## Israel: Staff Concluding Statement of the 2017 Article IV Mission

_IMF News, February 8, 2017_

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## Bibliographic details
- Published: February 8, 2017

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### Recent developments and outlook
- Israel’s economy grew solidly in 2016 with early estimates of 3.8 percent growth in 2016, partly reflecting one-off factors (notably a surge in vehicle purchases).
- Job creation was strong, at almost 3 percent in 2016, helping reduce the unemployment rate to 4.4 percent by the fourth quarter.
- CPI inflation was ‑0.2 percent in 2016; core inflation was 0.4 percent.
- Near-term outlook: real GDP growth around 3 percent in 2017, and expected to remain around 3 percent in the medium term.
- Risks to the outlook:
  - Regional tensions and uncertain trading partner growth.
  - Domestic constraints from infrastructure or skills bottlenecks.
  - Insufficient progress closing labor participation and productivity gaps for the Haredi (Ultra‑Orthodox Jewish) and Israeli‑Arab populations.

### Monetary policy
- Inflation dynamics:
  - Inflation expected to increase gradually, but timing uncertain.
  - Upward pressures: rising wage growth, higher foreign inflation and commodity prices.
  - Downward pressures: lower import prices partly due to shekel appreciation; narrowing margins (competition, internet purchases).
- Policy recommendation:
  - Maintain accommodative monetary policy pending a durable rise in inflation and inflation expectations.
  - Avoid premature tightening; wait until inflation is heading back toward the 1-3 percent target band on a durable basis.
- Observations:
  - BOI’s accommodative stance in 2015-16 was appropriate given foreign spillovers and helped keep long-term inflation expectations near the center of the 1-3 percent target band.
  - Some decline in short- and medium-term expectations argues for caution.

### Housing and macroprudential policies
- Recent developments:
  - Real housing prices doubled since 2007 and rose almost 8 percent on average in 2016.
  - Housing completions have not kept pace with household formation; affordability is low with house price-to-income ratios significantly above many other countries.
  - Growing share of households rent; rising rents reduce disposable income, affecting low‑income households most.
- Recent reforms and assessment:
  - Bringing relevant authorities under the Ministry of Finance is expediting land planning.
  - Housing Cabinet actions address financing and urban renewal impediments; these should be expanded where supply is most needed.
  - Buyer’s Price scheme helps some households buy a first house but benefits relatively few lottery winners and incurs significant off‑budget fiscal cost.
  - Some recent tax measures may dampen near-term price rises through investor sales, but without supply changes price trends likely persist.
- Policy recommendations to durably expand supply:
  - Correct municipal incentives that discourage land release and timely building permits (residential property taxes are well below commercial rates).
  - Improve public transport to relieve housing shortages in major centers.
  - Reduce construction costs and build times by streamlining building regulations and opening residential construction to foreign competition.
  - Charge taxes on undeveloped privately held land to promote development.
  - Continue BOI macroprudential monitoring; measures have helped avoid excessive household debt.

### Financial sector policies
- Supervisory strength and reforms:
  - Israel’s banking system robustness stems from rigorous BOI supervision.
  - A shift toward more risk‑focused supervision is welcome to lower compliance costs.
  - Establishment of an independent Capital Markets, Insurance, and Savings Authority is notable.
  - Implement Solvency II for insurance to ensure sector resilience.
  - Legislation for the Financial Stability Committee should be enacted to improve regulator coordination and information sharing.
- Measures to improve efficiency and competition:
  - Banking ID card available to improve customer information; a credit register is in development.
  - Policies enabling electronic banking and expanded access to payment systems; increased sharing of IT infrastructure.
  - Separation of credit card companies from the two largest banks to promote competition, while keeping BOI supervision.
  - Enact securitization legislation to facilitate funding of payment companies.
- Policy recommendations for financial stability and competition:
  - Establish deposit insurance with appropriate coverage limits and enhance bank resolution tools before lowering minimum capital requirements for bank entry.
  - Safeguard operational independence of financial regulators to reduce regulatory uncertainty and avoid deterring new entrants.

### Fiscal policy
- 2016 performance:
  - Central government deficit: 2.1 percent of GDP (below the 2.9 percent target).
  - General government debt declined by almost 2 percentage points to 62 percent of GDP.
- 2017–18 budget and outlook:
  - Central government deficit targets for both 2017 and 2018 raised to 2.9 percent of GDP, from 2½ and 2¼ percent respectively.
  - In practice, the deficit is likely to be about 2¾ percent of GDP in 2017‑18 given prudent revenue projections and firm spending control.
  - On existing commitments, deficits of about 3 percent of GDP can be expected in later years.
  - Debt ratio projected to rise 1½ percentage points in the next five years, to above the advanced economy median.
- Policy priorities and recommendations:
  - Fiscal policy should do more to support growth potential via reforms in education and vocational training, and increased resources for implementation.
  - Timely implementation and likely increased investment in public transport to address road congestion and productivity threats.
  - Contain pressures on healthcare resources while recognizing public service queue issues; recent steps to contain private insurer pressures are appropriate even at some budgetary cost.
  - Protect fiscal buffers while funding investments by:
    - Adhering to the multi‑year defense budget; defense spending is 6 percent of GDP and 20 percent of central government spending.
    - Raising efficiency in central government administration and improving public procurement.
    - Enhancing revenues by scaling back tax benefits (total 5 percent of GDP), replacing blanket VAT exemptions with targeted transfers, and improving revenue administration.
  - Fiscal target:
    - Aim to keep the central government deficit around 2 percent of GDP on average over the cycle (equivalent to 3 percent of GDP for general government on a Government Finance Statistics basis).
    - A somewhat higher deficit could be appropriate temporarily to accommodate upfront reform costs with clear benefits for potential growth.
  - If the deficit is below target in 2017, authorities should lock in overperformance and avoid tax cuts or spending increases without offsets.
- Medium-term framework:
  - Improvements: enhanced commitment controls (the Numerator rule) and an expenditure review procedure for 2017‑18.
  - Political commitment is critical: government must observe the Numerator rule and include concrete measures in budgets to close deviations from fiscal rules.
  - Set clear criteria that limit changes in spending and deficit ceilings to exceptional cases.

### Structural reforms
- Inclusiveness and labor participation:
  - Haredi and Israeli‑Arabs together make up 26 percent of the population but 43 percent of primary school children.
  - Continued progress needed to raise labor participation of Haredi men and Israeli‑Arab women and to close education and skills gaps.
- Product and market reforms:
  - Review and modernize regulation to achieve public policy goals at lower cost; consider “one‑stop shop” for timely administration.
  - State enterprise reform (notably in electricity) to reduce economy‑wide costs and make efficient use of natural gas.
  - Lower barriers to external competition: expand quota increases and tariff cuts (especially on food), simplify import procedures, align Israeli standards with other advanced economies, and ease restrictions hindering foreign competition in services.
- Targeted actions to reduce participation and productivity gaps:
  - Skills: expand promising innovative employment programs for Haredi men and Israeli‑Arab women (currently 0.2 percent of GDP) with close employer coordination.
  - Jobs: increase investments in connecting Haredi and Israeli‑Arab towns to main roads and public transport; support local business development and access to financing.
  - Support for working poor:
    - Minimum wage has risen to about 51 percent of average wages.
    - Priority is to substantially increase the Earned Income Tax Credit (EITC), which currently averages just 7 percent of the minimum wage, at a total fiscal cost of 0.1 percent of GDP.
    - Expand EITC eligibility, including lowering the minimum earnings threshold, to strengthen families’ capacity to support education and health and to reinforce work incentives.

### Closing
- The mission team thanks the Israeli authorities and other counterparts for the excellent discussions and warm hospitality.

*Israel: Staff Concluding Statement of the 2017 Article IV Mission*

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## References

- [Israel and the IMF](http://www.imf.org/external/country/ISR/index.htm)
- [IMF Policy Advice -- A Factsheet](https://www.imf.org/en/about/factsheets/imf-surveillance)
- [Mission Concluding Statements](https://www.imf.org/en/news/searchnews)
- [PRESS CENTER](http://presscenter.imf.org/)
- [https://www.imf.org/en/home](https://www.imf.org/en/home)

_Source: https://www.imf.org/en/news/articles/2017/02/08/mcs02082017-israel-staff-concluding-statement-of-the-2017-article-iv-mission_