IMF Executive Board Concludes 2017 Article IV Consultation with Israel
March 28, 2017
On March 24, 2017, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation [1] with Israel.
Israel is enjoying strong economic growth, estimated at 4 percent in 2016, supported by strong domestic demand—partly due to high vehicle sales ahead of a tax increase—and an export rebound. Unemployment declined to 4.4 percent in Q4 2016 and wage increases have picked up. Nonetheless, inflation remained below the 1–3 percent target range of the Bank of Israel (BOI), reflecting external factors and government measures to reduce the cost of living. The BOI has held the policy rate at 0.1 percent since February 2015 and stated that monetary policy in Israel will remain accommodative for a considerable time. Strong revenues contained the fiscal deficit to 2.1 percent of GDP in 2016 and the public debt ratio declined to 62 percent of GDP.
Housing prices rose at an average pace of 7.5 percent y/y in 2016, even after nearly doubling in real terms since 2007. Housing loans grew at a similar pace, bringing household debt to a still modest 74 percent of disposable income. Residential investment has risen but completions remain below estimated household formation. Some softening in the housing market emerged recently, with mortgage volumes and housing sales slowing and price declines recorded in late 2016, which may reflect a rise in mortgage interest rates driven by earlier macroprudential measures together with changes in real estate taxes. Israel’s banking system is sound and the authorities are taking a range of measures to promote efficiency and competition in the banking sector, including the separation of credit card companies from the two largest banks.
Israel’s near-term economic outlook is positive. Growth is expected to settle around 3 percent and inflation is likely to rise gradually, although with significant uncertainty around the timing of such a rise. In the longer term, however, the rising share of Haredi (ultra-orthodox Jews) and the Israeli-Arabs in the working-age population could slow potential growth and raise poverty given the lower labor force participation and average productivity of these groups.
Executive Board Assessment [2]
Executive Directors commended Israel’s sound policies, which have resulted in strong macroeconomic performance. While noting that the near-term outlook remains favorable, Directors also recognized that the country faces important structural challenges from elevated housing prices, high incidence of poverty and inequality, low labor productivity, and low labor force participation in some groups of the population. Against this backdrop, Directors called for continued sound policies that safeguard macroeconomic and financial stability and for deeper structural reforms that help improve potential growth, while reducing poverty and inequality.
Directors noted that the Bank of Israel (BOI) has maintained an appropriately accommodative monetary policy given that inflation remains below target. Most Directors concurred that monetary policy tightening should await clearer evidence of inflation returning toward the target in a lasting manner so as to avoid a premature policy tightening, although a few Directors considered that an earlier tightening might be warranted.
Directors called for reforms that expand housing supply in order to improve affordability—particularly for young and low-income households—and thereby also limit macro-financial risks from this sector. They welcomed recent progress in expediting land planning, and encouraged steps to improve municipal incentives for residential development, increase land privatization and urban renewal, and reduce construction times and costs. Directors considered macroprudential policies to be appropriately tight, and welcomed the BOI’s continued vigilance in relation to macro-financial risks.
Directors agreed that the banking system is sound. They welcomed the authorities’ plans to promote competition and efficiency in the sector, but underscored the importance of safeguarding financial stability when implementing these reforms. Directors noted that the separation of two credit card companies from banks should be supervised closely. They agreed that steps to facilitate new entry into the banking sector should be complemented with a strengthening of the bank resolution and deposit insurance frameworks. Directors also supported the establishment of the Financial Stability Committee to improve regulatory coordination.
Directors noted that the 2017–18 budget allows for higher fiscal deficits, which could reverse the declining trend in the public debt ratio. Against this backdrop, most Directors agreed that currently favorable macroeconomic conditions provide an opportunity to protect fiscal buffers by reducing the central government deficit to around 2 percent of GDP in coming years, including by saving any revenue over-performance in 2017. A number of Directors considered that the increases in the fiscal deficit and debt ratio could be accommodated without jeopardizing debt sustainability, especially given the need to implement structural reforms and raise essential public investments. More generally, Directors supported additional spending on education, training, and infrastructure, financed by increased central government efficiency, procurement savings, and lower tax benefits. Directors welcomed the improvements in the medium-term fiscal framework, especially the recent strengthening of expenditure commitment controls, and emphasized that political ownership of fiscal targets is key to their effectiveness.
Directors stressed that inclusiveness is central to sustaining strong growth and reducing poverty. They recommended expanding well-performing active labor market programs and promoting job creation for communities with lower participation, including through better transport connections and financing access for business development. To more immediately reduce poverty while reinforcing work incentives, Directors generally favored increasing the Earned Income Tax Credit. They also encouraged product market reforms, especially lowering trade barriers and regulatory burdens, so as to increase competition, boost productivity, and reduce living costs.
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[1] Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.
[2] At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.
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