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Bank of Israel Annual Report, 2009
Summaries
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Chapter 1
The Economy and Economic Policy
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Israel's economy came through the global economic crisis––the worst since the
1930s––relatively well. Following the contraction of economic activity at the
end of 2008 and the beginning of 2009, the economy started to recover in the
second quarter of the year.
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GDP grew by 0.7 percent in 2009, the result of a 1.5 percent decline in the
first half of the year and 3.3 percent growth in the second half. The rate of
unemployment reached 7.9 percent around the middle of the year, and fell to
7.3 percent by the end of the year.
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Exports shrank by 12.5 percent, and imports by 14 percent, in line with the
drop in world trade. The terms of trade improved, leading to an increase in the
surplus on the current account to $7.2 billion, and mitigated the effect of the
global crisis on national income and domestic demand.
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Private consumption recovered rapidly, and by the end of 2009 it surpassed
its pre-crisis level, contrary to the development in many other advanced
economies.
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The crisis had a limited effect on Israel's financial system, more moderate
than its impact on the advanced economies, and the main financial institutions
remained stable. The profitability and the capital ratio of the banking system
improved during the year.
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The factors contributing to the milder effect included a conservative financial
system, and in particular a conservative and closely supervised banking system,
a balanced housing market, and a successful economic policy.
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Monetary policy was very expansionary, and in addition to the sharp reduction
in the interest rate, it also involved intervention in the foreign currency market
and the government bond market.
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Inflation during 2009 was 3.9 percent, higher than the target inflation range and
higher than the inflation environment in the advanced economies, due mainly
to the rapid rise of housing prices and the increase in water prices and VAT by
the government.
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Fiscal policy was acyclic, and reflected the operation of the automatic
stabilizers. The share of public expenditure in GDP remained unchanged, and
the tax burden declined only because of the contraction of economic activity.
The general government deficit was 5 percent of GDP.
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Israel’s growth rate in the next few years will be heavily influenced by the rate
of recovery of the global economy.
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Chapter 2
GDP, Uses and the Principal Industries
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GDP increased in 2009 at a modest 0.7 percent pace due to the global economic crisis, which was at its most severe early in the year and Israel's GDP was less badly affected than that of the OECD countries.
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From mid-year on, the economy began to recover gradually in tandem with developments abroad, thanks to good fundamentals and an expansionary monetary policy.
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In Israel, much as in developed countries at large, the crisis took a heavy toll on exports and nonresidential investment. Current private consumption and construction investment continued to grow moderately, evidently due to lower leveraging of Israeli households and the stability of the financial system and the housing market.
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Total uses fell considerably, at a pace resembling that abroad. Since most of the decrease occurred in import-intensive uses, imports decreased steeply while GDP was less badly affected.
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Israel's terms of trade improved appreciably due to a steep decrease in the prices of imported inputs.
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The economic crisis had a swift and perceptible effect on domestic employment and wages while productivity remained strong-in contrast to the gradual response that the labor market typically exhibited in the past.
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The rate of foreign direct investment in total domestic investment has been around 20 percent on average since 2000 with an upward trend in recent years-a strong performance by the standards of emerging markets and developed countries alike.
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Manufacturing was the main casualty of the crisis due to the precipitous decrease in global demand for goods, especially given the high share of exports in domestic manufacturing activity.
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Construction product decreased by only one percent, in a display of stability relative to other industries. Thus, it contributed to the stability of total economic activity despite early fears of a credit crunch induced by the current crisis.
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Commerce and services were moderately affected in 2009, largely because the ravages of the crisis in these fields had already been manifested in 2008. The transport industry took a relatively severe beating whereas the communications industry continued to grow.
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An international comparison shows that it is best to earmark a larger share of the budget to public transport in metropolitan areas at the expense of road investment. An investment in developing a public-transit system in the Tel Aviv area should be made. In other countries, relatively small towns are rarely linked by rail. However, the development of an interurban road system and an interurban rail system has positive externalities.
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Chapter 3
Inflation and Monetary Policy
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The consumer price index rose by 3.8 percent in 2008, the second consecutive year when it
The consumer price index rose by 3.9 percent in 2009, which was above the upper limit of the inflation target. The annual inflation rate exceeded the upper limit of the target for most of the year. The index exclusive of tax hikes on consumer goods went up by 2.8 percent, which was within the upper part of the target range.
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The consumer price index rose by 3.8 percent in 2008, the second consecutive year when it
The higher than targeted inflation rate, despite the serious global crisis, derived from three main factors: price rises resulting from the government's indirect tax hikes, the rapid increase in the housing component of the index, which reflected a rise in rental prices, and an increase in the energy component of the index. The improvement in the economic environment during the year, expansionary monetary policy and the substantial depreciation of the shekel from the middle of 2008 acted against the moderating effect of the crisis on prices.
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The consumer price index rose by 3.8 percent in 2008, the second consecutive year when it
Monetary policy at the beginning of the year was dictated by the serious global financial and economic crisis, to which governments and central banks worldwide reacted with aggressive policy measures. Later in the year, monetary policy was managed against the background of the economy's gradual recovery from the crisis.
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The consumer price index rose by 3.8 percent in 2008, the second consecutive year when it
Serious concern over the potential adverse impact of the crisis on the Israeli economy at the end of 2008 and at the beginning of 2009, and the improvement in the economic environment later in the year, were reflected by the development of inflation expectations for a year ahead. These fell heavily, to below the lower limit of inflation target, and were actually negative during the last quarter of 2008. As assessments regarding the economic environment became more optimistic, from May 2009 inflation expectations reverted to around the center of the target range.
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The consumer price index rose by 3.8 percent in 2008, the second consecutive year when it
Due to the global crisis and the implications for the economy, the Bank of Israel cut the interest rate on its sources heavily, to a minimal level of 0.5 percent in April, and left the rate at this low level until August.
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The consumer price index rose by 3.8 percent in 2008, the second consecutive year when it
In addition to the reduction in the monetary interest rate to the vicinity of its lower bound, the Bank of Israel used other, unconventional instruments in order to help the economy cope with the global crisis. The central bank began daily purchases of government bonds in the secondary market in order to directly influence longer-term interest rates. The Bank also maintained its daily purchases of foreign currency, beyond the amount planned for the purpose of increasing the foreign exchange reserves, a program that started in March2008..
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The consumer price index rose by 3.8 percent in 2008, the second consecutive year when it
In the second half of the year, against the background of an initial rebound in the economy that was characterized by a high level of uncertainty, policymakers were faced with a challenge. They had to adjust the extent of monetary expansion to the improvement in the economic conditions and the rise in the inflation environment while continuing to help the economy recover from the crisis, at a time when central bank interest rates worldwide remained low.
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The consumer price index rose by 3.8 percent in 2008, the second consecutive year when it
In August, the Bank of Israel began to gradually reduce the exceptional monetary expansion which it had adopted due to the threats posed by the global crisis. Bond purchases ceased as planned, the policy of intervention in the foreign-currency market was changed from fixed purchases to case-specific intervention, and the interest rate for September was raised to 0.75 percent. In December, when indications for the improvement in the economic environment accumulated, the central bank continued to adjust the interest rate, and raised it to 1 percent, increasing it again in January, to 1.25 percent.
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Chapter 4
The Financial System and Its Stability
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In 2009 prices in the domestic financial markets rose steeply and gradually approached the early-2008 level, after a year (2008) of severe systemic shock due to one of the greatest financial crises in history and with share and corporate bond prices plummeting.
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The price declines in the domestic markets in 2008 resembled trends in markets abroad; the upturns in 2009, in contrast, surpassed those in other markets and were accompanied by falling market volatility and risk premiums.
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The global crisis dealt a milder blow to Israel's financial system than to those in other advanced economies; it focused mainly on the financial markets, whereas the financial institutions maintained relative stability.
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The corporate bond market exposed the domestic financial system to the ravages of the crisis abroad, following rapid expansion in 2005-07 and allowing an increase in the share of issues for the acquisition of real estate abroad-an industry that lay at the focus of the global crisis.
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In 2009, the corporate bond market started to function again: risk spreads narrowed sharply and issues gradually resumed, allowing the business sector to expand its activity despite the decrease in bank credit.
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The profitability of Israel's financial institutions-banks and insurance companies-increased notably in 2009 as the state of the real economy improved and the capital markets surged. Capital adequacy also improved markedly, partly due to capital issues and against the background of the supervisors' demand to refrain from distributing dividends.
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Despite the turn for the better, the global financial system remains clouded by uncertainty and is more susceptible to moral hazard than before. This is due to unprecedented government intervention designed to stave off the collapse of large financial institutions that, had they failed, might have aggravated the crisis and led to collapse of the financial system at large.
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Uncertainty in the domestic financial system also remained high due to the combination of uncertainty abroad and domestic factors including the resumed expansion of corporate bond issues before the adjustments warranted by the lessons of the crisis were implemented; the concentration of the financial system, which makes it necessary to contend with institutions deemed "too big to fail" and the attendant moral hazard, and the financial system's severe dependency on the resilience of large and complex business groups.
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Chapter 5
The Labor Market
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The Israeli labor market was in a situation of full employment when the global crisis began to affect it and thus weathered the crisis, during the first half of 2009, with only a moderate increase in unemployment relative to the developed economies and without a major decline in employment. The market started to recover already in the second half of 2009 and unemployment began to decline, even while it was increasing in the advanced economies.
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The global crisis was manifested in the labor market by a sharp drop in the demand for labor during the fourth quarter of 2008 and a recovery in the second half of 2009.
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Employment remained stagnant from the beginning of 2008 and despite the crisis did not decline in 2009. This was a result of several factors: the reduction in work hours per employee, flexibility in the composition of employment by industry, a decline in real wages in the business sector and a rapid recovery in the demand for labor.
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The standstill in employment--particularly in the business sector-since the beginning of 2008 and the decline in the average work hours per employee towards the end of this year led to a drop in aggregate labor input. In addition, the stagnation in employment and the natural labor force growth led to a moderate increase in the rate of unemployment to a level of 7.6 percent in 2009.
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The stagnation of employment in the business sector reflects a decline in employment in the manufacturing and construction industries and an increase in employment in other industries, such as finance and business services. Employment fell in industries intensive in unskilled labor, both in manufacturing and non-manufacturing. In contrast, the drop in employment in manufacturing industries intensive in skilled labor was fully offset by the increase in employment in non-manufacturing industries intensive in skilled labor.
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There has been an increase in recent years in the number of Palestinian workers from the territories in the Israeli economy, whose income represents more than 10 percent of Palestinian GDP. The low level of their wages is liable to create downward pressure on the wages and employment of unskilled Israeli laborers.
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Chapter 6
The General Government, Its Activity and Financing
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This year the government amended the deficit ceiling, allowing it to rise following the steep drop in tax revenues due to the economic slowdown. In other words, it enabled the 'automatic stabilizers' to operate.
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As a result of the reduction of the debt/GDP ratio between 2003 and 2008 and the more moderate impact of the economic crisis in Israel than elsewhere, the increase in the deficit was not accompanied by a rise in Israel's relative risk or in the interest rate on the public sector debt. Hence, in contrast with the crisis of 2001-03, this time the government did not have to deploy a policy of restraint during the crisis.
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The moderate nature of fiscal policy in Israel compared with the aggressive counter-cyclical policy which characterized the developed countries, improved Israel's relative situation as regards the public sector deficit, and especially as regards the debt/GDP ratio. Consequently, fewer long-term effects on fiscal policy are expected in Israel than in the developed countries.
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In addition to reflecting the operation of the automatic stabilizers, the large public sector deficit this year also expresses the lagged impact of the reduction of tax rates in previous years.
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The elasticity of tax receipts to GDP in Israel during the economic crisis was far higher than its long-term level; this was mainly due to the structural changes arising from the Bachar reform, which served to increase corporate tax receipts from the financial sector.
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The low interest rates in 2009 together with the large amount of debt that was rolled over have reduced expected interest payments in the next few years by NIS 3 billion a year relative to the forecasts at the beginning of the crisis.
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The existing path of the deficit ceiling, together with the new expenditure rule adopted by the government, constitute an ambitious track which could require significant adjustments on either the expenditure or the taxation side unless the economy shifts to a path of accelerated economic expansion.
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The government has recently adopted a long-term plan for extensive investment in the transportation infrastructure. Past experience in Israel and abroad has shown that plans of this kind are characterized by a marked increase in costs relative to the initial estimates, as well as by significant delays in completing the projects.
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The development of public sector wages in the last two decades has been in line with the development of per capita GDP; employment, however, reacted acyclically.
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Chapter 7
The Balance of Payments
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A considerable improvement was recorded in the balance-of-payments current account during 2009. The current-account surplus amounted to 3.7 percent of GDP compared with 1 percent in 2008. This was because imports fell more than exports at the time of the global crisis.
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During the crisis Israel's exports fell by 40 percent, annual rate, and have since shown a rebound. In the last quarter of 2009 they reached 90 percent of their pre-crisis level.
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The OECD country's trade was more hard hit than Israeli exports. The differing developments between Israel and the developed countries can be attributed to the differing composition of Israel's and those countries' exports, and especially the high proportion of service exports from Israel: tourism services (5 percent of total exports), transportation services (6 percent of total exports), and R&D and computer services (8 percent of total exports).
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Sixty percent of Israeli exports are channeled via multinational firms, and a significant share of this is exports of services and intermediate goods, which helped to moderate the impact of the crisis.
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The growth in the current account surplus during the last two decades was supported by the development of the economy's fundamentals: a reduced rate of increase in the population, a rise in per capita GDP, a growth in the country's asset balance, and a decrease in the public sector deficit.
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Incoming and outgoing direct investments in Israel decreased more heavily than worldwide.
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Institutional investors' overseas portfolio holdings continued to increase despite the global crisis, and in accordance with the long-term trend. Foreign investors' portfolios investments in Israel showed a rebound in the second half of the year, after plummeting at the time of the crisis.
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The Bank of Israel's foreign exchange reserves rose during the past two years concurrent with a growth in capital imports to the economy in the "other investments" item, principally Israeli banks' capital imports.
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The surplus of liabilities over assets abroad increased during the year due to the upsurge in the value of shares and bonds held by foreign investors in Israel.
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Chapter 8
Welfare Policy Issues
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The economic crisis and its effects on the labor market can be seen in the widening of poverty: the incidence of poverty, according to the accepted relative definition, rose to 24.3 percent of the population, about 1.7 million poor people. At the same time the incidence of poverty in families, the incidence of poverty according to the absolute approach and the SEN poverty index also grew. As opposed to these, the income gap (which measures the average distance of poor people's incomes from the poverty line) and the Gini index (which measures income inequality) remained almost unchanged.
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The rate of poor people by income who consume below the relative poverty line, an index that usually indicates continuing poverty, had already grown significantly in 2008, and stood at 62.4 percent.
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The scale of poverty in Israel is high, both in comparison with OECD countries and compared with the past. The trickling down of growth to the weaker segments was slow and relatively late, so that when the crisis broke out Israel did not have "social reserves" to lean on.
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The incidence of poverty rose in 2008/9, despite the real decrease of 1.6 percent in equivalised median per capita income, which led to a similar rate of decrease of the relative poverty line.
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The direct contribution of policy for reducing poverty by means of transfer payments and taxes grew slightly, but is very low in relation to the past and in relation to OECD countries.
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The incidence of poverty is particularly high among the Arabs and the ultra-Orthodox-two population groups characterized by a high birth rate and a low rate of employment (the latter particularly among Arab women and ultra-Orthodox men). In 2008/9 the Arab poor were 44 percent of the poor in Israel and the ultra-Orthodox poor-18 percent.
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Over the past decade the extent of poverty has grown among households with at least one earner. This development points, on the one hand, to the entry of weaker populations into the circle of employment, and on the other hand, to the absence of satisfactory policy to improve the level of earned income of populations whose earning power is low.
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In October 2008 the implementation of Earned Income Tax Credits (EITC) commenced in several regions in Israel. EITC acts to improve the welfare of workers earning low salaries, and in this respect is consistent with the overall policy of reducing poverty by increasing employment. However, because of the limited extent of the implementation, and the relatively low level of the grant, the impact on employment and on welfare is, at the present time, small.
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In 2008 there were in Israel about 195 thousands recipients of a general disability allowance, constituting about 4.6 percent of the population in the entitlement age for this allowance. Following the
recommendations of the Laron Committee, far-reaching policy changes have been instituted in recent years with regard to disability allowance recipients and the disabled in general, with the aim of promoting their integration into the community and the labor market.
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In Israel, unlike the developed countries, dental health services are provided largely by the business sector. The benefits of basic dental treatments for children are great, and their cost is low. For this reason it is important to introduce these treatments into the health basket.
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Chapter 9
Issues In Environmental Policy
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Economic incentives are an increasingly important component of environmental policy in many countries. The use of such incentives can be expanded in Israel as well, which would contribute to both the achievement of environmental objectives and the integration of Israel within global environmental trends.
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This chapter discusses the possibility of expanding the use of economic incentives in Israel in three areas: waste disposal, the number of private vehicles and their usage and increasing building density as part of planning policy.
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Israel lags far behind other developed countries in the area of waste disposal. About 87 percent of the waste in Israel goes to landfill, which is the worst solution from an environmental perspective. Israel has recently adopted a policy to reduce the share of landfill, including a landfill tax and the transfer of responsibility to the producer, which provides local authorities and producers with incentives to recycle and to reduce landfill.
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An econometric analysis shows that increasing the excise tax on gasoline together with reducing the purchase tax on new vehicles would reduce the mileage of private vehicles and thus improve the quality of the environment without reducing tax revenues.
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The proportion of low-density buildings in densely populated districts has not declined in recent years and in districts with an intermediate population density it has even increased.
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