Public Information Notice No. 12/33

Public Information Notice: IMF Executive Board Concludes 2012 Article IV Consultation with Israel

April 2, 2012

On March 27, 2012, the Executive Board of the International Monetary Fund (IMF) concluded the 2012 Article IV consultation with Israel.¹

Background

Israel’s economy remains strong with GDP growing 4.7 percent in 2011, led by robust private consumption and buoyant investment. However, the global downturn is slowing Israeli growth, with 2012 GDP growth expected at 2.8 percent. Nevertheless, Israel’s fundamentals are strong: inflation and inflation expectations are squarely within the 1–3 percent target range, unemployment is at historic lows, the net international investment position is a surplus, and public debt has fallen steadily to below 75 percent of GDP. These strengths are also underpinned by Israel’s sound institutional frameworks, including fiscal rules and a new central bank law. Furthermore, following recent discoveries of natural gas fields, Israel may become a net energy exporter in coming years.

With the global and domestic economy slowing, the Bank of Israel (BoI) began monetary easing cycle from September 2011, cutting the policy interest rate from 3.25 percent to 2.5 percent in steps. On the fiscal side, automatic stabilizers are operating fully, and the economic slowdown in the latter half of 2011 resulted in lower-than-projected revenue collections and a smaller-than-targeted headline fiscal consolidation. The budget deficit was 3.3 percent of GDP in 2011 and is projected at around 3.4 percent of GDP in 2012, exceeding the target almost 1½ percentage points of GDP. Meanwhile, appreciation pressures on the shekel have eased, and now the shekel is judged at around equilibrium.

The Financial Stability Assessment Program (FSSA) Update concludes that the financial system is stable, with the BoI maintaining strongly proactive supervisory practices, which have preempted the systemic risks. Banks’ cross border activities are limited, with negligible direct exposures to peripheral advanced European countries. However, real estate markets boomed over the past several years, and banks have significantly increased their exposures to housing and construction sectors. Moreover, some large corporate groups face rising risk premia in bond markets and sizable debt refinancing needs in the coming period.

Poverty remains among the highest in OECD countries, despite strong growth. This primary reflects low labor force participation rates among the Arab-Israeli and Haredi minority populations.

Executive Board Assessment

Executive Directors commended the authorities for sound macroeconomic management and policy frameworks that have underpinned Israel’s strong economic performance in recent years. Directors noted, however, that global uncertainties and elevated regional strains pose risks to the outlook, and that longer-term domestic challenges underscore the need to push ahead with the reform agenda.

Directors considered that near-term economic prospects remain favorable. In the face of a weak external environment, reductions in the policy interest rate and the free play of the automatic stabilizers in the context of the two-year budget have appropriately supported activity, although the 2012 deficit target will be overshot.

Directors stressed that fiscal policy should remain focused on reducing the debt-to-GDP ratio over the medium term. Accordingly, the total spending limits in this year’s budget and the ceilings under the expenditure rule for the 2013 and 2014 budgets should be respected, and a sizeable consolidation should be secured in 2013–14. In that context, further revenue mobilization would be appropriate.

Considering further reforms to the fiscal frameworks, Directors recommended that the deficit targets should be adjusted to take account of cyclical factors. Most Directors supported establishing an autonomous Fiscal Council to reinforce the momentum toward medium-term sustainability. In addition, Directors commended the authorities’ plan to place natural resource revenues in a sovereign wealth fund.

Directors noted that the FSSA Update confirmed the soundness of Israel’s financial institutions. However, given global risks, high concentration in the financial sector, and elevated house prices, they welcomed continued proactive supervision and plans to raise bank capital ratios. Directors also encouraged a review of the financial crisis management framework, as well as the establishment of a Financial Stability Committee to improve the coordination of supervisory agencies.

Directors noted that fiscal tightening would create space for further monetary easing. However, such easing would have to be evaluated against wage trends and second round effects of rising oil prices, with house price concerns addressed via macroprudential tools. Directors encouraged further strengthening of the monetary framework, including enhancement of central bank autonomy over remuneration of its staff and lengthening the horizon of published forecasts. They also agreed that, with the exchange rate broadly at its equilibrium level, a de facto free floating exchange rate regime should be maintained, although the option to intervene to sustain orderly conditions continues to be viable.

Directors emphasized macro-social concerns, notably that labor participation among the Arab-Israeli and Haredi populations is low, with adverse effects on growth prospects, poverty reduction, and fiscal sustainability. They welcomed recent reforms to address these concerns, while emphasizing that more is needed.