Recent Economic Developments, 79

01/08/1997
All Press Releases In Subject:
The Economy and Economic Activity
Recent Economic Developments, 79, January 1997 - June 1997


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



Previous Economic Developments 78


Main Developments

In the first half of 1997 (the period reviewed) economic growth continued to be sluggish, with the level of activity falling short of its potential, although recent indicators show that activity had been picking up previously. The financial and money markets were particularly lively throughout the period reviewed, however. The low level of real activity was reflected on the one hand by the persistence of the positive trends in inflation and foreign trade evident since 1996:lll, and by the rise in the unemployment rate, on the other. The growing gap between economic potential and performance during the period reviewed reflects the greater effect of moderation due to demand-side factors, in addition to the effect of the supply-side factors in evidence since 1996. In the period reviewed per capita private consumption stabilized and investment fell. These developments appear to be the result of the near-completion of most of the positive effects of the influx of immigrants and the business opportunities created in the past by progress in the peace process. Fiscal policy, which was tighter after the adoption of the 1997 budget, as well as the delayed effect of the contractionary monetary policy of the last two years, helped to reduce demand.

The Consumer Price Index (CPI) rose at an annual rate of 10.2 percent, slightly above the upper level of the inflation target set by the government, while inflation expectations were within the inflation target range throughout the period reviewed. The trade deficit continued to shrink, as it has since mid-1996, while in 1997:l the unemployment rate rose to 7.3 percent, its highest since 1995:l. Lively money market activity was expressed in extensive private-sector capital inflows and an unprecedented extent of foreign-exchange conversions in 1997:l, with increased demand for foreign currency and a rapid rise in the exchange rate towards the end of the period.

The stagnation of demand is evident from domestic resource uses, which rose by less than 1 percent (annual rate) in 1997:l, the decline in consumer goods imports, construction industry indicators, and the decline in immigration (down by 20 percent from the same period in 1996). However, such indicators as large-scale retail trade and bank credit indicate that demand rose slightly. On the supply side, there was a modest increase in gdp in 1997:l, industrial production rose more slowly than in the equivalent period in 1996, while business-sector employment and imports of intermediates declined. The rise in the state-of-the-economy index, which incorporates several of the indicators noted above, was also slower than in the same period in 1996, though growth has begun to pick up recently.

The rapid decline of the trade deficit (in current dollars) evident since the beginning of 1996 slowed appreciably during the period reviewed and came to a halt at the end of it. The reduction of the deficit was due mainly to the decline in goods imports, reflecting the economic slowdown. The slight relative rise in goods exports and the expansion of world trade also contributed to the reduction of the deficit.

Demand pressure in the labor market moderated; alongside the rise in the Israeli labor supply the demand for labor increased more slowly. The rise in the unemployment rate which began in mid-1996 persisted in 1997:l. Real wages increased slightly (up by 0.5 percent over the same period in 1996), rising more rapidly in the business than in the public sector.

There was a budget surplus each month from January 1997 until May, but in June the trend reversed, and there was a large deficit. During the period reviewed the deficit exceeded the target by NIS 1.3 billion, due to a marked shortfall in revenues that was partly offset by an unplanned fall in expenditure. The financing of the deficit by the public sector (including the Bank of Israel) was based mainly on deposits of the public with the central bank as well as on extensive proceeds from privatization. Since income from these sources exceeded the deficit, the government absorbed money from the public during the period reviewed. Tax receipts during this period were 6 percent higher in real terms than in the equivalent period in 1996, due to a rise in revenues from direct taxes and a smaller increase in those from indirect taxes, in light of a reduction in tax receipts from imports and real-estate transactions.

As regards monetary policy during the period reviewed, in view of the decline in inflation the Bank of Israel gradually reduced the nominal cost of the sources it made available to the banks, the effective interest on which declined from16 percent at the beginning of the period to 14 percent at the end of it. The reduction of inflation expectations slowed the fall in real interest to less than one percentage point, from 5.8 percent at the beginning to 4.3 percent at the end. The slow reduction of interest was accompanied by an inflow of foreign capital, exerting downward pressure on the exchange rate, which reached the lower limit of the band. In order to prevent the exchange rate from falling below the band, the Bank of Israel purchased large amounts of foreign currency - $ 7 billion - from the public. Concurrently, in order to attain the monetary targets, the Bank of Israel absorbed the excess liquidity, principally via auctions for banks' interest-bearing deposits with it. On 18 June changes were announced in the parameters of the exchange-rate band, the foreign-exchange market was liberalized further, and the Bank of Israel reduced the cost of its sources by 1.2 percentage points. In the wake of these changes, the business sector began buying foreign currency and the exchange rate rose rapidly until the end of the period reviewed. Capital market activity intensified during the period reviewed and securities prices soared.

Figure 1. State-of-the-economy index (average 1994=100)
Figure 2. Industrial production (index, average 1994=100)
Figure 3. Interest and the inflation environment
Figure 4. Housing starts and completions, and relative price


Table 1. Indicators of Business Activity, 1995-97
(all data, excluding construction are seasonally adjusted)


1996
1997
Jan-June**
*

1995 1996 II III IV I II 1996 1997
Rates of change (annual average, percent), compared with preceding quarter
State-of-the-economy
index

10.2 3.6 2.5 3.8 -4.0 8.0 4.9 7.5 6.4 6
Large-scale retail trade 8.6 12.9 16.7 3.2 4.2 16.2 11.3 14.8 9.2 6
Industrial production (excl. diamonds) 7.9 5.2 -0.7 5.2 -4.7 1.4 6.8 6.7 1.1 5
Industrial consumption
of electricity
6.3 2.2 0.8 3.4 -3.7 14.0 15.6 1.4 5.1 5
Rates of change (percent), compared with preceding quarter
Tourist arrivals 20.4 -5.4 -17.5 -2.2 2.8 0.7 1.8 7.7 -9.7 5
Immigrant arrivals -5.6 -6.4 -3.5 8.9 12.6 -30.0 -13.1 -5.4 -19.8 5
Residential starts
(percent)
45.5 -16.7 7.8 14.5 -5.4 -20.9
-44.4 -7.6 3
of which
Government-initiated
148.9 -31.3 23.5 32.0 -14.4 -42.8
-67.4 -20.2 3
Residential completions 12.7 27.9 -10.1 0.8 14.4 0.5
52.3 4.2 3
of which
Government-initiated
-22.7 114.1 -12.0 49.7 13.4 3.2
93.1 54.2 3
Survey of companies
(percent)a
Net output
of industrial firms
24b 3b 7 0 -10 -10 8b

6
Net sales
by commercial firms
21 -9 -3b -15b -35 -5b -5b

6
*
Last month for which data available.
**
Compared with same period in preceding year.
a
Difference between the number of firms reporting a rise and those reporting a fall, as a percentage of all reporting firms.
b
Denotes non-significant result at 5 percent level.

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The Principal Industries

Economic activity was sluggish during the period reviewed, continuing the trend evident since 1996:ll. Some indicators show that activity has been recovering in recent months, however. National Accounts figures show that business-sector product grew by 2.5 percent (seasonally adjusted, annual rate) in 1997:l, compared with 9.2 percent in 1996:l. This slowdown occurred in the context of the modest rise in domestic demand in 1997:l, the reduction of inventory, and a relatively small increase in public-sector output. Industry, construction, and tourism figures indicate a low level of economic activity in 1997:ll, too.

Replies from firms participating in the quarterly survey conducted by the Research Department of the Bank of Israel indicate that business-sector activity declined in 1997:l and held steady in 1997:ll; the exception to this was the hotel industry, which experienced a decline in 1997:ll, too. The Investment Center reported a steep 46 percent drop in investment in industry in 1997:l from 1996:l, with tourism investment falling by 48 percent, as well as a reduction in the rate of investment requests.

In the first five months of 1997 industrial production rose by only 2.4 percent (seasonally adjusted, annual rate) from 1996:lV. This was accompanied by a decline in labor input (both the number of employed persons and the number of hours worked fell). At the two-digit industry level (seasonally adjusted), in the first four months of 1997 the output of most industries remained stable at the 1996:lV level, with a sharp fall in that of quarrying and nonmetallic minerals (7.3 percent, annual rate), connected with the concomitant decline in construction. During the period reviewed the long-term shift in the composition of industry continued, consisting primarily of a decline in the output of the textile and clothing industry, which had plummeted in 1996:Vl, too.

According to most industry indicators, construction slowed in the period reviewed. In 1997:l the supply of unsold new privately-constructed units (75 percent of them 4- and 5-room apartments) reached its highest level for a long time. The rise in excess supply has persisted since the beginning of 1996, and since mid-1996 supply has increased and sales have dropped. Both private and government-initiated building starts contracted in 1997:l, and completions rose slightly. There was a fall in total real-estate transactions (according to property-tax files opened), the number of new units sold by the ten largest contractors declined, and both the number of mortgages taken out by eligible persons and sales of units constructed in the framework of the govenrment-initiated program dropped.

Tourism activity continued to shrink. In 1997:l the number of tourist bed-nights was down by 10 percent from the equivalent period in 1996, alongside a change in the composition - a fall in incoming tourism and a rise in internal tourism. The inverse relation between incoming and internal tourism is a permanent feature deriving from sales campaigns and reductions which hotels offer Israelis at times of crisis in the industry. Occupancy rates in 1997:l averaged 57 percent - 14 percent less than in 1996:l - this fall being greater than that in bed-nights due to the 4 percent rise in the number of hotel rooms.

Figure 5. Tourism (index, average 1989=100)

Table 2. National Accounts, 1995-97
(seasonally adjusted)


1996
1997
Jan-June**
*

1995 1996 II III IV I II 1996 1997
Rates of change (average annual rates, percent, constant prices), compared with preceding quarter
GDP 7.1 4.5 3.0 2.5 1.8 2.8
6.7 2.5 3
Business-sector product 8.9 5.2 2.0 2.5 0.8 4.6
9.2 2.5 3
Private consumption 7.3 5.5 6.7 10.2 -14.3 7.3
6.3 1.9 3
Gross domestic investment 10.6 7.4 -4.9 4.1 -15.2 -10.7
14.3 -7.0 3
Goods & services exports 10.1 5.0 -11.5 19.8 5.2 13.5
9.0 6.1 3
Goods & services imports 8.6 7.6 -0.3 21.9 -17.3 1.1
9.6 0.4 3
Public-sector consumption
0.6 6.0 14.5 -1.3 15.1 -8.2
3.6 4.5 3
*
**
Last month for which data available.
Compared with same period in preceding year.

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The Labor Market

The pressure on Israel's labor market continued to abate in 1997:l, as it has since mid-1996. The incremental labor force was not entirely taken up by demand, wages per employee post remained unchanged, and the unemployment rate rose for the third successive quarter, reaching 7.3 percent. The number of labor-force participants rose by 7,500 (seasonally-adjusted figures), and employed persons by only 1,300. In the business sector their number fell to the same level as in 1996:l, while in the public sector this rose relatively rapidly. Further evidence that labor-market pressure has eased is provided by the decline in the employment rate for the working-age population, the rise in requests for unemployment benefits, and the steep increase in the number of job-seekers. According to the last two, labor-market pressure eased in 1997:ll, too.

In comparison with 1996:l, in 1997:l the number of Israelis employed fell throughout the business sector, with the exception of services, and was especially marked in agriculture. In the public sector employment rose, particularly in the civil service (15 percent). The decline in private-sector employment, the rise in public-sector employment, and the increase in labor-force participants indicate that much of the additional unemployment is in the business sector. The average number of weekly hours per employee rose in most principal industries, most prominently in construction, where it reached 43.8 hours, even though the number of Israelis employed in it fell by 2.3 percent compared with 1996:l.

The characteristics of unemployment in 1997:l indicate that hard-core unemployment has risen, with a higher proportion of married and older persons, and those out of work for a relatively long time. Fewer women than men were unemployed in 1997:l, although in other respect their unemployment characteristics were the same.

Total gross payments per employee post at constant prices (excluding workers from the Autonomy and the administered areas) rose by 0.5 percent in 1997:l over 1996:l. This stability characterized both the business and the public sectors. In the business sector wages developed unevenly, rising by 4.7 percent in agriculture, by 3.3 percent in industry (falling in the traditional and rising in the high-tech industries), and by 3.2 percent in business services, while declining by 5.3 percent in banking, insurance, and finance. The average wage per employee post (seasonally adjusted, constant prices) rose minimally in 1997:l, prior to which it had risen consistently for a long time.

During the period reviewed the upper limits for calculating tax deductions and national insurance and health insurance payments were updated, and the health service deduction was cancelled.

Figure 6. The labor market (thousands)
Figure 7. Real wage per employee post (NIS)


Table 3. Indicators of Labor Market Developments, 1995-97
(seasonally adjusted)


1996
1997
Jan-June**
*

1995 1996 II III IV I II 1996 1997
('000s)
Civilian labor force 2,109.5 2,157.1 2,158.8 2,172.9 2,174.1 2,181.7
1.1 2.8 3
Israelis employed*** 1,964.4 2,013.3 2,019.5 2,029.3 2,020.5 2,021.8
1.9 1.9 3
   Business sector
1,400.0 1,436.0 1,438.2 1,460.3 1,432.9 1,420.1
2.7 0.5 3
   Public sector 564.4 577.3 581.3 569.0 587.6 601.7
0.1 5.3 3
Average hours worked
per employee***
37.8 37.6 37.6 37.6 37.7 38.0


3
Claims for
unemployment benefit
68.6 75.5 71.1 77.0 82.9 88.5 95.5 7.9 29.4 6
Work seekers 71.3 82.6 74.3 79.4 103.3 111.5 118.8 6.8 57.1 5
Real wage per employee post (NIS) 4,178.8 4,245.8 4,258.4 4,291.6 4,230.9 4,217.7 4,245.9 2.1 0.5 4
   Business sector 4,146.2 4,208.0 4,170.1 4,204.7 4,251.9 4,225.8 4,326.8 2.0 0.8 4
Unemployment rate (%) 6.9 6.7 6.5 6.6 7.1 7.3


3
*
**
***
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 $ 499 million, monthly average ,compared with $ 672 million for 1996. This was the result of a relatively small reduction of goods imports and a rise in their exports, both of which can be attributed to lower domestic demand. In 1997:I the terms of trade improved, due mainly to the strengthening of the dollar against other currencies, and possibly in part to lower raw material prices. This latter development contributed to a further contraction of the trade deficit (measured in current dollars).

The rapid reduction of goods imports, which had started at the beginning of 1996, slowed significantly in the period reviewed, while the expansion of goods exports eased slightly; this combination led to a slower decline of the trade deficit, as most of this decline derived from that in imports. All the major categories of goods imports showed a fall: intermediates (whose level is an indication of current activity) rose from 1996:IV to 1997:I, declined in 1997:II, and in the period reviewed were only 1.5 percent below their average level in 1996. Capital goods (which indicate future activity), which have declined relatively rapidly since the beginning of 1996, did not deviate from this trend in the period reviewed. Consumer goods increased in 1997:I, stabilized in 1997:II, and in total were slightly lower than the average level in 1996. Industrial exports excluding diamonds rose to an average monthly level of $ 1.1 billion, 6 percent higher than the average in 1996, the most notable increases occurring in electronics, office machinery, and computers (which rose by 13 percent compared with the second half of 1996), chemicals and oil refining (9 percent), and communications, medical, and scientific equipment (8 percent).

The current-account deficit shrank to about $ 1.1 billion in 1997:I, from $ 1.6 billion in 1996:I. This was due to a reduction in the private-sector deficit (i.e., a decline of $ 0.5 billion in the import surplus and of $ 100 million in unilateral transfers), while the public-sector deficit remained stable. The total external debt (in terms of gdp) fell by about 1.5 percentage points from 1996:IV to 1997:I, and the Bank of Israel's foreign reserves rose in the period reviewed by about $ 6 billion, to $ 18 billion at the end of the period.

Capital inflow, which had fallen in 1996, rose again in the period reviewed, and by May 1997 totaled some $ 4.3 billion, compared with $ 4.5 billion in the whole of 1996. Most of the increase was in capital movements by residents, but those of nonresidents also rose steeply (nonresidents' portfolio investments on the Tel Aviv Stock Exchange (tase) increased, while sales of securities on stock exchanges abroad and nonresidents' local-currency deposits fell.)

At the end of March several foreign-exchange controls were relaxed for the first time in a long period, primarily those concerning money which could be deposited in a resident deposit and the purchase of foreign currency for travel abroad. In June, at the same time as the exchange-rate band was altered, the limits on investments in foreign securities were raised, and various assets accumulated overseas were defined as unrestricted assets (this referred to Israelis who had been abroad for a long period). It was also announced that in a year all restrictions on foreign-currency transactions would be removed, so that trade in foreign exchange would be carried out in the manner customary in advanced countries.


The Background to the Change
in the Exchange-Rate Band.

Since the end of 1994 there has been extensive capital inflow into Israel. This was connected essentially with the Bank of Israel's tight monetary policy, which was aimed at achieving the inflation target, and with the rise in nonresidents' direct and portfolio investment in Israel. The capital inflow exerted downward pressure on the exchange rate; to modify the effect of monetary policy on the exchange rate the Bank bought foreign currency for most of the period, so that the rate remained near the midpoint of the band. In February 1996 the Bank of Israel stopped intervening in the foreign-currency market, but as the private sector continued importing capital the exchange rate declined, reaching the lower limit of the band in August 1996. From then until mid-June 1997, with short periods of nonintervention, the Bank of Israel purchased foreign exchange - as the exchange-rate regime required - in order to prevent the exchange rate from crossing the lower limit of the band.

Since the beginning of 1997, foreign-currency purchases from the public have amounted to about $ 7 billion; in order to prevent an increase in the money supply, which would jeopardize the attainment of the inflation target, the Bank absorbed money, thereby raising the internal local-currency debt. It was clear that the conflict between the Bank's commitment to achieving the inflation target while defending the lower limit of the exchange-rate band would have to be resolved. One solution would have been to broaden the band, allowing the exchange rate to fluctuate more widely, thereby adding to the risk of importing short-term capital. The decision finally reached on June 17, which took part of the argument into account, was that the rate of change of the lower limit of the band was reduced from 6 percent to 4 percent, and the upper limit was raised by 15 percent, its slope remaining at 6 percent (Figure 12).

Since the upper limit is changing faster than the lower one, the band is getting wider. The width of the band - which went from 14 percent to almost 28 percent on the day the change was introduced - will rise gradually, reaching 30 percent (15 percent on either side of the midpoint rate) by the end of May 1998. The wider band will give the exchange rate greater flexibility and mobility in responding to market forces and the flow of capital to and from Israel. This step is part of the policy of liberalizing Israel's money and capital markets, and of Israel's integration into the process of economic globalization.


Figure 8. Foreign trade (($million per month))

Table 4. Foreign Trade and the Reserves, 1995-97
(seasonally adjusted, excluding ships, aircraft, diamonds & fuel)


1996
1997
Jan-June**
*

1995 1996 II III IV I II 1996 1997
Monthly averages ($ million, current prices)
Trade deficit 675 672 711 653 519 514 485 759 499 6
Goods imports 1,774 1,858 1,890 1,849 1,742 1,774 1,728 1,920 1,751 6
   Consumer goods 304 329 323 336 310 324 324 334 324 6
   Capital goods 389 420 433 420 389 373 351 436 362 6
   Intermediates 1,081 1,109 1,135 1,093 1,043 1,076 1,052 1,150 1,064 6
Goods exports 1,100 1,186 1,179 1,196 1,223 1,259 1,243 1,161 1,251 6
   Industrial 1,013 1,080 1,055 1,094 1,117 1,153 1,150 1,055 1,151 6
Net current account -1,211 -1,337 -2,004 -1,825 39 -1,136
-1,557 -1,136 6
Long- and medium-term
capital flows
643 1,190 459 1,468 1,758 1,522
1,075 1,522 3
   Private sector 420 769 635 445 1,665 669
331 669 3
Short-term capital flow 490 495 453 1,113 -1,236 3,574
1,648 3,574 3
   Private sector*** 790 292 373 1,242 -1,170 3,602
721 3,602 3
Net foreign debt
(% of GNP)
22.95 20.72 21.49 22.24 20.72 21.09
20.85 21.09 3
End-period Bank of Israel
reserves
8,158 11,420 8,887 10,230 11,420 15,336 17,794

6
*
**
***
Last month for which data available.
Compared with same period in preceding year.
Including the banking system.

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International developments

In the second half of 1996 and at the beginning of 1997 the advanced economies grew slightly faster than in the previous two years, albeit unevenly. In west Europe, excluding Britain, growth was relatively slow (and also below expectations), whereas the us and Britain grew relatively fast. Domestic demand expanded rapidly in all the countries in 1997, especially the emerging ones, and this was reflected by the growth of trade. In the advanced economies unemployment declined and inflation was stable. The modification of inflationary pressure and moderation of the growth rate in Europe led to some monetary relaxation. Moreover, it was expected that interest-rate differentials would widen to the advantage of the us and Britain, a consideration which strengthened their currencies against the others in Europe. In the us the reaction to the faster growth rate was a rise in the yield on bonds, but at the beginning of 1997 it fell, due to the lower inflation environment. In Europe bond yields also declined during the period, and short-term interest rates remained low.

Worldwide economic developments had two positive effects on Israel's foreign trade in the period reviewed: first, the expansion of world trade apparently also raised demand for Israeli goods. Secondly, as a result of changes in world prices, Israel's terms of trade improved, helping to reduce the import surplus.



Table 5. Indicators of Economic Development
in Advanced and Developing Countries,* 1995-98



1995
1996
Estimate
1997
Forecast
1998
Annual rate of change, percent**
World GDB
   Total 3.7 4.0 4.4 4.4
   Advanced countries 2.5 2.5 2.9 2.9
   Developing countries 6.0 6.5 6.6 6.5
World trade
   Total 9.2 5.6 7.3 6.8
Advanced countries
   Imports 8.7 5.3 5.9 6.1
   Exports 8.4 5.0 6.9 6.7
Developing countries
Inflation (CPI)
   Advanced countries 2.6 2.4 2.5 2.5
   Developing countries 21.3 13.1 9.7 8.5
Short-term interest*** (%)
   Dollar deposits 6.1 5.6 6.0 6.1
   Yen deposits 1.3 0.7 1.0 2.8
   DM deposits 4.6 3.3 3.3 3.8
Unemployment rate
   OECD countries
7.5 7.3 7.1
*
According to "World Economic Outlook", Israel is classified as an advanced country.
**
Apart from interest and unemployment rates, which are shown as percentage.
***
6-month LABOR rate.
SOURCE: "World Economic Outlook", (IMF), and OECD "Economic Outlook".

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Prices

In the period reviewed the inflation environment stabilized close to the upper limit of the target set by the government (7–10 percent). The CPI rose by 5 percent in the period, equivalent to an annual rate of 10.2 percent, and inflation expectations were less than 10 percent in each month except for February. The CPI did not develop uniformly during the period reviewed. In 1997:I it rose relatively fast (by 10.8 percent, annually), easing to 9.6 percent in 1997:II. Twelve-month inflation expectations, as derived from the capital market, were relatively high in the first quarter (an average of 9.8 percent), and somewhat lower (9 percent) in the second.

Among the CPI items, notable changes occurred in prices of fruit and vegetables in February and March (increases of 12.3 percent and 4.8 percent respectively), and in housing (a 2.4 percent rise in June). The steep rise of the latter is explained by the April/May survey of apartments, which showed a rise of 1.5 percent (after declining by 0.1 percent in March/April), and a large (2.5 percent) increase in construction inputs. Excluding the categories of fruit and vegetables and housing, the CPI rose by only 8.5 percent, annual rate.

Wholesale prices rose at an annual rate of 6.8 percent in the period reviewed, compared with 10.3 percent in the equivalent period in 1996, slower than the 11.1 percent rise in the dollar exchange rate, faster than the rise in both prices of tradables (7.2 percent) and the currency-basket exchange rate (5.1 percent).



Table 6. Selected Price Indicies, 1995-97
(annual rates of change during period, percent)


1996
1997
Jan-June**
*

1995 1996 II III IV I II 1996 1997
(CPI) 8.1 10.6 17.6 4.4 9.2 10.8 9.6 14.6 10.2 6
CPI excl. housing, fruit & vegetables 8.8 10.1 15 7 8.7 6.3 10.8 12.3 8.5 6
CPI excl. housing, fruit & vegetables, controlled goods, clothing & footwear 9.2 10.2 12.0 9.2 5.1 10.1 7.5 13.4 8.8 6
Index of housing prices 13.6 13.2 31.8 -6.3 15.6 14.2 10.8 23.1 12.5 3
Wholesale price index 10 7 12.1 1.7 6.1 6.3 7.2 10.3 6.8 6
NIS/$ exchange rate 3.1 5.0 21.8 -10.5 14.6 11.5 10.7 8.9 11.1 6
NIS/currency busket rate
5.8 3.0 17.1 -8.9 12.7 -0.8 11.3 4.6 5.1 6
*
**
Last month for which data available.
Compared with same period in preceding year.

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The Government

The government's domestic deficit excluding credit granted (cash basis) was NIS 2.7 billion, 1.6 percent of gdp, compared with 3.6 percent in the equivalent period in 1996. Until May the domestic budget was in surplus, but in June revenues fell, expenditure rose considerably, and there was a deficit of NIS 3 billion. Several underlying assumptions made by those responsible for preparing the budget were not realized in the period under review, so that by the end of June both revenues and expenditure had deviated from the figures planned. Revenues were over-estimated by NIS 4 billion (despite a real increase in tax receipts), and expenditure was some NIS 2.7 billion less than planned, so that the deficit for the first half of the year exceeded the planned figure by NIS 1.3 billion. The non-fulfilled assumptions included the rate of price increases, which fell short of the estimate, the lower than anticipated rate of immigration (which reduced expenditure), and the greater than expected economic slowdown, which led to lower receipts from real-estate and import taxes (particularly due to a sharp decrease in durables imports); unemployment benefits, which are regarded as a negative tax, increased. Note that some of the shortfalls in both revenue and expenditure are not expected to be reduced in the second half of the year, as the changes in the planned bases of government expenditure and revenues are nonseasonal.

Most of the deficit of the public sector (which includes the Bank of Israel and the Jewish Agency) was financed from the public's deposits in the Bank of Israel, and also from proceeds from privatization (including Israel Chemicals, Bank Discount, and Bank Leumi), which amounted to some NIS 2 billion in the period reviewed, compared with only NIS 375 million in the whole of 1996. Total financing exceeded the public-sector deficit, so that in the period reviewed the public sector absorbed financial resources from the public.

Compared with the equivalent period in 1996, tax revenues rose by a real 6 percent in each of the first two quarters. The turning point came as a result of the relatively rapid rise in direct taxes and national insurance payments: in real terms, they were stable in 1996, rising by 10 percent in the first half of 1997 over the first half of 1996. Indirect taxes on domestic production also increased, in real terms, by about 9 percent, period-on-period. Property tax receipts declined by about 10 percent because of the sluggish real-estate market, and import taxes fell at the same rate. Legal changes introduced in 1996 and 1997 affected tax revenues. Notable among them was the halt in updating tax brackets in 1997, the reduction of employers' share in both national insurance and health insurance contributions, and the increase in the tax on fuel, tobacco, and air-conditioners for cars.

National insurance transfer payments to households rose by 6 percent in 1997:I, notable among them being unemployment benefits, which increased by a real 30 percent compared with the equivalent period in 1996.

Figure 9. Government cash flows (NIS million, monthly average)

Table 7. Financing the Budget, 1995-97
(cash flows as percent of GDP)


1996
1997
Jan-June**
*

1995 1996 II III IV I II 1996 1997
1. Government domestic expenditure 40.5 40.7 38.1 41.1 41.6 40.9 37.3 40.0 39.1 6
2. Government receipts 37.0 36.0 35.0 36.9 34.0 40.2 34.8 36.5 37.5 6
3. Domestic budget deficit (1)-(2) 3.5 4.7 3.1 4.1 7.6 0.6 2.6 3.6 1.6 6
4. Public-sector domestic deficit*** (5)+(6) 4.4 5.4 3.5 6.1 8.6 1.4 2.3 3.4 1.8 6
5. Government net borrowing from the public 3.3 2.6 1.3 2.9 3.7 4.3 4.7 1.9 4.5 6
6. Public-sector injection (9)-(8)-(7) 1.1 2.8 2.2 3.2 5.0 -2.9 -2.4 1.5 -2.7 6
  7. Bank of Israel injection
-8.4 -3.4 -1.4 -6.3 -3.6 -15.9 -6.9 -1.9 -11.3 6
  8. Private-sector foreign-currency conversions 7.0 1.9 -0.2 3.7 1.1 17.3 10.6 1.3 13.9 6
  9. Change in monetary base
-0.3 1.3 0.6 0.6 2.5 -1.6 1.2 1.0 -0.1 6
  * Last month for which data available.
 ** Compared with same period in preceding year.
*** Budjet deficit plus Jewish Agency injection plus non-budgetary injection.


Top



The Money and Capital Markets

In 1997:I the CPI rose slightly faster (annual rate) than the upper limit of the inflation target, expectations stabilized a little below it (see section on prices), the exchange rate hovered close to the lower limit of the band, and indicators of real economic activity suggested that the slowdown was continuing, with a slight rise in unemployment. Against this background, the Bank of Israel slightly reduced the rate of interest on the sources it makes available to the banks, and as this reduction exceeded the decline in inflation expectations, real interest went down from 5.8 percent at the beginning of 1997 to 4.3 percent at the end of March. Together with the modest reduction in interest, the supply of foreign currency rose, due inter alia to nonresidents' investments and the growth of long-term credit, so that in order to prevent the exchange rate from slipping outside the band, the Bank of Israel had to step in and purchase foreign currency from the public. In 1997:I the private sector converted $ 4.2 billion at the Bank of Israel, an unprecedented quarterly amount. In 1997:II there was no change in the interest rate until mid-June, and inflation expectations fell (so that real interest rose, and approached its level at the beginning of the period reviewed). The private sector continued to convert foreign currency, although to a lesser extent ($ 2.7 billion). Alongside the widening of the exchange-rate band (see box) and the introduction of several liberalization measures regarding foreign-exchange transactions, the central bank reduced the rate of interest on the monetary loan by 1.2 percentage points, which raised private-sector demand for foreign currency. The Bank of Israel did not intervene in trading, and the exchange rate rose sharply. At the end of the period reviewed the currency-basket exchange rate was 5.32 percent above the lower limit of the band.

Sterilizing the effect of foreign-currency conversions on monetary policy which is aimed at attaining the inflation target incurs a cost, because on many occasions the return on investing the Bank of Israel's foreign-exchange reserves is less than the local-currency cost the Bank incurs through its sterilization activities. The steep rise in the exchange rate towards the end of the period served to reduce this cost.

Despite the public's large-scale conversions (NIS 23 billion), the monetary base contracted by NIS 250 million during the period reviewed. The extraneous injection of money was in the main absorbed by the Bank of Israel by means of the auction for local-currency deposits, the balance of which increased by about NIS 20 billion in the period reviewed to NIS 25.5 billion. The period of these auctions, which started as three-month deposits, was shortened in February to one month, and in March to only one week. The interest rate at the auctions declined during the period from about 16 percent at the beginning to 14 percent at its end.

M1 rose by 7.7 percent, similar to its rise in the preceding period, and increased faster in 1997:I than in 1997:II. This increase was slower than that of other monetary aggregates, because inter alia the large-scale sterilization increased the Bank of Israel's short-term debt, which in turn increases the public's holdings of interest-bearing liquid assets.

Bank credit to the public rose by 8.5 percent, and its composition altered. Nondirected foreign-currency credit rose by 37 percent, while that in local currency went up by only 1.6 percent. Foreign-currency credit surged, despite both the low position of the exchange rate within the band and the resulting implicit risk in foreign-exchange transaction;, this may be due to the low expected cost of such credit compared with local-currency credit. (The distribution of credit by currency also changed: the share of credit in yen and Swiss francs rose, while that in German marks and dollars remained stable. This was the result of sharp changes in cross rates and the widening of the interest-rate differentials between the dollar on the one hand, and the yen and franc on the other.)

Share prices surged by 30 percent in real terms in the period reviewed; turnover was also higher than in the previous year. The extent of new issues expanded, especially those of banks being privatized. For the first time in several years, corporate bonds were issued on the tase. Factors which may have played a role in expanding activity include the signing of the Hebron agreement (in January), the world rise in prices, and the reduction of domestic interest. Bond prices rose modestly, and at the end of the period the yield to maturity on indexed bonds was about 4 percent, the highest level for two and a half years.

Figure 10. Monetary aggregates and credit (change in prev. 12 months)
Figure 11. Nondirected bank credit (NIS per month)

Table 8. Monetary Indicators
and Nondirected Bank Credit, 1995-97

(annual terms, percent)


1996
1997
Jan-June**
*

1995 1996 II III IV I II 1996 1997
Average rates of change compared with preceding quarter
M1a (narrow money supply)
8.4 14.9 15.1 16.9 1.7 26.6 9.2 20.3 19.5 4
M2b 35.2 27.0 17.0 38.3 25.0 30.3 17.0 23.9 24.7 4
M3c 25.5 26.5 25.9 30.6 23.9 30.9 15.4 23.7 23.3 4
Nondirected bank credit 26.2 21.6 24.9 21.8 20.1 14.5 20.0 23.9 18.1 4
   Unindexed local-currency 11.0 10.6 16.9 10.5 14.4 3.1 -2.1 21.1 1.4 4
   CPI-indexed 33.4 23.7 28.1 31.9 17.6 18.1 17.4 26.0 15.6 4
   Foreign-currency indexed & denominated 54.6 40.0 33.8 26.3 33.3 27.7 63.1 25.7 50.6 4
*
Last month for which data available.
**
Compared with same period in preceding year.
a
Cash in the hands of the public and demand deposits.
b
M1 plus short-term local-currency deposits.
c
M2 plus foreign-currency-indexed and denominated deposits.


Figure 12. The sheqel exchange rate against the currency basket
Figure 13. Yield on Treasury bills (end-period figures)

Table 9. Interest Rates, Yields,
and the Share-Price Index, 1995-97



1996
1997
Jan-June**
*

1995 1996 II III IV I II 1996 1997
Nominal interest
   Nondirected local-currency credit 20.2 20.7 20.5 21.9 20.7 19.7 19.2 19.8 19.5 5
   Monetary loan (average rate) 15.6 16.1 15.9 17.6 16.2 15.0 14.5 15.3 14.8 6
   SROs 13.3 13.8 13.6 15.1 13.9 12.8 12.5 12.8 12.7 5
   3-month Eurodollar 5.9 5.4 5.4 5.5 5.4 5.4 5.7 5.3 5.6 6
Yield to maturity
Treasury bills 15.4 15.6 15.7 17.0 15.8 14.6 14.1 14.7 14.3 6
10-year bonds 4.3 4.5 4.3 4.9 4.4 4.1 4.0 4.3 4.1 6
5-year bonds 4.1 4.4 4.1 4.8 4.3 4.0 4.0 4.1 4.0 6
General share-price index (points) 90.7 92.4 94.8 84.4 93.0 116.3 127.9 96.1 122.1 6
*
**
Last month for which data available.
Compared with same period in preceding year.