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Bank of Israel Annual Report, 2005
Summaries
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Chapter 1
The Economy and Economic Policy
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Growth in GDP was 5.2 percent this year and was led by the business sector which grew by 6.6 percent. |
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The underlying economic conditions this year were favorable: continued growth worldwide, particularly in the high-tech industries, and the improved security situation. |
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Economic policy provided support for sustainable growth and met its three targets: the rate of inflation was within the price stability target range and the deficit and growth in public expenditure were lower than their ceilings. |
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The rate of unemployment fell to less than 9 percent by the end of the year while both employment and the participation rate grew. |
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The surplus in the current account grew while the rate of growth in exports and imports decreased. Investment abroad by residents grew substantially. |
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The booming capital market remained stable as it underwent structural changes initiated by the reforms implemented in recent years. |
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The positive trends continued in the stability of the financial system. |
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The ratio of public debt to GDP fell this year although its absolute level remained very high. It should be reduced considerably. The government should persevere in maintaining that the deficit and the increase in expenditure do not exceed their ceilings and should also endeavor to create a downward trend in the deficit. |
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A number of steps are proposed in order to reduce poverty and encourage integration within the workforce among defined segments of the population. The number of families with a wage earner who are below the poverty line has increased in recent years and the institution of a “negative income tax” would reduce this population. |
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In order to maintain financial stability, it is important to strengthen the financial infrastructure. The reforms instituted in recent years will indeed strengthen long-run stability but the regulation of institutional investors should be expanded. |
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Appropriate infrastructure is essential to the growth and proper functioning of the economy. The efforts to develop the infrastructure should continue while the externalities of their use should be taken into consideration. Priority should be given to the development of public transportation and competition should be increased in the infrastructure sectors, including air travel, electricity and communications. |
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Chapter 2
Output, Uses and Principal Industries
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During 2005, the fast pace of growth prevailing in the economy from the second half of 2003 continued. Expansion was led by the business sector, and especially by the service sectors, and was clearly reflected in a marked improvement of the labor market. |
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Per capita GDP and the rate of unemployment returned to their 2000 levels—before the recession. The growth in GDP during the year resulted from a substantial increase in the total factor productivity. However, the average rate of increase in total factor productivity from 2000 until 2005 was low. |
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The boom in economic activity resulted mainly from relative quiet in the security front and from strong growth in the world economies, matched by a continuing recovery of the international high-tech sectors. |
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The growth process was also due to responsible macroeconomic policies that were in step with their goals of price stability and deficits—this for the second year running and thus contributed to a reduction in the uncertainty and risk in the economy. |
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The improvement in background conditions and economic policy stimulated an increase in demand, which was quickly matched, against the background of existing unutilized production factors—capital and labor. |
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The service, trade and transportation industries grew significantly because of the increase in domestic demand, but this increase did not trickle down to the construction industry, which saw a decrease in output. Manufacturing product and exports grew only at moderate rates. |
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During the year the rate of growth in exports slowed down, and industrial exports did not grow; this because the unique production factors in this sector were fully exhausted, and not because of a slowing in demand for exports. |
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The government also made efforts during the year to increase competition in the maritime, air, public and communications sectors. These sectors have significant influence on the productivity and welfare of the overall economy. |
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Chapter 3
Inflation and Monetary Policy
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The Consumer Price Index rose by 2.4 percent in cumulative terms in 2005, more than in recent years but within the price-stability target range of 1–3 percent. |
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The upturn in inflation in 2005 traced mainly to relatively rapid NIS depreciation against the dollar (after two years of appreciation) and the continued upward march of oil prices globally. |
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Domestic demand and wage increases did not generate perceptible pressure on prices, despite the acceleration in growth. The restraining effect of prices that typified the past few years, however, has diminished and may even have passed. |
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Monetary policy continued to strive for price stability and was supported by a fiscal policy that was aimed at reducing the budget deficit and the government debt, and that made the target attainable at relatively low interest rates. |
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In the first two months of the year, in view of very sluggish price developments and below-target inflation expectations, the rate-cutting process continued. Subsequently, until September, the Bank of Israel key rate was left unchanged at a low 3.5 percent. |
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Only in Q4, when forces auguring pressure on prices became visible, did the Bank of Israel begin to raise the rate and increased it by a total of one percentage point by the end of the year. |
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Chapter 4
The Financial System
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In 2005 the positive trends evident in 2003 and 2004 in the markets and the financial institutions continued, and the financial system showed stability. |
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Against the background of the improvement in the domestic and global economic environment in which the financial system operates, the share market was buoyant, the bond and foreign currency markets were relatively calm, and borrowing by businesses increased. |
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The banking system became more resilient, due to its improved capital adequacy and the reduction in credit risks. Insurance companies showed unchanged capital ratios, but concurrently the rise in credit accelerated. |
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The Bachar and other reforms implemented in the last few years are expected to boost the resilience of the financial market in the long run, as they promote the reduction in the banks’ dominant position and the continued development of the long-term-savings markets and nonbank credit. |
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In the transition period of the reforms, systemic financial risks are expected to increase, and in particular credit risk among institutional investors, which make it necessary to take steps in the areas of structure, organization, enforcement, and information available to the public. |
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Chapter 5
The Labor Market
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Rapid economic growth affected the labor market in 2005, boosting employment, reducing unemployment, and causing a rise in wages.
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The rise in wages was accompanied by improved labor productivity and a drop in the cost of labor per unit of production, a continuation of the trend over the two preceding years.
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Hiring of workers in the business sector reflected heterogeneity in real activity: approximately 60 percent of new employees were in the trade and services sectors. In contrast, less than 10 percent of the new employees were hired by industry, which accounts for approximately one quarter of all business sector employment.
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Expansion in activity affected all sections of the population, but not to the same degree. Among highly educated people, the unemployment rate fell-approaching its natural level-which caused their wages to rise.
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Despite the recognition that helping economically disadvantaged people requires their inclusion in the labor force, some programs with this aim were cut back in 2005, while the policy of reducing employment of foreign workers was relaxed. Even so, a number of programs were formulated and put into operation, and are expected to yield results in the coming years.
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In order to promote the welfare of economically disadvantaged groups, policies designed to integrate them in the labor market should be continued and strengthened.
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Chapter 6
General Government and How It Is Financed
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In 2005, the government deficit was substantially lower than the deficit ceiling and the 2004 deficit. The general-government deficit, measured according to the National Accounts rules,2 also declined, to 2.9 percent of GDP as against 4.9 percent in 2004 and 5.9 percent in 2003. |
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The public-debt/GDP ratio fell considerably in 2005, for the first time since 2000. |
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The deficit and debt/GDP ratio decreases traced mainly to a decline in the share of public expenditure in GDP. This indicator has fallen by 5 percentage points since 2002 and was below 50 percent in 2005 for the first time since 1970. |
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The ratios of public debt, deficit, and general-government expenditure to GDP remained high by the standards of developed countries, although the decreases have narrowed the gaps. In contrast, Israel’s tax burden, especially in respect to wage taxation, resembles the accepted levels in these countries and is expected to continue falling in the coming years. |
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By honoring the cap on expenditure increases and avoiding tax cuts beyond those already decided upon, the government will be able to lower the debt and deficit ratios to GDP appreciably over the next few years, if growth continues. The increase in general-government employment relative to total civilian employment in 2005, however, indicates that staying within the expenditure ceiling in the long run will be a challenge. |
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If the 2006 budget will be based on the current legal deficit ceiling of 3 percent of GDP, primary government civilian expenditure will increase significantly relative to 2005 performance, holding the decline in the debt/GDP ratio to a moderate extent. Adopting a lower expenditure trajectory will allow the government to distance itself more quickly from the current debt level, which exposes the economy to risks in the events of adverse developments in the global economy and the security situation. Such a trajectory would also give the government more latitude in the future in smoothing the effects of external and security shocks on economic activity. |
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Chapter 7
The Balance of Payments
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The current account surplus amounted to 1.9 percent of GDP in 2005, more than in 2003 and 2004. |
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From the perspective of the last three years, the move to a surplus in the current account reflects mainly an improvement in the goods and services account, despite the deterioration in the terms of trade. |
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The export and import growth rates in 2005 were lower than in 2004, although they continued to rise as a proportion of GDP. The slower rate of increase in world trade reduced the expansion in exports, while imports were affected by the lower level of the real exchange rate, the deterioration in the terms of trade and by the slower pace of goods exports, which contain a large component of imported inputs. |
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The globalization process is reflected by the range of countries that are Israel’s trading partners. The share of the less affluent countries in Israel’s exports and imports rose during the last five years. The increased share of these countries, in which labor is relatively inexpensive, was particularly notable in labor-intensive industries although their share in the high-tech industries, which are capital-intensive, also rose. |
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The economy’s financial account amounted to substantial net capital exports of $6.1 billion due to a large $16.9 billion increase in Israeli resident’s investments abroad, which exceeded the $10.8 billion growth in nonresidents’ investments in the Israeli economy. |
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The growth in Israeli residents’ investments mainly derived from institutional investors’ more rapid diversification of investments abroad. Another major factor was the repayment of foreign-currency credit by the business sector and an increase in its deposits as the interest rate differential between Israel and abroad contracted, a development that led to the banking system transferring sources to abroad. |
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Developments in the financial account were affected by two main processes: government activity and government decisions that were reflected by a record amount of privatization, and by the impact of the structural reforms in taxation and in the capital market; and worldwide financial trends, primarily the rise in short-term yields, which had the effect of increasing Israeli residents’ investments abroad, the stable level of long-term yields and the growth in capital movements to the emerging economies, which supported additional capital movements to the economy by foreign residents. |
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Chapter 8
Issues in Welfare Policy
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The incidence of poverty, based on the relative index customarily used in Israel – according to which the income of the poor households' population is less than half the median income adjusted for family size – has been rising in recent years. In the year ending June 2005, it reached a peak of 24.1 percent. The relative incidence of poverty in Israel is high also by international comparison. |
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Poverty grew significantly also according to alternative measures based on a definition by which households are considered poor if their net income from all resources falls short of the amount needed to consume a basket of basic needs. The data indicate that poverty rose from 2002 to 2004, after a fall in the two preceding years mainly due to economic growth. |
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Poverty has risen since 2002 according to all indices – relative, absolute and mixed measures of basic needs – due, partly, to the recession and, in the last two years, to the budget cuts in social benefits, |
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The incidence of poverty is high according to all methods among Arabs, the Jewish ultra-orthodox, large families, the low skilled and families without an income earner. |
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The indices of poverty emphasize the need for a continued policy to reduce poverty, consistent with fiscal discipline that ensures sustainable growth. The policy should operate to encourage the integration in the work force of those capable of working, by increasing the return to work of low-income earners, and to assist the poor whose earning power is severely limited with direct support. At the same time, employability- and means-tests should be further improved. |
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