|
Bank of Israel Annual Report, 2006
Summaries
|
|
Chapter 1
The Economy and Economic Policy
|
|
 |
Developments in the economy were particularly positive this year, and were reflected in several areas; GDP grew by 5.1 percent, led by an increase in high-tech exports ;rapid growth has continued now for more than three years ;employment fell to its lowest this decade and reached 7.7 percent this year; the debt to GDP ratio fell significantly ;the surplus in the current account was very high, and foreign investment in Israel reached record levels. The pace of growth and market stability were all the more impressive in light of several shocks, primarily the Second Lebanon War.
|
|
The character of economic growth changes gradually as the recovery part of the economic cycle nears its full potential and the long-term growth components--expansion in factors of production and increase in productivity--become more important.
|
|
Continued growth worldwide ,articularly in the high-tech industries, the relatively low number of terror attacks and the macroeconomic policies provided the favorable background conditions for economic growth. The impact of the war was modest.
|
|
The government budget deficit was lower than the ceiling ,and public expenditure grew in line with its target. While the public debt to GDP ratio fell considerably ,its level was still high .An increase in defense spending following the war sharpens the challenges faced by fiscal policy.
|
|
The consumer price index fell by 0.1 percent this year ,that is inflation significantly deviated below the lower boundary of the target range. The sharp appreciation of the shekel, influenced by the dollar's global weakness, greatly contributed to this deviation, which occurred in the second half of the year.
|
|
As a response to the sharp fall in prices which began in September ,the Bank of Israel reduced the interest rate by a cumulative 1.5 percent in the last quarter of 2006 and the beginning of 2007 .This followed the rise in the interest rate at the beginning of the year, when inflation exceeded the target range.
|
|
Long-term forces are acting to increase the current account surplus, though the sharp increase of the surplus this year was mainly affected by one-time factors.
|
|
The resilience of the banking system improved ,though that of insurance companies declined .It is important to step up the regulation of institutional investors ,particularly the insurance companies
|
|
The low employment rate in certain segments of the population and the low incomes of workers with poor levels of education are central causes of poverty .It is recommended that a number of steps be taken to increase employment and the earning potential of these populations ,including an earned income tax credit system in line with the government's decision, and a cut in the number of foreign workers.
|
|
 |
The Economy and Economic Policy -
PDF file (1.30Mb)
|
|
Back
|
|
|
Chapter 2
GDP, Productivity, and the Principal Industries
|
|
|
The trends of rapid growth and falling unemployment rates that typified the Israeli economy in 2004 and 2005 continued in 2006.
|
|
The economy's ambient conditions improved and the macroeconomic policy allowed them to find full expression.
|
|
The hostilities in the north dealt economic activity only a temporary and relatively minor blow-for reasons including the healthy state of the economy before the hostilities started.
|
|
As growth persists, the contribution of the cyclical element has contracted ,and that of long-term factors, especially improvements in the production process, has increased. Total factor productivity has improved perceptibly since the beginning of the decade after stagnating in the 1990s, despite its decline in the years of recession.
|
|
The combination of a higher national savings rate and a lower gross domestic investment rate brought about a large and aberrant surplus on balance-of-payments current account.
|
|
The growth rate of manufacturing output accelerated, mainly due to an upturn in exports. In the past three years, manufacturing industries' exports have been powered by high-tech and innovative products, which are human-capital intensive.
|
|
Construction activity edged upward but housing starts declined due to an increase in the prices of raw material, an upturn in construction workers' wages, and continued sluggish demand in most parts of the country.
|
|
GDP per worker in Israel is on a par with the OECD average but falls short of the US level. Israel's per capita GDP is under the OECD average, mainly due to its relatively low participation rate in the labor force.
|
|
|
GDP, Productivity, and the Principal Industries -
PDF file (1.91Mb)
|
|
Back
|
|
|
Chapter 3
Inflation and Monetary Policy
|
|
|
The Consumer Price Index (CPI) dropped by 0.1 percent in 2006, and for most of the year the actual development of prices deviated from the target-mainly from above in the first half of the year and from below in the last quarter.
|
|
The variance in the development of prices during the year derived primarily from the variance in the development of the NIS exchange rate vis-?-vis the dollar-depreciation from mid-2005 to February 2006, and appreciation during the rest of the year. This variance was also influenced by the variance in fuel and energy prices ,which rose sharply at the beginning of the year and plummeted at the end of it.
|
|
Rapid economic growth continued in 2006, due mainly to increased demand, as had been the case in the preceding two years, exerting upward pressure on domestic prices during the year.
|
|
In the wake of actual price developments and inflation expectations, the Bank of Israel raised the interest rate three times during the course of the first third of the year, by a cumulative 0.75 percentage points, and by another 0.25 percentage points during the war, in August. In the last quarter this trend was reversed and the interest rate was reduced twice by a cumulative 0.5 percentage points, and by another 0.75 percentage points in the first two months of 2007.
|
|
The interest-rate reduction at the end of 2006 and beginning of 2007 led to a negative 1 percentage-point differential between the Bank of Israel's key interest rate and that of the US Federal Reserve. This unprecedented differential was supported by Israel's economic fundamentals, and particularly by the considerable surplus in the balance of payments on current account.
|
|
|
Inflation and Monetary Policy -
PDF file (0.92Mb)
|
|
Back
|
|
|
Chapter 4
The Financial System
|
|
|
The trends in the financial markets remained favorable in 2006 and the financial system maintained its stability despite external and domestic shocks.
|
|
Notable developments in 2006 included continued upturns in the equities market, declining bond yields as real long-term interest fell to a historical low, currency appreciation against the dollar coupled with relative calm in the foreign-currency market, and continued growth in corporate issues, foremost of bonds.
|
|
Auspicious macroeconomic conditions and structural reforms made the market more liquid and tradable amidst increasing involvement of long-term institutional and foreign investors. The dominance of banks in financing the business sector and controlling the public's savings by means of provident funds, mutual funds, and management of deposits decreased gradually but steadily.
|
|
These developments, coupled with a decline in credit risks, supported continued improvement in the resilience of the banking system. However, Israel's banking system has lower capital ratios than corresponding systems in other developed countries. Insurance companies' resilience slipped slightly despite the continued general economic improvement, as capital ratios declined and risk assets increased.
|
|
Given the major changes that the financial system has undergone in recent years, developments and risks must be monitored regularly in order to identity needed adjustments. Concurrently ,long-term institutional investors, whose involvement in financing the business sector and managing the public's assets has increased greatly due to the reforms, should be placed under stronger supervision.
|
|
|
The Financial System -
PDF file (2.13Mb)
|
|
Back
|
|
|
Chapter 5
The Labor Market
|
|
|
The labor market in 2006 was characterized by positive trends-increased employment, lower unemployment, and a rise in real wages.
|
|
The main reason for the expansion of employment in the various industries was the acceleration of economic activity, which was not adversely affected even by the second Lebanon war ,which broke out in the middle of the year.
|
|
Economic growth continued to be based on a rise in labor productivity and fall in unit labor cost-developments which are typical of a process of emergence from a recession-but there were signs of a transition to sustainable growth. The most important of these was the significant decline in unemployment and its stabilization at a level below that of 2000-the peak of the previous business cycle-despite the increase in the participation rate.
|
|
The expansion of the human-capital-intensive industries led to an increase in the relative demand for skilled employees, a rise in their wage, and a decline in their unemployment rate to its 'natural rate .' n the other hand , the unemployment rate of unskilled workers remained very high, and the real wage in the industries employing them did not increase, and even declined in some of them.
|
|
In addition to the efforts to increase the participation in the labor market of weaker segments of the population, supplementary measures should be adopted which will make it easier for them to find employment and improve their remuneration. Consequently, the programs currently in effect aimed at encouraging employment should be expanded, particularly since the current level of expenditure on them is low by international standards. In the long term most of the emphasis should be placed on investing in education.
|
|
|
The Labor Market -
PDF file (0.93Mb)
|
|
Back
|
|
|
Chapter 6
General Government and its Financing
|
|
|
There were positive developments in the fiscal aggregates in 2006, constituting a significant achievement for budgetary policy. Aided by rapid economic growth and one-off income, and despite the costs incurred by the fighting in the north ,the budget deficit was well below both the deficit ceiling and its level in 2005, The general government deficit, measured according to the National Accounts definitions used in developed countries, also declined, to 1.8 percent of GDP, compared with 3.3 percent in 2005 and 6.1 percent in 2003.
|
|
The public debt/GDP ratio plummeted in 2006 ;after rising significantly at the beginning of the decade it reverted to the level seen in 2000.
|
|
Despite the achievements, security developments in 2006 and social gaps underlined the challenges facing the government in formulating fiscal policy for the next few years.
|
|
The reduction of the deficit and the debt/GDP ratio in recent years derived mainly from the reduced share of public expenditure in GDP; this has fallen by 5 percentage points since 2003 to stand at its lowest level since the late 1960s in 2006. The composition of expenditure has remained virtually unchanged since the beginning of the decade.
|
|
The public debt/GDP ratio has remained high in comparison with the developed countries, but its decline in 2006 has significantly reduced this difference. The continued decline of the deficit/GDP and public expenditure/GDP ratios puts Israel somewhere in the middle of the distribution of the developed countries with regard to these indicators, after many years in which it was at the upper end.
|
|
The tax burden in Israel-especially on wages-is similar to that in the developed countries and is expected to continue declining in the next few years.
|
|
Expenditure by the civilian ministries remained low relative to the budget. Even though this contributes to fiscal control ,it impacts on the efficiency of budgetary allocation and the transparency of priorities.
|
|
The main challenge of budgetary policy in the next few years will be to balance the need to continue reducing the public debt/GDP and deficit/GDP ratios-so that fiscal policy can continue to support economic expansion, and interest payments will continue to decline-with the need to respond to both security needs and the rise in poverty in recent years. The expenditure ceiling set by the government and avoidance of tax reductions further to those already resolved, will make it possible in the next few years to achieve a significant reduction of the debt/GDP and deficit/GDP ratios, provided economic growth persists, but the government is yet to submit a program indicating how it will cope with security needs and social gaps in this framework. A detailed long-term budget plan could significantly increase the credibility of the various objectives.
|
|
|
General Government and its Financing -
PDF file (0.91Mb)
|
|
Back
|
|
|
Chapter 7
The Balance of Payments
|
|
|
The current account was in a surplus equal to 4.9 percent of GDP in 2006 which is an exceptionally high level, both from the historical and international perspectives.
|
|
The high current account surplus was primarily the result of the tax reform on investment abroad and the expansion of investment by institutional investors abroad, larger-than-expected public savings and a domestic interest rate at a similar level to that in the US, which created pressure for both a nominal and a real depreciation.
|
|
In addition to these forces, there are others acting to reduce investment and increase the share of savings in GDP, which would mean a rise in the current account surplus. These forces include the decline in the number of immigrants arriving in Israel, which exerts downward pressure on investments; the structural change in the economy, that serves to reduce the physical investment and to increase the investment in human capital--which theoretically are likely to offset each other, but in the light of individuals' liquidity constraint and their uncertainty regarding the return to education, the reduction in physical investment is the stronger effect; and the shrinking of the social security net, which raises the level of individual's uncertainty about their future situation and tends to increase private savings.
|
|
The rapid growth in the last three years, accompanied by an increase in the current account surplus, in contrast to the previous period of growth in which the deficit in the current account expanded, emphasizes the intensity of the forces acting to create the surplus. These include exports, which are a leading factor in the growth process, and short-term factors that support real depreciation. Together these factors have led to a current account surplus alongside rapid growth.
|
|
In 2006, the upward trend in the net export of investment continued, alongside an increase to record levels of investment flows into and out of the economy. This trend, which began in 2002, is a manifestation of Israel's integration within the global economy and is a result of both global and domestic factors.
|
|
The global processes that have influenced the financial account this year are primarily cyclical and include the continuing global trend of mergers and acquisitions ,which has worked to increase the volume of direct investment by nonresidents in Israel. The sharp decline in share indices in the emerging markets in May-June worked to reduce the volume of financial investment by both nonresidents in Israel and local residents abroad. The domestic influences that brought about the increase in capital flows are primarily structural and are the result of reforms in the financial markets.
|
|
A long-term comparison to countries similar to Israel shows that Israel, like other developing countries, is a net importer of direct investment, though on a relatively small scale. In recent years, there has been a noticeable upward trend in the volume of incoming and outgoing investment in terms of percentage of GDP.
|
|
The proportion of direct investment that contributes directly to capital accumulation within total direct investment has risen since the beginning of the decade but has fallen during the last two years as a result of the privatization process.
|
|
|
The Balance of Payments -
PDF file (1.93Mb)
|
|
Back
|
|
|
|
|
|
|
|
