Israel: IMF Staff Concludes Visit

Israel’s budget deficit is on a rising path, reaching 3 percent of GDP in 2018 despite very low unemployment, lifting debt to 61 percent of GDP.

An International Monetary Fund (IMF) staff team led by Craig Beaumont visited Israel from May 19-23, 2019 to discuss macroeconomic, financial, and structural policy issues, in preparation for the annual Article IV consultation to be held later in 2019.

At the end of the visit, Mr. Beaumont issued the following statement:

"Israel’s solid macroeconomic performance continues, with output rising by 3.2 percent in the year to the first quarter of 2019, and similar growth is expected for 2019 as a whole. Export growth, led by hi-tech services, declined little despite a weakening global economy, but fixed investment slowed as falls in housing construction outweighed strong machinery spending. Job creation exceeded 2 percent in 2018, driven by 3.5 percent gains for women, keeping unemployment at historic lows of about 4 percent. The tight labor market pushed business sector wage rises up to 4.3 percent in 2018, from 2.9 percent in 2017."

According to Mr. Beaumont, Israel's monetary policy remains accommodative, with the policy rate at 0.25 percent following a hike in the last quarter of 2018. Inflation has risen from low levels, to remain just above the floor of the 1-3 percent target range since mid-2018. A further increase in inflation is expected in the next few years, although this outlook is subject to risks from global growth and inflation, together with uncertainties around the net impact of rising wages and increased competitive pressures in Israeli markets. In that context, it is appropriate that the Bank of Israel has indicated that future interest rate rises will be gradual and cautious.

"Unlike in many advanced economies, Israel’s banks did not become a burden on the budget or drag on growth during the global financial crisis. Earlier IMF reports noted that banking supervision in Israel follows a very rigorous and comprehensive approach, contributing importantly to this financial stability. By approving legislation for the Financial Stability Committee which recently became operational, the Knesset has helped close regulatory and supervisory gaps across the financial system. Looking forward, any new legislation should remain consistent with international principles for effective bank supervision, especially by preventing government or political interference that compromises the operational independence of the supervisor. The Bank of Israel releases information on its supervisory activities through various channels, and it should continue to enhance this public transparency and its engagement with the Knesset while safeguarding confidential information on specific institutions, companies, and individuals."

Israel’s budget deficit is on a rising path, reaching 3 percent of GDP in 2018 despite very low unemployment, lifting debt to 61 percent of GDP. Even with strong efforts to keep spending close to budget allocations, the deficit is expected to rise to 3.5 percent or more in 2019, and current policies imply further deficit increases in the coming years. Leaving debt on a rising path will constrain Israel’s ability to use fiscal policy to cushion shocks to the economy. The budget deficit should, therefore, be reduced to 2.5 percent of GDP to ensure that the debt ratio stabilizes. Israel’s healthy economic position supports making timely progress to this target in the budget for 2020, through the adoption of high-quality structural measures to cut tax benefits, raise revenues, and improve spending efficiency.

"Since the mid-2000s, Israel’s growth has averaged 3.7 percent thanks to rises in the working-age population and in participation, but labor productivity contributed only 0.8 percentage points on average. Although there is scope to increase employment rates in the Arab and Haredi populations, demographics will slow the average pace of job creation in the coming decades. Faster productivity gains must, therefore, be ignited to sustain solid increases in Israeli household incomes. Much further progress is needed on cutting regulatory costs and uncertainties that lower business investment, including through digitalization of government. Productivity lost in traffic should be reduced by charging congestion fees and boosting investment in transport infrastructure. Deep reforms of education and training are crucial to upgrading the skills of those already employed as well as those of the Haredi and Arab populations. Building on measures taken in recent years, expanding the Earned Income Tax Credit and the support for childcare can help contain poverty while also boosting employment and productivity."

In the end, on behalf of the mission team, Mr. Beaumont thanked the Israeli authorities and other counterparts for candid and insightful discussions and their warm hospitality.