Recent Economic Developments, 76

01/11/1996
All Press Releases In Subject:
The Economy and Economic Activity
Recent Economic Developments, 76, April 1996 - September 1996


 Main Developments
  The Principal Industries
   The Labor Market
    The Balance of Payments
     Prices
      The Government
       The Money and Capital Markets



Main Developments

From April to September 1996 (the period reviewed) the growth rate of economic activity slowed. This seems to have been due to the continued slowdown of the increase of domestic supply, alongside the slower rise in demand in 1996:III. These developments caused the demand pressure evident in 1996:II to ease, positively affecting both the balance of payments and inflation. Prices rose more slowly in 1996:III than in 1996:II, and the trade deficit - which had started declining in 1996:II - continued to contract in 1996:III. Although changes in economic trends could have been expected in the second half of the year, signs of this were detected only on the demand side of the private sector, and not on the supply side. It appears that on the one hand, uncertainty regarding budget policy does not encourage the supply side, and on the other, tight monetary policy in 1996:III started holding demand back.

National accounts figures for 1996:II indicate the high level of demand at the beginning of the period reviewed. Private consumption surged (in per capita terms, too), and both public-sector consumption and domestic use of resources rose. The trends relating to demand were unclear in 1996:III: the index of large-scale retail trade continued to rise at the same rate as in 1996:II, while indicators from the construction industry and tourism showed significant falls in demand. Further slowing of the rate of expansion of economic activity is indicated by the index of industrial production, the reduction in the number of building starts, the slow increase of industrial exports, the decline in imported inputs, and the slow rise of GDP in 1996:II. The state-of-the-economy index, which combines several indices reflecting the demand and the supply sides, reveals a similar picture.

The Consumer Price Index (CPI) rose by 10.8 percent (annual rate) in the period reviewed, remaining above the upper limit of the inflation target. Housing was particularly prominent among the components of the index, but the index excluding this component also rose relatively steeply, exceeding both its rise in the equivalent period in 1995 and the inflation target. At the beginning of the period reviewed, price indices rose rapidly, as did inflationary expectations. This trend seems to have eased in July–September.

The trade deficit, in current dollar terms, remained high throughout the period reviewed, averaging $ 700 million a month. Nonetheless, for the first time in a long period, there are indications of a downturn. The terms of trade deteriorated in 1996:II, after improving during the preceding six months; despite this, the trade deficit contracted. In the period reviewed, goods imports fell by about 2 percent from their level in the previous six months, with a decline in each of the main categories. Exports increased by 3 percent, with slight changes in their composition.

In the labor market, pressures built up in 1996:II: the labor supply grew rapidly, employment increased even faster, and the long-term decline in the number of unemployed persons continued. Interim indicators for 1996:III (a rise in the number of job-seekers and claims for unemployment benefit) suggest that the trend reversed during the quarter and that labor market pressures eased. The real wage per employee post in the business sector increased slightly in 1996:II.

At the end of September the government's domestic deficit stood at NIS 8.8 billion, and already then, three months before the end of the year, had exceeded the annual target set in the budget by NIS 1.3 billion. Most of this can be attributed to the failure to achieve the forecast revenues.

In monetary policy, as a result of negative developments regarding inflation and the government deficit, the Bank of Israel raised the interest rate on its sources, and at the end of 1996:II this reached an effective annual rate of 18.5 percent. In 1996:III, in the context of low price indices and lower inflationary expectations, the Bank reduced interest, though it remained high compared with its level at the beginning of the period reviewed, in both nominal and real terms (adjusting for inflationary expectations, which declined). The exchange rate rose steadily from the beginning of the period, but immediately after the elections at the end of May started to fall rapidly, and towards the end of August touched the lower limit of the exchange-rate band. Adherence to tight monetary policy, the movement of the exchange rate at the lower limit of the band, and renewed intervention by the Bank of Israel in the foreign-exchange market, apparently dispelled fears - at least in the short term, that the exchange rate would deviate significantly from the slope of the band. Thus, capital inflow increased, as did the rate of foreign-currency conversions at the Bank of Israel.

In the middle of the period reviewed, withdrawals from provident funds surged, share prices fell, and flotations on the stock exchange ceased completely, all these creating an atmosphere of crisis in the capital market. In this context, the policy-makers announced that they would intervene in the capital market, extending a safety net in order to prevent sharp fluctuations in bond prices. About a week after this announcement, bond prices began to rise steadily, and by the end of the period had reverted to their mid-period level.

Figure 1. State-of-the-economy index (average 1994=100)
Figure 2. Industrial production (index, average 1994=100)
Figure 3. Housing starts and completions, and relative price


Table 1. Selected Economic Indicators, 1995-96: III
(Annual rates, seasonally adjusted)


1995
1996
Apr-Sep***
*

1995 II III IV I II III 1995 1996
Rates of change
(in annual terms, percent)
(compared with preceding quarter)**
Industrial production 7.9 16.1 3.6 4.1 9.0 1.2 -0.4 9.3 4.0 8
State-of-the-economy index 10.2 13.6 5.2 10.1 13.1 1.4 0.8 9.3 1.1 9
Business-sector employment 5.5 3.7 6.2 -1.8 -0.5 10.0
8.1 3.4 6
Private building starts 7.7 -5.2 -29.1 18.7 -8.1 -54.4
22.3 -22.9 6
Consumer Price Index
(CPI) (during the period)
8.1 9.3 10.1 12.3 11.6 17.6 4.4 9.7 10.8 9
CPI excl. housing, fruit and vegetables, controlled goods, clothing and footwear (during the period) 9.2 9.6 9.5 7.6 14.7 12.0 9.2 9.5 10.6 9
NIS/currency basket rate 4.6 9.0 -2.5 5.2 2.3 9.9 -5.4 4.2 3.2 9
NIS/dollar rate 0.0 -2.3 3.5 6.8 7.6 15.0 -7.3 -1.0 6.7 9
GDP 7.6 13.3 5.0 1.8 5.0 0.8
11.8 3.1 6
Business-sector gross product 9.5 18.8 6.5 3.0 3.8 -0.3
15.2 3.2 6
Private consumption 7.8 1.4 5.2 8.7 6.9 10.0
6.7 7.7 6
Levels (average monthly level)
Unemployment rate (percent) 6.9 6.7 6.7 6.7 6.6 6.4


6
Immigrants ('000) 6.3 5.5 6.6 7.0 5.6 5.4 5.4 5.9 5.4 8
Domestic budget deficit
(percent of GDP)
3.5 4.9 6.3 3.5 4.2 3.3 4.2 5.6 3.7 9
Trade deficit ($ million) 676.0 606.1 705.4 770.4 795.0 718.8 682.8 655.7 700.8 9
Bank of Israel reserves at end of period ($ million) 8,158 8,780 8,838 8,158 9,697 8,887 10,230

9
Monetary loan
(percent, average)
15.6 15.1 14.2 15.0 14.9 15.9 17.7 14.6 16.8 9
General share-price index 171.5 167.4 184.4 182.0 182.8 174.8 157.9 175.8 166.4 9

*
**
***
Source: based on Central Bureau of Statistics data.
Last month for which data are available.
Top section of table.
Compared with same period in preceding year.

Top



The Principal Industries

The slow growth of industrial production evident since the second half of 1995 persisted in April-July 1996. Until mid-1995 industry grew at an average monthly rate of 0.8 percent, subsequently falling to 0.5 percent. This is reflected first by the slower rate of increase in the number of hours worked, and then, in May-July, when this indicator reverted to its previous rate, by reduced labor productivity. Similar trends can be seen from the continuous three-monthly survey of companies carried out by the Research Department of the Bank of Israel. The survey data, seasonally adjusted, indicate that the slowdown in economic growth which has prevailed since the second half of 1995 became more pronounced in 1996:III.

The annual reports of companies traded on the stock exchange give an indication of profitability. These show that the net profit/sales ratio (average, weighted by size of company) declined from the first to the second quarter in each one of the major industries. In 1996:I profitability was at its highest level since 1994. Net profit rose in only two industries - electronics, consistent with the expansion of exports (see section on balance of payments), and wood and wood products, in line with the increase in completions in residential construction.

Industry survey data indicate that the output trends evident in the first half of the year continued in the period reviewed. In 1996:II production in the food industry continued declining, as did production in light industry. In contrast, production in the construction goods, plastics and chemicals, and heavy industries, expanded further.

Demand-side indicators show that in construction there was a sharp trend reversal; demand rose in 1996:II, and plunged in 1996:III, in comparison with the equivalent periods in 1995. The number of new apartments sold by the ten major contractors increased by 5.6 percent in 1996:II, but fell by 30 percent in 1996:III. The number of sales registered by the property and land betterment tax authorities rose by 9 percent in 1996:II, and fell by 19 percent in 1996:III. The number of mortgages taken out increased by 14 percent in 1996:II, and declined by 18 percent in 1996:III. Sales within the framework of the Ministry of Housing program went up by 9 percent in the second quarter, and plummeted by 28 percent in the third. On the supply side, trends were inconsistent. In 1996:II, the number of residential building starts fell by 30 percent, while completions - mainly those initiated by the public sector - soared by 43 percent. Towards the end of the period, construction time fell and cement sales rose. This was apparently related to the easing of the closure of the Autonomy and the administered areas, which had previously disrupted construction and led to a decline in demand for cement there as well as within the Green Line.

Tourism, which had expanded since the beginning of the 1990s, rose almost constantly until February. Thereafter, due to acts of terrorism, the "Grapes of Wrath" campaign, and uncertainty regarding the peace negotiations, there was a sharp fall in the number of tourist entries and hotel bed-nights.

Figure 4. Large-scale retail trade (average 1995=100)
Figure 5. Tourism (index, average 1989=100)


Table 2. Indicators of Business Activity, 1995-96: III
(All data in this table, excluding construction, are seasonally adjusted)


1995
1996
Apr-Sep**
*

1995 II III IV I II III 1995 1996
Rates of change (average annual rates, percent)
Industrial production
(excl. diamonds)
7.9 16.1 3.6 4.1 9.0 1.2 -0.4 9.3 4.0 8
Large-scale retail trade 8.7 19.8 3.7 14.2 23.9 9.7 9.3 7.7 13.4 9
Industrial demand
for electricity
6.4 4.4 -1.2 1.8 7.0 -0.5 33.6 6.0 3.5 7
Cement sales 24.8 28.4 -18.7 11.2 -30.2 -0.3 -3.3 20.2 -9.1 8
Levels ('000, during period) (percent)
 
Residential starts (percent) 62.6 16.2 14.3 12.0 12.1 11.4
66.0 -29.6 6
of which: Government-initiated 27.7 7.2 6.0 3.4 3.7 4.5
200.0 -37.9 6
Residential completions
38.5 7.6 9.4 13.1 12.2 10.9
-17.8 43.1 6
of which: Government-initiated 7.3 1.7 1.7 2.2 3.3 3.0
-28.1 70.7 9
Tourist arrivals 2,218 540 572 589 623 498 318 27.1 -11.0 8
*
**
Last month for which data are available.
Compared with same period in preceding year.

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The Labor Market

Pressure on Israel's labor market increased in 1996:ll, and alongside the relatively steep rise in the labor supply, demand for it rose even more rapidly, so that the unemployment rate fell slightly. The number of labor-force participants rose by 38,500 in 1996:ll (compared with 2,000 in 1996:l), and the number of Israelis employed rose by 40,000 (after remaining stable in 1996:l), so that the unemployment rate fell to its lowest level for a very long time - 6.4 percent. Further evidence of increased pressure on the labor market in 1996:ll is provided by the fact that alongside the relatively rapid rise in the working-age population (32,000), the employment rate rose by 50.4 percent, after falling consistently in the two preceding quarters. According to the survey of industry, the average number of hours worked in manufacturing in 1996:ll (seasonally adjusted) was similar to that in 1996:l. Employment service figures appear to indicate that end-May marked a turning-point in the labor market. The number of work-seekers registered in June soared, remaining at a high level in the following two months and reaching 122,000 in September (seasonally adjusted) - the highest level since 1993. A similar trend is evident in claims for unemployment benefit.

A comparison of employment levels in equivalent periods shows that the number of Israelis employed in 1996:ll was 3 percent higher than in 1995:ll, that with the exception of agriculture - in which employment plummeted - employment rose slightly in most industries, and that it rose faster in transport and electronics (by about 11 percent).

Since April, in the wake of the closure imposed on the Autonomy and the administered areas, the number of labor permits issued for foreign workers rose steeply, and at the end of 1996:ll reached 100,000 - up by 25,000 over the number at the beginning of 1996:ll. During 1996:lll it continued to rise, though at a slower rate.

Since 1993 the number of unemployed has been falling, and in 1996:ll reached 139,000. At the beginning of 1996, after three years in which the number of unemployed women was higher than that of men, the trend reversed. In 1996:ll the number of unemployed women was lower than that of men, even though the number of women entering the labor force (26,000) was double that of men. Hard-core unemployment fell again, and the proportion of persons unemployed for over a year (seasonally adjusted) shrank to 43 percent in 1996:lll, the proportion of young and unmarried unemployed persons rose, and the time spent looking for work declined.

In 1996:ll the real wage per employee post rose slightly in the business sector (0.6 percent), and remained unchanged in the public sector. The nominal wage in the public services fell by only 1.5 percent in 1996:lll, following a seasonal rise in 1996:ll (due to the payment of vacation and clothing allowances). The relatively small decline was due inter alia to the 3.2 percent cost-of-living allowance paid in August, and the jubilee grant paid to long-serving employees in September.

Figure 6. Employment and unemployment (thousands)
Figure 7. Immigrants arrivals (thousands, monthly average per quarter)
Figure 8. Real wage per employee post (index average 1994=100)


Table 3. Indicators of Developments in the Labor Market
(Israelis), 1995-96: III

(All data in this table, excluding wages, are seasonally adjusted)


1995
1996
Apr-Sep**
*

1995 II III IV I II III 1995 1996
Labor force
participants
('000)
2,109.1 2,097.6 2,118.6 2,122.2 2,120.0 2,158.5
3.8 2.9 6
Employed persons ('000) 1,963.9 1,956.2 1,976.5 1,980.0 1,979.5 2,019.4
5.1 3.2 6
of which: Business sector
1,452.6 1,446.6 1,468.4 1,461.9 1,460.0 1,495.2
8.1 3.4 6
             Public sector 515.5 514.4 518.7 518.2 517.6 529.7
-1.5 3.0 6
Labor input in business sector
(rate of annual change over preceding quarter)
6.0 3.5 13.9 -15.2 4.6 7.3
7.9 1.6 6
Unemployment rate (percent) 6.9 6.7 6.7 6.7 6.6 6.4


6
Claims for unemployment benefit ('000) 68.6 67.1 72.3 70.9 70.9 70.6 77.3 10.5 6.1 9
Job applicants ('000) 71.3 71.3 73.9 74.0 73.3 73.8 79.1 8.6 5.4 9
Real wage per employee post
(deflated by CPI, quarterly rate, compared with same period, preceding year)
2,2 1.9 3.1 0.0 1.9 0.4
1.9 0.4 6
of which: Business sector 0.4 -0.3 2.2 0.4 1.8 0.6
-0.3 0.6 6
*
**
Last month for which data are available.
Compared with same period in preceding year.

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The Balance of Payments

During the period reviewed the average monthly trade deficit (excluding ships, planes, fuel and diamonds, seasonally adjusted) was $ 700 million. Although this is higher than in recent years, it was down by 10 percent from the level in the preceding six months. This decline should be seen in the context of the peak deficit in 1996:l - some $ 795 million - and combines a 3 percent rise in exports with a 2 percent fall in imports over the preceding six months. The deficit shrank during the period reviewed, despite real local-currency appreciation and a slight deterioration in the terms of trade in 1996:ll, prices of imports fell more slowly (1.1 percent) than export prices (1.5 percent), after a continuous improvement in the terms of trade in July-December 1995.

The decline in goods imports (in current dollar terms) compared with the previous six months encompassed all the principal items. Capital goods declined by 1 percent, consumer goods by 1.5 percent, and raw materials by some 3 percent. The fall in the latter and in capital goods persisted in both quarters of the period reviewed, while consumer goods, which had declined in 1996:ll picked up in 1996:lll.

Industrial exports excluding diamonds were up by some 2 percent in the period reviewed over the preceding six months, with a 7.5 percent drop in chemicals and 14 percent rise in equipment for communications, control and supervision, and medical and scientific purposes.

Regarding the regional distribution of trade in current prices, there was no significant change in the destinations of goods exports compared with the preceding six months. The share of the US in goods imports rose by 2 percent, however, and that of Europe fell by approximately the same rate.

No significant changes were made in the foreign-exchange regulations in 1996:lll. The foreign-exchange reserves in the Bank of Israel, which fell throughout 1996:ll, rose markedly in 1996:lll, after private-sector conversions soared (see section on money and capital markets). At the end of the period reviewed the reserves stood at a record $ 10.2 million.

Figure 9. Foreign trade ($million per month)

Table 4. Foreign Trade and Reserves, 1995-96: III
(Excluding ships, aircraft, diamonds, and fuel)


1995
1996
Apr-Sep**
*

1995 II III IV I II III 1995 1996
Monthly averages ($ million, current prices, seasonally adjusted)
Trade deficit 676 606 705 770 795 719 683 656 701 9
Merchandise imports 1,774 1,727 1,802 1,908 1,944 1,895 1,867 1,764 1,881 9
of which: Consumer goods 304 289 303 327 346 323 340 296 332 9
             Capital goods 390 373 394 427 441 436 424 384 430 9
             Intermediates 1,080 1,065 1,105 1,154 1,157 1,136 1,103 1,085 1,119 9
Merchandise exports 1,098 1,121 1,096 1,138 1,149 1,176 1,184 1,109 1,180 9
of which: Industrial
1,011 1,032 1,017 1,038 1,060 1,055 1,085 1,024 1,070 9
Bank of Israel reserves,
at end of period
8,158 8,780 8,839 8,158 9,697 8,887 10,230

9
*
**
Last month for which data are available.
Compared with same period in preceding year.

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Prices

The rapid rise of the CPI, which began at the end of 1995, persisted in 1996:l and the first two months of the period reviewed. Subsequently, as monetary restraint intensified and the exchange rate fell, the CPI gradually reverted to the rates evident in 1995. Throughout the period reviewed the CPI rose by 5 percent (an annual rate of 11.8 percent), exceeding the upper limit of the inflation target for 1996 - 10 percent. Housing was notable among CPI items, rising at an annual rate of 32 percent in 1996:ll and falling by 6 percent in 1996:lll. This sharp fluctuation contributed to the pronounced shift in the rate at which the CPI rose. Adjusted for this item, the CPI rose relatively rapidly (an annual rate of 11 percent) - faster than in the equivalent period in 1995 (8 percent) and overshooting the inflation target.

The 12 months' moving average inflation rose continuously in 1996:ll. At the beginning of 1996:lll it stabilized at a high level, falling gradually in August-September to its level at the beginning of the period. This development was affected by housing, which is influenced in the short run by the exchange rate against the dollar which, as stated, fell in July-August.

Wholesale prices increased by 6.7 percent (annual terms) in the period reviewed - less than the rate at which tradables prices rose (8 percent), more than the rise in the exchange rate against the dollar and the currency basket, and less than the rate in the equivalent period in 1995 (9.1 percent).

Inflationary expectations for the coming 12 months, as derived from the capital market, rose sharply at the beginning of the period reviewed, continuing the trend evident since the beginning of the year. These expectations peaked in May, considerably exceeding the inflation target. Afterwards, in the wake of tight monetary policy, they fell significantly, though remained above the inflation target. As Figure 10 shows, despite the changes and fluctuations, estimates of inflationary expectations were higher than the upper limit of the inflation target throughout the period reviewed.

Figure 10. Estimated inflationary expectations for the next 12 months

Table 5. Selected Price Indicies, 1995-96: III
(Annual rates of change, percent)


1995
1996
Apr-Sep**
*

1995 II III IV I II III 1995 1996
Consumer price index 8.1 9.3 10.1 12.3 11.6 17.6 4.4 9.7 10.8 9
CPI excl. housing, fruit and vegetables, controlled goods, clothing and footwear 9.2 9.6 9.5 7.6 14.7 12.0 9.2 9.5 10.6 9
Index of housing prices 13.6 11.0 17.1 18.9 15.1 31.8 -6.3 14.0 11.1 9
CPI excl. housing, fruit and vegetables 8.8 12.3 6.9 10.7 9.7 15.0 7.2 9.6 11.0 9
Wholesale price index 10.0 14.9 4.8 9.6 8.6 12.1 1.7 9.7 6.7 9
NIS/$ exchange rate 3.1 0.7 7.5 11.6 -2.6 21.8 -10.5 4.0 4.4 9
NIS/currency busket rate
5.8 3.3 -2.9 13.0 -6.5 17.1 -8.9 0.2 3.2 9
*
**
Last month for which data are available.
Compared with same period in preceding year.

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The Government

In the period reviewed the government's domestic budget excluding credit (cash basis) showed a deficit of NIS 5.8 billion, i.e., 4 percent of GDP. From the beginning of the year until the end of September the budget deficit amounted to some NIS 8.8 billion - NIS 1.3 billion above the limit set in the annual budget. The entire annual deviation is estimated at NIS 4 billion - most of it due to an unexpected fall in revenues. A comparison with equivalent periods points up the fall in revenues, rise in expenditure, and the creation of a sizeable deficit, which is not characteristic of the first quarter of a year. The deficit was high in the two subsequent quarters, though below its level in the equivalent period in 1995. Thus, the large deviation from the target deficit of 1996:l was carried forward throughout the year.

At the beginning of July the government decided to cut expenditure on the 1996 budget by NIS 350 million, attaining a total budget deficit for 1997 (excluding credit) of 2.8 percent of GDP, and to accelerate the decline in the legally-permitted deficit.

During the period reviewed the public-sector deficit was financed equally by net borrowing from the public and sales of foreign exchange to the Bank of Israel (a budget-related injection). Most of the net borrowing from the public took the form of sales of bonds, while income from privatization was negligible. This combination of a rise in the budget deficit and its financing composition served to increase pressure in the capital and long-term credit markets, so that during the period reviewed long-term interest rates (represented by yields to maturity on 5- and 10-year bonds) rose in comparison with those prevailing in the equivalent period in 1995.

Government receipts in the period reviewed were up by only 2.6 percent in real terms over the equivalent period in 1995. This low rate of increase is the result of a 6.3 percent rise in indirect tax receipts (domestic manufacturing and imports), and stability in direct taxes and national insurance payments. The tax laws were not amended during the period reviewed.

In real terms, total national insurance benefits were high, and in April-July 1996 they were up by some 4 percent over the equivalent period in 1995. This rise was evident for all types of allowances excluding old-age and survivor's pensions, which remained stable. Unemployment benefits rose by 7 percent in 1996:ll, and by 13 percent in July, in comparison with the equivalent periods in 1995.

Figure 11. Government cash flows (NIS million, monthly average)

Table 6. Fiscal and Monetary Indicators, 1995-96: III
(Cash flows as percent of GDP)


1995
1996
Apr-Sep**
*

1995 II III IV I II III 1995 1996
Government domestic expenditure 40.5 39.9 42.0 39.3 43.5 38.6 40.2 40.9 40.7 9
Government receipts 37.0 35.0 35.7 35.8 39.2 35.3 36.0 37.4 36.8 9
Domestic budget deficit 3.5 4.9 6.3 3.5 4.3 3.3 4.3 3.5 4.0 9
Public-sector domestic deficit 4.4 5.9 7.3 4.0 3.3 3.6 6.0 4.5 4.3 9
Government net borrowing from the public 3.3 3.2 4.0 3.2 2.5 1.3 2.8 3.3 2.2 9
Public-sector injection 1.1 2.7 3.3 0.9 0.8 2.2 3.2 1.2 2.1 9
Bank of Israel injection
-8.4 -9.3 -9.1 -5.8 -2.5 -1.4 -6.3 -9.3 -3.5 9
of which: Monetary loan -4.2 -5.6 -1.5 -1.5 1.1 -0.4 -2.5 -5.2 -0.7 9
Private sector conversion of foreign exchange
7.0 7.7 5.7 4.8 3.0 -0.2 3.7 7.8 2.2 9
Change in monetary base
-0.3 1.1 -0.1 -0.1 1.3 0.6 0.6 -0.3 0.8 9
 * Last month for which data are available.
** Compared with same period in preceding year.

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The Money and Capital Markets

In 1996:ll, against the backdrop of exceptional price increases, intensified inflationary expectations (see Figure 10), and significant deviations from the budget deficit target, the Bank of Israel raised the interest rate on its sources three times (by 0.8 percentage points in May, 0.7 percentage points in June, and 1.5 percentage points in July), so that the effective interest rate reached 18.5 percent—the same as at the end of 1994 and the beginning of 1995. In 1996:lll, in the context of low CPIs and a decline in inflationary expectations, the Bank of Israel reduced the interest rate on its sources, three times but more slowly, so that by the end of the period reviewed it was higher than at the outset (an effective 17 percent). When adjusted for inflationary expectations, this represented a real interest rate of 5 percent. The Bank of Israel has not intervened in the foreign-exchange market since the beginning of February, enabling market forces to set the exchange rate. At the beginning of the period reviewed the currency-basket exchange rate was 5.8 percent below the midpoint rate of the crawling band. Because of the approaching elections and expectations of budgetary discipline after them, demand for foreign exchange grew, the currency-basket exchange rate rose, and on election day it was only 1.68 percent below the midpoint rate. Immediately after the elections it began to fall rapidly. and between end-August and end-September it remained close to the lower limit of the band. At the same time, the capital inflow intensified, and in order to prevent the exchange rate from falling below the band the Bank of Israel intervened once again in the foreign-exchange market. Between end-August and end-September the Bank converted some $ 1 billion for the private sector, while sterilizing its effect on liquidity.

The monetary base grew by 9.6 percent (some NIS 1 billion) during the period reviewed, with wide fluctuations in its components. In June-August the government injection amounted to NIS 5 billion, most of which was absorbed by the Bank of Israel. In September, in the wake of extensive capital imports by the private sector, foreign-exchange conversions amounted to NIS 3 billion and, as stated, these were sterilized by the central bank. Altogether, during the period reviewed the Bank of Israel absorbed NIS 6 billion, most of it (NIS 4 billion) by means of a new monetary instrument - a 3-month auction between commercial banks for local-currency deposits - as well as by reducing the monetary loan and selling Treasury bills to the public. At the end of June, when this instrument was first deployed, the average interest rate on these deposits was 17.8 percent, and fell gradually to reach 16.2 percent.

During the period reviewed narrow money (M1) rose by 6.7 percent (13.8 percent in annual terms), a slightly lower rate than GNP, and a development that is in line with the monetary policy objective. On the other hand, M2 rose by 14 percent (30 percent in annual terms), after a continual monthly increase in interest-bearing deposits (SROs and resident time deposits) and a rise in Treasury-bond issues. Deposits denominated in or indexed to foreign currency also rose during the period reviewed, though at a slower rate than that of unindexed local-currency deposits.

Nondirected bank credit to the public expanded throughout the period at an average monthly rate of 1.7 percent, with a gradual reduction in the share of its unindexed component. In 1996:ll foreign-currency-indexed credit rose particularly rapidly, while in 1996:lll foreign-currency credit rose steeply (though the rise was slower in local-currency terms. This shift reflects expectations that the yield differential would continue to favor foreign-currency credit for the rest of the year.

During 1996:ll the general share-price index rose slowly, by 6 percent, after which it fell steeply, and at end-August it reached its lowest level since the February 1995 slump. The index then rose, and by the end of the period reviewed it was slightly below its level at the beginning. The bond index fell by 5 percent during July and August, and some NIS 6 billion was withdrawn from provident funds. This was financed by sales of indexed bonds by the funds, apparently contributing to a further decline in their price. Shifts in the prices of financial assets, the rapid switch between them, the fall in the price of most shares, and the almost total stagnation of stock-market offerings, created an atmosphere of crisis. Consequently, in July the Treasury and the Bank of Israel announced the introduction of a safety net, involving the Bank's active intervention in the bonds market to prevent their price from plummeting. The fall in bond prices was curbed, and after slight falls in the first two weeks after the announcement was made, they began to rise once more, and by end-September the decline of the previous months had been cancelled out.

During the period reviewed the public's financial portfolio became more liquid. The share in it of provident funds and indexed assets declined, while that of unindexed assets, savings plans, and indexed deposits rose.

Figure 12. M1, M2 and bank credit (constant prices; index 1988: I=100)
Figure 13. Nominal interest rate and inflation (annual rate)
Figure 14. The shequel exchange rate against the currency basket


Table 7. Monetary Indicators, 1995-96: III
(Percent, in annual terms)


1995
1996
Apr-Sep***
*

1995 II III IV I II III 1995 1996
Rates of change (over previous quarter, percent)
Increase in aggregates (average)
during period**
 
M1 8.4 20.7 46.9 0.0 14.3 15.1 18.1 36.5 11.7 8
M2 (excluding securities) 35.2 36.1 41.1 22.4 25.1 17.0 40.6 39.9 31.6 8
M3 (excluding securities) 25.5 24.2 32.9 23.7 25.4 25.9 32.8 30.5 33.0 8
Nondirected bank credit 26.2 25.7 18.0 19.3 21.8 24.9 23.7 21.4 24.9 8
Unindexed local-currency credit
11.0 15.6 -4.0 10.0 11.9 16.9 12.6 4.9 16.3 8
Levels
Nominal interest (percent)









Short-term unindexed local-currency credit 20.2 19.7 18.9 19.8 19.6 20.5 22.2 19.4 21.2 8
Monetary loan (percent, average) 15.6 15.1 14.2 15.0 14.9 15.9 17.7 14.6 16.8 9
Self-renewing overnight deposits 13.3 12.8 12.0 12.7 12.5 13.6 15.4 12.5 14.3 8
3-month Eurodollars 5.9 6.0 5.8 5.7 5.3 5.4 5.5 5.9 5.4 9
Yield to maturity of Treasury bills (percent) 15.4 15.2 14.0 15.1 13.7 15.7 17.4 14.6 16.4 8
Yield to maturity of 10-year bonds (percent) 4.3 4.4 4.4 4.4 4.3 4.3 4.9 4.4 4.6 9
General share price index 90.7 88.1 97.4 97.1 97.4 94.8 84.4 92.8 89.6 9
*
**
***
Last month for which data are available.
Top section of table.
Compared with same period in preceding year.