage pressures and appreciation of the sheqel (NIS) against the US dollar (US$), though these are likely to weaken.
- Unemployment falling to levels where supply bottlenecks appear; higher wage growth is likely.
- External current account is retreating from unprecedented highs, diminishing medium-run pressure for NIS appreciation.
- Link between NIS/US$ exchange rate and housing services prices is weakening.
Monetary policy developments and framework
- Policy stance:
- Higher interest rates are "probably needed" for inflation to stay within the "1-3 percent target range" over the medium run.
- Uncertainty about external demand and higher corporate bond risk premia argue for caution in raising rates.
- Well-anchored inflation expectations provide time to assess incoming developments.
- Policy implementation and communication:
- Conduct of monetary policy judged "exemplary" by stability of inflation expectations.
- Support for publishing quarterly inflation reports and releasing a model-based inflation and interest rate forecast.
- Suggested enhancements: clarify role of forecasts in decision making; clarify relationship between forecasts for different macro variables (notably the exchange rate); clarify the monetary policy horizon.
- Recommendation for "swift adoption of the draft Bank of Israel law" to strengthen institutional foundations.
Fiscal policy challenges and institutions
- Shorter-run requirements: maintaining a strong fiscal policy
- Fiscal performance: higher-than-budgeted tax revenue allocated to debt reduction; well-managed expenditure.
- Central government budget likely close to balance by end-2007, implying a general government deficit of "roughly 1 percent of GDP" on an internationally comparable basis.
- Central government deficit ceiling of "1.6 percent of GDP" should be treated as a ceiling, not a target.
- Maintain strict compliance with the "1.7 percent expenditure growth ceiling" and allocate revenue overperformance to debt reduction to keep central government budget close to balance.
- Debt reduction lowered interest payments by "some NIS 10 billion."
- Longer-run objectives: securing the welfare of younger generations
- Demographic and labor force projections:
- Labor force growth may decelerate "from around 2½ percent per annum during 2000-05 to around 1½ percent during 2010-15."
- Projections suggest that by "2050 only about 2-3 people in the workforce will support each retiree," down from "more than 4 people today."
- Implications: lower economic growth and upward pressure on public spending; debt service consumes "the equivalent of about half of all welfare spending."
- Policy prescription:
- Continue rapid public debt reduction; prioritize debt reduction over tax cuts.
- Objective to achieve "at least the much safer 60 percent ratio by 2015" from current "82 percent public debt to GDP ratio."
- Achieving this would require keeping central government accounts in balance, implying a general government deficit of "about 1 percent of GDP on an internationally comparable basis through 2015."
- Scope exists to simplify the comparatively complex tax system, including by reducing tax exemptions.
- Fiscal governance improvements:
- Budget documentation should include multi-year scenario analysis of conjunctural and other risks and a long-term fiscal sustainability analysis.
- Strengthen fiscal surveillance, combine better budget analysis, strong rules, and independent, nonpartisan fiscal evaluation.
Financial sector developments and framework
- Progress to date:
- Ambitious reforms fostering a stronger and more diversified financial system; financial soundness indicators improving though capital and solvency levels remain lower than in many advanced economies.
- Shift in financing away from banks to bond markets and institutional investors.
- Authorities progressing toward international standards: preparing for Basel II and Solvency II; introducing risk-based supervision; strengthening insurance regulation; securities regulator progress; primary dealer system for government bond market; work on repo market and securitization; introduction of real time gross settlement.
- Main remaining challenges (five key issues):
- Need for regulators to build expertise to support the more complex regulatory system; requires greater recruitment flexibility and competitive pay scales.
- Risk that rapid regulatory change may be inconsistent with high-quality implementation; major regulatory initiatives should undergo careful cost-benefit analysis.
- Need for appropriate balance between principles-based and rules-based approaches to avoid stifling market entry, innovation, and accountability.
- With more competition comes more risk; require strong capacity to manage and resolve financial stress, supplementing the Memorandum of Understanding with financial crisis scenarios to identify gaps.
- Insurance supervisor needs independence to set solvency standards, enforce managerial changes, resolve failing institutions, and perform group-wide supervision.
- International integration:
- Israel's formerly closed financial system is opening to the world; a coherent vision to guide international integration is recommended as a key task of the capital markets committee.
Source: Israel -- 2007 Article IV Consultation Concluding Statement of the IMF Mission (December 9, 2007).