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2022 Article IV Consultation with Israel Summary

Core Content

The IMF conducted the 2022 Article IV consultation with Israel, resulting in a comprehensive assessment of the country's economic performance and policy outlook. The consultation highlighted Israel's strong recovery from the pandemic, supported by robust fiscal and monetary measures, as well as its resilient financial system.

Main Economic Developments

• Economic Recovery: Israel's economy recovered strongly from the pandemic, with real GDP growth of 8.1% in 2021, driven by consumption and high-tech exports. The output gap turned positive in 2021Q4.
• Fiscal Performance: The 2021 fiscal deficit was 4.3% of GDP, significantly smaller than expected, due to strong tax revenues and reduced pandemic support. Public debt declined to 69% of GDP.
• Monetary Policy: The Bank of Israel (BOI) maintained accommodative monetary policy, but inflation pressures rose, prompting the need for gradual tightening.
• Current Account: The current account reached a surplus of 4.6% of GDP in 2021, mainly due to high-tech services exports.
• Labor Market: Unemployment dropped to near pre-pandemic levels, but job vacancies remain high, indicating skill mismatches.
• Financial Sector: Banks remained resilient with low non-performing loans, strong capital ratios, and increased lending. Housing prices rose by 10% in 2021 due to mortgage growth and limited supply.

Economic Outlook and Risks

• Growth Outlook: The economic recovery is expected to solidify in 2022 with a projected real GDP growth of 5.0%. However, growth remains uneven across sectors.
• Inflation: Inflation is expected to decline as temporary factors fade, but the 2021Q4 spike will have a carry-over effect, leading to a higher average inflation rate in 2022.
• Uncertainty: The economic outlook is subject to significant uncertainty, including potential geopolitical risks, new virus variants, and the challenge of addressing skill gaps.
• Downside Risks: Risks are tilted to the downside, with concerns about global financial conditions, inequality, and social unrest.

Key Policy Discussions

A. Fiscal Policy

• Fiscal Space: The fiscal deficit has narrowed faster than expected, and fiscal space needs to be reoriented toward productivity-enhancing spending.
• Reforms: There is a need to refocus on reducing public debt and rebuilding fiscal buffers. Tax reforms could enhance revenue and support growth-enhancing spending.
• Efficiency: A review of public spending efficiency is recommended to address inefficiencies and ensure effective use of resources.

B. Monetary and Exchange Rate Policies

• Policy Rate: The BOI is expected to start raising the policy rate gradually as inflation pressures rise.
• Foreign Exchange: Foreign exchange purchases should taper off, allowing the shekel to be determined by market forces.
• Exchange Rate: The NIS per USD has declined, and the real effective exchange rate has increased, reflecting a stronger currency.

C. Financial Sector Policies

• Housing Risks: Rapid mortgage growth and limited housing supply have contributed to rising prices. Structural measures to increase housing supply are needed.
• Macroprudential Measures: Tightening debt-service-to-income caps could help prevent unsustainable borrowing.
• Financial Stability: The financial sector remains stable, with strong capital and liquidity ratios.

D. Macro-Structural Policies

• Inclusiveness: Efforts are needed to make growth more inclusive, addressing skill gaps and mismatches.
• Labor Market Reforms: Strengthening active labor market policies (ALMPs) and improving vocational training can help align skills with labor market needs.
• Education and Innovation: Increasing digital penetration and investing in future human capital are important for long-term growth.
• Climate Goals: Further efforts are required to meet climate objectives, including higher carbon prices and support for green technologies.

Key Recommendations

• Fiscal Framework: Strengthen the fiscal framework with a review of fiscal rules, buffers, and the potential establishment of an independent fiscal council.
• Monetary Policy: Continue data-driven monetary tightening to address inflation pressures.
• Structural Reforms: Address long-standing challenges in productivity, labor participation, and human capital development.
• Education and Training: Improve the marketability of skills for Haredi and Arab students to support labor market integration.
• Climate Action: Implement policies to support the transition to clean energy and reduce greenhouse gas emissions.

Summary of Economic Indicators