Recent Economic Developments, 78

01/05/1997
All Press Releases In Subject:
The Economy and Economic Activity
Recent Economic Developments, 78, October 1996 - March 1997


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



Previous Economic Developments 77


Main Developments

Between October 1996 and end-March 1997 (the period reviewed) real economic activity slowed, stabilizing at a lower level than that projected in the budget. In the capital and money markets, however, activity was particularly lively. The low level of real economic activity was reflected by the persistence of the positive trends of prices and foreign trade evident since 1996:lll, on the one hand, and by the rise in unemployment, on the other. The Consumer Price Index (CPI) rose at an annual rate of 9.75 percent, very near the upper limit of the government's inflation target; the trade deficit shrank, despite real local-currency appreciation and the relatively large budget deficit; the unemployment rate rose to 7 percent in 1996:lV, its highest level for 18 months. Lively money-market activity was expressed in considerable capital imports by the private sector, and extensive foreign-currency conversions in 1997:l.

The slowdown in demand is indicated by the steep 9 percent drop in domestic use of resources in 1996:lV, the fall in consumer goods imports in 1997:l, various construction indicators, and the decline in immigration. On the other hand, such indicators as large-scale retail trade and bank credit actually indicate that there was expansion. The slowdown on the supply side is attested by the small increase in GDP in 1996:lV, the steep decline in industrial production, worsening still further at the beginning of 1997, the number of business-sector employees, and the decline in imported intermediates. The rise in the state-of-the-economy index, which incorporates some of these indicators, was checked in the period reviewed, after a long period of steady growth.

Inflation indicators suggest that in the period reviewed it stabilized at the level to which it had fallen in 1996:lll, within the limits of the inflation target but near its ceiling, in spite of the rapid rise in the prices of housing and fruit and vegetables in the CPI, and in the exchange rate against the dollar.

The trade deficit (in current dollars) shrank as imports in all the principal categories continued to fall and exports rose. At the end of the period reviewed there was a trend reversal, and the deficit, which had declined constantly, bottoming in January, began to rise, and in March 1997 it reached a level only marginally lower than the annual average for 1996. The exchange rate against the currency basket, which in 1996:lV had risen above the lower level of the crawling band, declined and reached it again in 1997:l, remaining there till the end of the period reviewed.

Demand also moderated in the labor market; while the Israeli labor supply remained stable, demand for it fell, and the unemployment rate rose slightly. Nonetheless, wages continued to rise, albeit moderately, possibly indicating that the supply of certain categories of employees - probably knowledge workers - had been exhausted.

As far as government activity is concerned, the period reviewed can be divided into two parts. In 1996:lV the domestic budget deficit rose to NIS 6 billion, i.e., 7.7 percent of GDP (compared with 3.3 percent in the equivalent period in 1995), as a result of a relatively high level of expenditure and a low one of revenues. In 1997:l, after the new Budget Law had gone into effect, the deficit shrank to less than 1 percent of GDP, after revenues had risen sharply and expenditure had plummeted vis-a-vis 1996:l. Nonetheless, considering the fact that in the first quarters of previous years the deficit was usually small, and in some cases there was even a surplus, the 1997 figure certainly does not guarantee that the deficit target for the entire year will be attained.

In monetary policy, as inflation declined, the Bank of Israel gradually reduced the nominal cost of the sources it makes available to the banking system, but because of the decline in inflation expectations real interest did not fall. At the same time, potential excess liquidity was created due to extensive foreign-currency conversions by the public ($ 5 billion). Excess liquidity was absorbed in order to meet the monetary targets, primarily by means of auctions for banks' interest-bearing deposits in the Bank of Israel as well as by rapidly reducing the Bank's monetary loans. Thus, the period reviewed was characterized by high real interest (in the wake of the decline in inflation expectations), a flood of foreign-currency conversions, and the rapid expansion of banks' deposits in the Bank of Israel.

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, 1995-97
(Annual rates, seasonally adjusted)


1995
1996
1997
Oct-March**
*

1995 1996 IV I II III IV I 1996 1997
Rates of change
(annual average, percent)
Industrial production
(excl.diamonds)
7.9 5.2 4.3 11.3 0.5 4.5 -5.3 -12.8 8.1 0.3 2
State-of-the-economy index 10.3 3.1 12.1 11.6 2.7 3.5 -4.5 4.8 11.9 0.0 3
Business-sector employment 5.5 2.6 -4.5 -0.9 8.2 7.0 -7.2
3.4 1.6 12
Private building starts 7.7 -8.7 -2.2 3.7 -45.9 53.3 25.0
-3.7 1.8 12
Consumer Price Index
(CPI) (during the period)
8.1 10.6 12.3 11.6 17.6 4.4 9.2 10.8 12.0 10.0 3
CPI excl. housing, fruit and vegetables, controlled goods, clothing and footwear (during the period) 9.2 10.2 7.6 14.7 12.0 9.2 5.1 10.1 11.1 7.6 3
NIS/currency basket rate 4.6 3.5 5.2 2.3 9.9 -5.4 9.9 -0.1 3.5 3.7 3
NIS/$ exchange rate 0.0 5.9 6.8 7.6 15.0 -7.3 11.1 9.9 2.5 6.5 3
GDP 6.9 4.2 2.8 4.9 2.9 1.9 1.9
5.5 2.9 12
Business-sector gross product 9.0 4.7 7.5 2.8 1.8 1.5 0.9
8.4 1.7 12
Private consumption 8.1 5.5 12.3 3.8 6.8 10.4 -14.2
9.0 1.2 12
Levels (monthly average)
Unemployment rate (percent) 6.9 6.7 6.7 6.6 6.5 6.6 7.0


12
Immigrants ('000) 6.3 5.9 7.0 5.6 5.4 5.9 6.6 4.7 6.4 5.9 2
Domestic budget deficit
(percent of GDP)
3.5 4.8 3.5 4.1 3.1 4.1 7.7 0.6 3.7
3
Trade deficit
($ million)
676.8 670.2 775.5 814.4 705.6 644.8 516.5 560.2 794.8 538.4 3
Bank of Israel reserves at end of period ($ million) 8,158.3 11,420 8,158.3 9,697.3 8,887.1 10,230 11,420 15,336

3
Interest of monetary loan
(percent, average)
15.6 16.1 15.0 14.8 15.9 17.6 16.2 15.0 14.9 15.6 3
General share-price index 171.5 172.0 182.0 182.8 174.8 157.9 172.6 216.7 182.4 194.6 3

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

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The Principal Industries

During the period reviewed economic activity declined. National accounts data show that in 1996:lV business-sector product (seasonally adjusted) rose by a mere 0.9 percent, its slowest rise during the whole year. This slowdown occurred in the context of a steep drop in domestic resource uses, the reduction of inventories, and a faster rise in public-sector output. Additional evidence of the economic slowdown is provided by the index of industrial production, which fell in 1996:lV, for the first time in a very long period. Direct reports from companies participating in the Bank of Israel's quarterly survey also indicate the same trend. Seasonally adjusted, these reports reveal a decline in economic activity in a large segment of the business sector (manufacturing, construction, hotels); without this adjustment the decline is even more pronounced.

An analysis of industries in the two-digit category shows that output declined in most industries from 1996:lll to 1996:lV, particularly in textiles, clothing, and leather (by 10 percent). In mining and quarrying, however, output actually rose, and this was evident throughout 1996, mainly because exports of phosphates rose, and because of certain developments in construction and road-building.

According to the indicators. during the period reviewed construction activity was uneven. Starts in both the public and the private sectors fell in 1996:lV, while completions rose in both of them. In 1997:l the trends indicating a slowdown in construction activity were accentuated, and alongside the continued sharp fall in government-initiated construction, a decline was evident in sales of cement, as well as of apartments by the ten major construction companies; the number of mortgages taken, and sales of new and old apartments, also fell. However, the number of apartments sold by the Ministry of Construction and Housing, and preliminary data for March on sales by the ten major companies, indicate a rising trend.

Tourism continued to dwindle in the context of security incidents, and during the period reviewed tourist entries were 14 percent below the level in the equivalent period a year earlier.

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


Table 2. Indicators of Business Activity, 1995-97
(All data in this table, excluding construction, are seasonally adjusted)


1995
1996
1997
Oct-March**
*

1995 1996 IV I II III IV I 1996 1997
Rates of change (average annual rates, percent)
Industrial production
(excl. diamonds)
7.9 5.2 4.3 11.3 0.5 4.5 -5.3 -12.8 8.1 0.3 2
Large-scale retail trade 8.5 13.0 15.7 16.2 17.4 3.4 3.3 13.2 14.4 9.5 3
Industrial demand
for electricity
6.5 2.6 -1.8 10.2 2.4 3.0 -4.5 -1.0 2.1 1.1 2
Cement sales 24.0 -5.8 -2.6 -28.2 1.8 8.3 16.0 -19.8 17.7 -2.9 2
Levels ('000, during period) (percent)
 
Residential starts (percent) 63.5 52.9 12.0 11.8 12.7 14.6 13.8
-13.8 14.8 12
of which: Government-initiated 27.7 19.0 3.4 3.6 4.5 5.9 5.1
-31.6 48.5 12
Residential completions
38.2 48.9 12.6 12.7 11.4 11.5 13.2
48.5 4.8 12
of which: Government-initiated 7.3 15.7 2.2 3.3 2.9 4.4 5.0
-1.8 132.1 12
Tourist arrivals 2,209.6 2,089.6 580.0 608.0 494.0 487.0 498.0 351.0 18.5 -14.8 2
*
**
Last month for which data are available.
Compared with same period in preceding year.

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The Labor Market

In 1996:lV the pressure in the labor market abated, and alongside stability in the Israeli labor supply, demand for it fell and the unemployment rate rose. Despite the increase of 30,000 in the working-age population, the labor force did not grow substantially (after increasing by 16,000 in 1996:lll). Employment of Israelis, which had expanded constantly until then, shrank by 9,000, so that the unemployment rate rose to 7 percent, higher than it had been in any previous quarter in 1996. Further evidence of the easing of demand pressure in the labor market is provided by the decline of the employment rate to its lowest level for a very long time, the rise in the number of claims for unemployment benefit, and the marked increase in the number of work-seekers. The last two indicators also show that the easing of labor-market pressures continued in 1997:l, and additional evidence is provided by the results of the January survey of industry, in which labor input fell by 2 percent (seasonally adjusted) from the 1996:lV average, due to the decline in both hours worked and the number of employees.

The number of Israelis employed in 1996:lV was 2 percent higher than in 1995:lV, and the number of hours worked per employee was 6 percent higher. These high levels were the result of the relatively rapid rise of employment in the first half of 1996, followed by stabilization and then even a decline, contrary to the seasonal trends of 1995. The Labour Force Survey for 1996:lV shows that the number of man-hours rose thoughout the private sector, while the number of employees fell in parts of the private sector, especially in hotels and catering, because of the fall in tourism. The combination of the increase in man-hours with the decline in the number of employees indicates that some employers regarded the easing of demand as a long-term trend (similar to the situation in which capital utilization increases when a decline in economic activity is expected).

The number of work permits issued to foreign workers, which has risen consistently in the last three years, remained stable at 106,000 in the period reviewed.

The characteristics of unemployment in 1996:lV attest to a rise in long-term unemployment: the greater proportion in it of married persons, adults, and the rise in the number of persons jobless for a year. For the last two years the trend shift by gender in persons unemployed has alternated each quarter: when the number of unemployed women rose, the number of unemployed men fell (seasonally adjusted data), and vice versa. Only in 1996:lV did unemployment soar for both men and women, especially among the latter.

Despite the easing of pressure in the labor market, real wages per employee post were 2.2 percent higher in 1996:lV than in 1995:lV (2.4 percent in the business sector). This development reinforces the view that demand pressure focuses on knowledge workers, the supply of which is almost fully utilized. Wages continued to rise at the beginning of 1997, inter alia because the ceiling on National Insurance contributions was raised, employers' contributions to health insurance were canceled, the tax brackets were adjusted, and a cost-of-living increment of 0.6 percent was paid in February. A minimum wage was introduced in April 1996.

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
1995-97

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


1995
1996
1997
Oct-March**
*

1995 1996 IV I II III IV I 1996 1997
Labor force
participants
('000)
2,109.6 2,157.8 2,121.9 2,121.1 2,159.2 2,175.2 2,157.7

2.5 12
Employed persons ('000) 1,964.6 2,014.0 1,980.3 1,981.5 2,019.5 2,031.8 2,023.2

2.2 12
of which: Business sector***
1,400.2 1,436.7 1,413.3 1,410.1 1,438.2 1,462.8 1,435.6
3.4 1.6 12
             Public sector*** 564.4 577.3 567.0 571.4 581.3 569.0 587.6
5.9 3.6 12
Israeli labor input in business sector
(rate of annual change over preceding quarter)
5.6 1.6 -29.3 0.1 16.4 21.5 -22.3


12
Unemployment rate (percent) 6.9 6.7 6.7 6.6 6.5 6.6 7.0


12
Claims for unemployment benefit ('000) 68.6 75.5 70.9 71.3 70.7 76.8 83.4 88.7 7.8 21.0 3
Job applicants ('000) 71.3 85.9 73.3 72.8 74.6 79.7 116.3 107.3 13.2 53.6 2
Real wage per employee post***
(deflated by CPI, quarterly rate)
2,2 1.5 0.0 2.1 0.8 0.9 2.2 1.5 0.7 2.1 1
of which: Business sector 0.7 1.5 0.7 2.0 1.1 0.7 2.4 0.3 1.3 2.1 1
*
**
***
Last month for which data are available.
Compared with same period in preceding year.
Not seasonally adjusted.

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The Balance of Payments

During the period reviewed the trade deficit (excluding ships, planes, fuel, and diamonds, seasonally adjusted) contracted to a monthly average of $538 million, compared with a monthly average of $670 million for the whole of 1996. This decline came in the wake of a relatively rapid reduction of goods imports and a rise in goods exports - all this despite continued real local-currency appreciation during the period reviewed. In 1996:lV Israel's terms of trade improved, primarily due to the strengthening of the dollar vis-a-vis other world currencies (and possibly also to the fall in raw materials prices), contributing to the further reduction of the trade deficit measured in current dollars. In 1997:l the trade deficit rose, and this was particularly marked in March, when it was higher than at any other time in the period reviewed.The decline in goods imports encompassed all their principal components: intermediates (indicating the level of current economic activity) and consumer goods fell relatively rapidly in 1996:lV, but then began to rise gradually. Capital goods (indicating future economic activity) declined steadily throughout the period reviewed, by a total of 8 percent.

Industrial exports, excluding diamonds, were up by 5.5 percent in the period reviewed over the preceding six months, alongside a marked increase in chemicals exports and oil refining, communications equipment, and medical and scientific equipment (by about 12 percent), while exports of electronic components, office machines, and computers remained stable.

During the period reviewed several foreign-exchange controls were relaxed for the first time in a long period, primarily those concerning sources which could be deposited in a resident deposit and the purchase of foreign currency for travel abroad.

The Bank of Israel's foreign-exchange reserves rose by $5 billion during the period reviewed, stabilizing at $15.7 billion at end-March. Most of the increase derived from foreign-currency conversions by the private sector, mainly in 1997:l.

Figure 9. Foreign trade ($million per month)

Table 4. Foreign Trade and Reserves, 1995-97
(Excluding ships, aircraft, diamonds, and fuel)


1995
1996
1997
Oct-March
*

1995 1996 IV I II III IV I 1996 1997
Monthly averages ($ million, current prices, seasonally adjusted)
Trade deficit 677 670 776 814 706 645 517 560 795 538 3
Goods imports 1,776 1,856 1,919 1,958 1,880 1,843 1,742 1,794 1,938 1,768 3
of which: Consumer goods 304 328 331 346 323 334 311 327 339 319 3
             Capital goods 389 421 422 445 428 419 390 380 434 385 3
             Intermediates 1,082 1,107 1,165 1,167 1,130 1,090 1,042 1,088 1,166 1,065 3
Goods exports 1,099 1,186 1,143 1,144 1,175 1,198 1,226 1,234 1,144 1,230 3
of which: Industrial
1,013 1,079 1,044 1,055 1,052 1,092 1,118 1,145 1,049 1,132 3
Bank of Israel reserves,
end-period
8,158 11,420 8,158 9,697 8,887 10,230 11,420 15,326

3
*
Last month for which data are available.

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Prices

After falling in 1996:lll, inflation stabilized at its low level in 1996:lV, rising slightly again in 1997:l. The CPI rose by 4.8 percent in the period reviewed, representing an annual rate of 9.75 percent. Although this is below the upper limit of the annual inflation target, two factors call its attainment into question. The first is inflation expectations (see below), which fell in the first four months of the period reviewed. but rose in the last two months right up to the upper limit of the target. The second is actual inflation, which for the first time rose to the level of the equivalent months in 1996. Among the CPI items, the rise in the prices of fruit and vegetables and of housing (25 and 14 percent respectively, in annual terms) is notable. Adjusted for these two items, the total rise in the CPI amounted to 7 percent in annual terms, near the lower level of the inflation target, and below the rate in the same period in 1996 (some 10 percent).

Wholesale prices rose by 6.3 percent in annual terms in the period reviewed, slightly below the increase in prices of tradable goods (7 percent) and the rise in the dollar exchange rate (12 percent), higher than the rise in the exchange rate against the currency basket (5,7 percent) and lower than the rate at which wholesale prices rose in the same period last year (8 percent).

Inflation expectations for the next 12 months, as estimated from figures derived from the capital market, declined gradually in 1996:lV, rose slightly in 1997:l, stabilizing at 10 percent (gross estimate) in March. At the same time, average inflation in the preceding 12 months fell less steeply than did expectations for the coming 12 months, and since November the former has been slightly higher than the latter. From the development of these two indicators it can be inferred that inflation may be lower in the year than in the past one, although, as stated, it is still near the ceiling of the target.

Figure 10. Estimated inflationary expectations for the next 12 months

Table 5. Selected Price Indicies, 1995-97
(Annual rates of change during period, percent)


1995
1996
1997
Oct-March
*

1995 1996 IV I II III IV I 1996 1997
Consumer price index (CPI) 8.1 10.6 12.3 11.6 17.6 4.4 9.2 10.8 12.0 10.0 3
CPI excl. housing, fruit and vegetables, controlled goods, clothing and footwear 9.2 10.2 7.6 14.7 12.0 9.2 5.1 10.1 11.1 7.6 3
Index of housing prices 13.6 13.2 18.9 15.1 31.8 -6.3 15.6 14.2 17.0 14.9 3
CPI excl. housing, fruit and vegetables 8.8 10.1 10.7 9.7 15.0 7.2 8.7 6.3 10.2 7.5 3
Wholesale price index 10.0 7.0 9.6 8.6 12.1 1.7 6.1 6.3 9.1 6.2 3
NIS/$ exchange rate 3.1 5.0 11.6 -2.6 21.8 -10.5 14.6 11.5 4.2 13.0 3
NIS/currency busket rate
5.8 3.0 13.0 -6.5 17.1 -8.9 12.7 -0.8 2.8 5.8 3
*
Last month for which data are available.

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The Government

Regarding government activity, the period under review can be divided into two: in 1996:IV, at the end of the fiscal year, the government's domestic deficit excluding credit granted (cash basis) was NIS 6 billion, 7.7 percent of GDP, compared with 3.3 percent in the equivalent period in 1995. The sharp rise in the deficit arose from both relatively high expenditure and low revenues. In 1997:I, when the 1997 Budget Law was in force, the deficit shrank to less than one percent of GDP, as a result of a steep rise in revenues and a reduction in expenditure from 1996:l. Nevertheless, by comparison with the same periods in previous years, when there was usually a small deficit or even a surplus, the budget data of 1997:l are far from providing assurance regarding the attainment of the target deficit for the year.

Following the significant deviation from the planned reduction of the budget deficit in 1996, the new Budget Law specified a reduction redirecting the budget to its original path, i.e., a cut of NIS 7.1 billion at 1997 prices. The main deficit reduction was achieved by increasing the public's tax burden, with very little cutting back of public-sector expenditure. Although the new budget reimposes long-term fiscal discipline to some extent, it represents increased government intervention in the economy and greater uncertainty regarding private-sector activity, thereby possibly harming future growth which that sector is intended to lead.

Most of the deficit of the public sector (which includes the Jewish Agency and the Bank of Israel) was financed from the public's deposits in the Bank of Israel and the sale of bonds, and in March also from revenue arising from privatization (Israel Chemicals). The budget injection reached an exceptionally high level in December, and then, once the new Budget Law had gone into effect, budgetary activity eased, and this trend strengthened during 1997:I.

Real tax revenues were down by one percent in 1996:IV from 1995:IV and up by 5 percent in 1997:I over 1996:I, so that for the whole period under review they rose by 2.2 percent. The turning point in tax revenues came as the result of a relatively rapid rise in indirect taxes on domestic production in 1997 (from a two percent increase in 1996:IV to 13 percent in 1997:I), and from an increase in direct taxes (from stability to a rise of 10 percent). On the other hand, tax receipts on imports declined faster (a fall of 8 percent in 1996:IV from 1995:IV became an 18 percent drop in 1997:I from 1996:I), and revenues from property tax - usually highest in the first quarter - plunged at the beginning of 1997 because of the paucity of real-estate transactions. During the period reviewed legal changes intended to broaden the base of tax revenues - including a halt in the updating of direct tax brackets, and an increase in the excise tax on fuel - went into effect.

In October 1996–January 1997 real national insurance benefits increased by 9 percent in real terms over the same period a year earlier. Unemployment benefits in particular were higher in every month in 1996 than in the equivalent months in 1995, and in the period under review were 26 percent more than in the equivalent period a year earlier.

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

Table 6. Fiscal and Monetary Indicators, 1995-97
(Cash flows as percent of GDP)


1995
1996
1997
Oct-March
*

1995 1996 IV I II III IV I 1996 1997
Government domestic expenditure 40.5 40.7 39.3 42.1 38.1 41.1 41.4 41.5 40.7 41.5 3
Government receipts 37.0 35.9 35.8 38.0 35.0 36.9 33.7 40.9 37.0 37.3 3
Domestic budget deficit 3.5 4.8 3.5 4.1 3.1 4.1 7.7 0.6 3.8 4.1 3
Public-sector domestic deficit 4.4 5.4 4.0 3.2 3.5 6.1 8.6 1.4 3.6 5.0 3
Government net borrowing from the public 3.3 2.6 3.2 2.4 1.3 2.9 3.7 4.4 2.8 4.0 3
Public-sector injection 1.1 2.8 0.9 0.8 2.2 3.2 5.0 -3.0 0.8 0.9 3
Bank of Israel injection
-8.4 -3.5 -5.8 -2.4 -1.4 -6.3 -3.6 -16.1 -4.1 -9.9 3
of which: Monetary loan -4.2 -1.0 -1.5 1.0 -0.4 -2.5 -2.0 -0.1 -0.2 -0.9 3
Private sector foreign-exchange conversions**
7.0 1.9 4.8 2.9 -0.2 3.7 1.1 17.5 3.8 9.4 3
Change in monetary base
-0.3 1.3 -0.1 1.3 0.6 0.6 2.5 -1.6 0.6 0.4 3
 * Last month for which data are available.
** As of August 1995 this includes swaps.


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The Money and Capital Markets

The main factors affecting monetary policy-makers' decisions are the inflationary environment (the estimate of which is based inter alia on a combination of the actual and expected rates of annual inflation), the narrow money supply (M1), the position of the exchange rate within the crawling band, the level of economic activity, and the budgetary situation. During the period under review these factors moved in different directions, as is indicated by a certain tightening of monetary restraint in 1996:IV (resulting from a combination of a reduction in nominal interest and a greater decline in inflation expectations), followed by some easing in 1997:I. The real cost of the Bank of Israel's monetary loan (nominal interest adjusted for inflation expectations) rose gradually from September to December and then fell, and in March stood at an annual 4.75 percent, similar to its level at the beginning of the period under review, but more than one percentage point higher than in March 1996. Its nominal level (in effective terms) reached its peak for the year in July 1996, as did the real cost; since then it has declined gradually, and by the end of March 1997 reverted to its level of January 1996. Alongside the reduction in the nominal cost of the Bank of Israel's sources in the period under review, each of the monetary aggregates in the hands of the public expanded, particularly interest-bearing financial assets.

Indicators of inflation generally showed an improvement during the second half of 1996, and especially in 1996:IV. Inflation expectations fell to below the level of actual inflation - suggesting that inflation would decline - and below the upper limit of the inflation target. The improved inflation environment, together with the slowdown in economic activity, was the main reason for the slow reduction of the cost of the Bank of Israel's monetary loan in 1996:IV and 1997:I.

The money supply, which is highly correlated with economic activity in nominal terms (a direct correlation with a lag) and with interest rates (an inverse correlation), rose moderately in 1996:IV. The rise in M1 accelerated in January and February, even exceeding that of the public's interest-bearing monetary assets.

The movement of the exchange rate within the crawling band is determined by market forces and the Bank of Israel's willingness to intervene in the market. With the announcement of planned fiscal restraint in 1997 giving rise to greater expectations of a reduction in the interest rate, the exchange rate rose above the bottom limit of the band during 1996:IV (in Novem-ber). In 1997:I - apparently as a result of the publica-tion of budget data, the failure to implement the steps announced in July 1996, and high nominal interest - expectations of a continued tight monetary policy strengthened, however; there was large excess supply in the foreign-exchange market, and in January–February this reached unprecedented levels. To prevent the exchange rate from slipping below the band's lower limit, the central bank bought large quantities of foreign currency from the private sector, and since then the exchange rate has remained close to the lower limit.

The external injection (i.e., from the government and the Jewish Agency, which are independent of monetary policy, and from foreign-currency conversions) reached exceptionally high levels, but most of this was absorbed by the Bank of Israel, maintaining its monetary target, so that the monetary base expanded by only NIS 0.5 billion. The Bank's major instrument of absorption was the auction for local-currency deposits, the balance of which expanded by some NIS 10 billion during the period reviewed, reaching NIS 19.5 billion by end-March 1997. Originally the auction was for three-month deposits, but in February this was shortened to one month, and in March to just one week. The significant increase of these deposits entails large interest payments, which constitute a budgetary cost.

The Bank of Israel's monetary loan to the banks contracted rapidly, and its cost fell as the deposit auctions gradually became cheaper. Banks' credit to the public grew (at a monthly average of about 1.5 percent), but its composition changed. Before the budget was adopted, most of the increase was in the unindexed segment; but afterwards foreign-currency credit accelerated.

In the capital market, all the share indices rose in the period under review, with slight falls at the beginning and end of the period. The general share-price index surged by more than 30 percent in the period reviewed. At the same time, the general index of bond yields also rose constantly, and at the end of the period was 8 percent higher than at the beginning, while the extent of trading almost doubled.

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 sheqel exchange rate against the currency basket


Table 7. Monetary Indicators, 1995-97
(Percent, in annual terms)


1995
1996
1997
Oct-March
*

1995 1996 IV I II III IV I 1996 1997
Rates of change (over previous quarter, percent)
Increase in aggregates (average)
during period**
 
M1 8.4 14.9 0.0 14.3 15.1 16.9 1.7 34.2 -4.1 18.3 2
M2 (excluding securities) 35.2 27.0 22.4 25.1 17.0 38.3 25.0 33.4 22.8 26.1 2
M3 (excluding securities) 25.5 26.5 23.7 25.4 25.9 30.6 23.9 34.4 23.9 27.1 2
Nondirected bank credit 26.2 21.6 19.3 21.8 24.9 21.8 20.1 15.0 21.1 17.9 2
Unindexed local-currency credit
11.0 10.6 10.0 11.9 16.9 10.5 14.4 8.5 14.3 9.7 2
Levels
Nominal interest (percent)
  Short-term unindexed
  local-currency credit
20.2 20.7 19.8 19.6 20.5 21.9 20.7 19.8 19.7 20.4 2
  Monetary loan
  (percent, average)
15.6 16.1 15.0 14.8 15.9 17.6 16.2 15.0 14.9 15.6 3
  Self-renewing overnight
  deposits (SRO)
13.3 13.8 12.7 12.5 13.6 15.1 13.9 13.7 12.6 13.6 2
  3-month Eurodollar 5.9 5.4 5.7 5.3 5.4 5.5 5.4 5.4 5.5 5.4 3
Yield to maturity of Treasury bills (percent) 15.4 15.6 15.1 13.7 15.7 17.0 15.8 14.6 14.4 15.2 3
Real yield to maturity of 10-year bonds (percent) 4.3 4.5 4.4 4.3 4.3 4.9 4.4 4.1 4.4 4.3 3
General share price index 90.7 92.4 97.1 97.4 94.8 84.4 93.0 116.3 97.2 104.7 3
*
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Last month for which data are available.
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