Bank of Israel Annual Report 2005

In 2005, Israel’s economic recovery continued and became even more firmly based. GDP grew rapidly by 5.2 percent, led again by the business sector which expanded by 6.6 percent. The integration of the Israeli economy into the global economy continued apace.

Macroeconomic policies in 2005 achieved its three numerical objectives: The rate of inflation at 2.4 percent was within the price-stability range, and both the budget deficit at 1.9 percent of GDP and the increase in public expenditure at about 0.3 percent were below their ceilings. Correspondingly the public-debt/GDP ratio declined significantly, although it remains very high in international terms.

The main goal of economic policy for the next few years should be to create the necessary conditions for sustainable growth, which will raise the overall economic well-being of Israelis, and make it possible to tackle social problems, in particular that of poverty. To do this, economic policy will need to maintain fiscal discipline, price stability and financial stability, while promoting reforms that will improve infrastructures and intensify competition in the economy. Alongside all these, a continuous policy focused on reducing poverty is required.

These included the decline in unemployment from 9.8 percent at the end of 2004 to 8.8 percent at the end of 2005, accompanied by increases in the rates of both employment and labor force participation; the increase in the surplus in the current account of the balance of payments; and positive developments in the capital markets. The above points are taken from the Annual Report of the Bank of Israel for 2005, which was presented today to the President, the Vice Prime Minister and the Knesset Finance Committee.

The Report also states that Israel’s economic growth was bolstered by the continuation of strong global growth and the sustained improvement in the security situation, as well as the steady implementation of a supportive economic strategy. The macroeconomic policy mix combined fiscal discipline, reflected in tight control of expenditure, a considerable reduction in the deficit, and tax cuts, together with an accommodative monetary policy. These made it possible to take advantage of the favorable underlying conditions, and were a key factor in the positive reactions of the financial markets.

The integration of the Israeli economy into the global economy continued apace in 2005: Imports currently constitute more than 40 percent of GDP, and exports more than 35 percent; Israelis’ investments abroad, direct and portfolio, reached $10.1 billion; nonresidents’ investments in Israel totaled $10.8 billion; and nonresidents’ participation in the NIS/forex market rose to 49 percent. Integration into the global economy is vital for Israel’s continued economic growth.

In the capital markets, where important reforms have been under way for some years, progress was made on two fronts: A significant start was made on the implementation of the recommendations of the Bachar Committee to reduce banks’ holdings in provident and mutual funds, aimed at increasing competition in the capital markets and reducing conflicts of interest; and the process of equating tax rates on income earned on securities in Israel and abroad was completed, thus ending the tax discrimination that had favored Israelis’ investment in securities in Israel over such investment abroad.

The incidence of poverty in Israel has risen in the last few years, whether measured in relative terms or in terms of basic needs. This reflects both the long recession, and the cuts in welfare benefits from 2002. The latter were intended to raise the rate of participation in the labor market, which is an important means of reducing poverty in the long run.

The main goal of economic policy for the next few years should be to sustain and strengthen the continuing growth of the economy. Sustained strong growth will make it possible to raise the overall economic well-being of Israelis, and to tackle social problems, in particular that of poverty. To sustain growth, economic policy will need to maintain fiscal discipline, while striving to keep government spending and the budget deficit as a share of GDP on a downward path. In addition, macroeconomic policy should maintain price stability and financial stability, while promoting structural reforms aimed at improving infrastructure and intensifying competition.

Alongside all these, a continuous policy focused on reducing poverty is required. It is important that resources be allocated to education to ensure that, in the long term, the weaker sections of the population receive a level of education that will enable them to participate in the labor market. Several steps are required to reduce poverty in the medium term; These should focus on the sections of the population with a particularly high incidence of poverty - low-wage employees, the elderly, the ultra-orthodox and the Arab sector. At the same time some welfare benefits will need to be adjusted for those unable to participate in the labor force.

Legislation should be completed of a new central bank law, which will deal with the independence of the central bank, clearly define its purposes, and determine new frameworks for decision-making and transparency. The main objective of the Bank will be defined as maintaining price stability in the long run in accordance with the target set by the government, while supporting other government targets such as growth and employment, without undermining long-term price stability, and while supporting the stability of the financial system.