Recent Economic Developments, 89

01/02/2000
All Press Releases In Subject:
The Economy and Economic Activity
Recent Economic Developments, 89, July 1999 - December 1999


 Main Developments
  The Principal Industries
   The Labor Market
    The Balance of Payments
     World Developments
       and Their Effect on Israel's Economy
       Prices
        The Public Sector
         The Money and Capital Markets



Previous Economic Developments 88


Main Developments

Data on the activity of the principal industries and the labor market reinforce the assessment that since 1999:II an economic recovery has been under way, although unemployment has grown and several indicators of activity slowed in the last few months of the year. In the second half of 1999 (henceforth the period reviewed) activity accelerated in most industries. Some of the acceleration was led by exports, while the response of GDP to the expansion of demand lagged behind that of imports of goods and services. The rate of price increases in the period reviewed was also below the 1999 inflation target, and inflation expectations declined to their lowest annual level at the end of the period reviewed. The foreign-currency market remained relatively calm, the exchange rate vis-a-vis the currency basket was administered within the band, and there was slight nominal shekel depreciation. Manufacturing exports rose more rapidly in the period reviewed than in the previous three years, primarily in the high-tech industries, which have led export growth in recent years. The government's domestic deficit for 1999 as a whole was slightly above the deficit target set in the budget, and was somewhat below the 1998 deficit. At the beginning and end of the period reviewed the nominal interest rate was reduced by a cumulative 0.8 percentage points, but the real interest rate remained relatively high, and even rose-because the fall in inflation expectations was more rapid than the decline in nominal interest.

As in 1998, in the period reviewed macroeconomic developments in Israel were closely connected with global economic developments: the expansion of world trade in 1999 helped to increase Israel's exports, and hence the rise in the output of export industries; the global decline in inflation slowed the rate of increase of tradables prices in Israel, and the subsequent improvement in the terms of trade helped to reduce the current-account deficit in the balance of payments as well as to moderate domestic price rises. Short-term interest rates (e.g., Libor on the currencies comprising the basket), which fell as an annual average, rose during the period reviewed, so that the spread between Israel and abroad narrowed. Capital inflow continued during the period reviewed.

The Consumer Price Index (CPI) rose by 3.5 percent in the period reviewed, after rising steadily each month at the beginning of the period (generating uncertainty as to its trend) and declining steeply in its last two months. Expectations regarding price increases in the first four months were above the annual inflation target (as was the case throughout the first half of 1999), and in the last two months they fell below the range of the annual target for 2000 (3-4 percent). The decline in inflation expectations at the end of the year appears to be connected with the overturn of fears of accelerated depreciation, inter alia in view of the appreciation of the shekel. The main contribor to the decline in the rate at which the CPI rose was the housing component, which declined each month in 1999:IV after being the major contributing factor to its rise in the first two quarters.

In fiscal policy, during the period reviewed public consumption expanded more rapidly than GDP - inter alia because public services employment expanded. Despite the accelerated growth of tax revenues towards the end of 1999, they remained below the forecast level, inter alia because of the delay in concluding wage agreements. For the year as a whole there was a slight upward deviation from the budget deficit, inter alia because in the first four months of 1999 tax and bond revenues were higher by NIS 3 billion than predicted by the updated forecast prepared at the beginning of September 1999. With regard to the budget framework for the year 2000, on the basis of the low forecast of revenues made in September, and assuming that the 1999 deficit will amount to 3 percent of GDP, it was decided that the deficit target for 2000 would be 2.5 percent of GDP compared with the 1.75 percent arising from the deficit path under the Budget Deficit Reduction Law. As the reason for the lower deficit in 1999 than was forecast is the unexpected rise in revenues, it is important to keep expenditure at the level approved by the Knesset in order to ensure that the actual deficit continues to decline in the year 2000, too.

The labor market remained slack, as it has been for a long time, and in November the unemployment rate rose to an annual peak of 9,2 percent. Nonetheless, various indicators, chiefly those relating to the utilization of the labor force and the depth of unemployment, point to the possibility that the revival of economic activity has begun to have an effect in this area too, which generally responds with a lag to swings in economic activity. In 1999:III the business sector (especially manufacturing) did not absorb the incremental labor force in accordance with its relative share, while the public sector, which increased its workforce, made a substantial contribution to the reduction of unemployment. Despite the significant rise in employment in 1999:III, the unemployment rate grew, due to the relatively large increase in the labor supply as a result mainly of the greater participation rate. Real wages per employee post, which rose in the first half of the year, also continued to grow in the period reviewed, albeit at a slower rate. In the business sector real wages rose by some 3 percent - inter alia because of the inflation surprise, while in the public sector they fell in real terms, inter alia because of the delay in concluding wage agreements in certain segments.

In the area of monetary policy, against the backdrop of uncertainty regarding the inflation environment for most of the year and the narrowing interest-rate spread between Israel and abroad, the Bank of Israel persisted with its policy of gradually reducing the interest rate in order to consolidate inflation within the target range for the next two years. The nominal interest rate fell more slowly than inflation expectations, while the real interest rate rose. In the capital market, as in many capital markets abroad, share prices rose rapidly in the period reviewed, and this the case for all industries. The value of the stock market grew considerably, and turnover also rose gradually, although the extent of share offerings on the capital market remained relatively small.
 

Figure 1. State-of-the-economy index (average 1994=100)
Figure 2. Industrial production (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, 1998-99
(all data, excluding construction are seasonally adjusted)


1998
1999
July-Deca
*

1998
1999
IV
I
II
III
IV
1998
1999
Rates of change (annual average, percent), compared with preceding quarter
State-of-the-economy
index

3.0 2.8 2.1 -0.3 0.8 15.3 -3.5 -0.1 5.5 12
Large-scale retail trade 6.5 4.5 7.8 8.6 -3.4 12.6 1.4 5.6 5.4 12
Industrial production (excl. diamonds) 2.7 1.4 3.3 -5.1 0.9 19.1 -3.2 2.5 3.5 11
Business-sector consumption
of electricity
2.5 3.5 5.4 -1.9 0.6 18.9 38.8 2.5 6.1 10
Index of revenue
in commerce
0.8 3.3 0.2 -1.9 7.3 20.3 5.6 1.3 6.3 11
Index of total revenue 3.6 4.4 12.3 -4.9 8.5 16.8 7.9 3.0 7.6 11
Rates of change (percent), compared with preceding quarter
Tourist arrivals 4.6 24.1 -0.6 4.1 8.6 15.1 10.6 -1.9 34.5 10
Immigrant arrivals -15.4 21.3 14.5 -16.8 9.8 45.7   -23.7 52.3 9
Residential starts -21.2 -8.3 5.7 -18.9 1.9 15.1   -26.2 0.4 9
of which:
 Government-initiated
-44.4 4.8 -20.6 16.9 11.9 31.8   -45.0 36.8 9
Residential completions -21.6 -14.9 -12.9 -4.4 -6.4 16.2   -20.0 -9.4 9
of which:
 Government-initiated
-22.7 -0.9 -26.2 39.4 -23.2 11.7   -18.4 -11.7 9
Survey of companies (percent)b
Net output of manufacturing
firms (original)
-8 9 -1c -8 7 18 19

12
Net output of manufacturing
firms (adjusted)
-8 9 -3c 1c 8 10 15

12
Net sales by commercial
firms (original)
-13c 12c -28 3c 8c 26 13c

12
Net sales by commercial
firms (adjusted)
-13c 13c -17 -10c 8c 6c 28

12
*
Last month for which data available.
a
Compared with same period in preceding year.
b
Difference between the number of firms reporting a rise and those reporting a fall, as a percentage of all reporting firms.
c
Denotes non-significant result at 5 percent level.

Contents



The Principal Industries

Indicators of economic activity (Table 1) show that this accelerated in 1999:III. In 1999:IV it slowed slightly, and the indices of the state of the economy and manufacturing even declined, but their level remained higher than in the first half of the year, reinforcing the view that since 1999:II an economic recovery has been under way.

National Accounts figures (Table 2) show that the level of all uses rose during 1999 more than did that of GDP. Thus, the rapid expansion of imports of goods and services, whose response to changes in aggregate demand should be faster than that of GDP, is apparently another indication of economic revival. Exports of goods and services accelerated between every quarter, so that by 1999:III they were 10 percent higher than in 1998:III; the continuous expansion of investment since 1998:IV also persisted, mainly in equipment (ships, planes, and Intel) and inventories. Private consumption also increased relatively rapidly, especially in 1999:III, so that per capita consumption rose; public consumption grew slowly, except in 1999:II (when the general elections were held). On the sources side, by contrast, GDP and business-sector product, which had fallen in 1999:I, expanded once again, although their level in 1999:III was only 2 percent above that of 1998:III (thus, per capita product shrank, and the gap between actual and potential GDP appears to have widened, the annual growth rate of the latter being estimated at 4 percent). Imports of goods and services, which declined in 1998:IV, rose rapidly throughout 1999, the steep increase in capital goods being particularly prominent.

The results of the Bank of Israel's quarterly Survey of Companies show that the resurgence of all the principal industries continued, even strengthening in 1999:IV. Thus, starting in 1999:II the activity of firms involved in manufacturing, commerce, transport and communications, and hotels expanded, and for the first time the decline in construction activity was checked. In the first three quarters of 1999 the output of manufacturing firms grew, after six successive quarters in which it had declined, and their exports increased, too. All the principal industries indicated that they expected the high level of activity to continue. Nonetheless, slack domestic demand remained the main constraint preventing the more rapid expansion of output.

All the indicators in Table 1, except construction, show that activity accelerated in 1999:III, and for the first time they all rose by more than 20 percent. Manufacturing output data indicate a steady rise since 1999:II, alongside a relatively rapid increase in the export industries (electronic equipment, machinery and electrical equipment, and transport vehicles), while the output of the other industries, which produce mainly for the domestic market, fell or rose slightly.

In construction, beginning in 1999:II and for the first time in years, there are some indications that demand is expanding, although other indicators, including construction investment, show that the decline is continuing. An analysis of the trend of the principal indicators of construction show that in 1999:II and 1999:III, for the first time, there was a slight rise in the rate of growth of residential starts (2 percent in each quarter), all of it in government-initiated construction. Data on residential completions also point to a recovery: in 1999:II and 1999:III the number of units whose construction was completed rose (by 16 and 9 percent respectively), the main contributor to this trend being the business sector. Other indicators of increased construction activity are the greater number of persons taking mortgages and the sharp rise in apartment sales by the ten largest construction companies in 1999:III. On the other hand, total investment in construction fell (according to National Accounts data) in each quarter of 1999 (seasonally-adjusted figures), especially in 1999:IV, most of it in non-residential construction, and construction time grew longer.

There were signs of recovery in the other industries, too. The index of the revenue of all the commerce and services industries (based on VAT data, seasonally adjusted) was 5 percent higher on average in the period reviewed than in the equivalent period in 1998. The number of tourist entries, which had fallen steadily in the previous two years, reaching a record low in 1999:I (seasonally-adjusted figures), began to rise subsequently, and by the end of the period reviewed it was 35 percent higher than in the equivalent period in 1998. An analysis of the trend of tourists entering the country by air indicates that this has been rising for about a year, as the average monthly growth rate was 3.3 percent in July-September, and 2.5 percent in October and November.
 

Figure 5. Tourism (index, average 1989=100)
 
Table 2. National Accounts, 1998-99
(seasonally adjusted)


1998
1999
July-Deca
*

1998
1999
IV
I
II
III
IV
1998
1999
Rates of change (average annual rates, percent, constant prices, compared with preceding quarter)
GDP 2.2 2.0 1.2 -4.1 6.9 5.2
1.9 2.2 9
Business-sector product 2.2 1.6 -2.1 -4.0 7.4 7.6
2.1 2.1 9
Private consumption 3.6 3.7 -5.8 7.7 2.8 10.2   4.3 3.5 9
Gross domestic investment -8.0 11.3 16.3 11.1 25.7 3.6
-6.0 13.9 9
Goods and services exports 6.3 7.4 1.4 7.1 12.4 18.4
4.0 9.6 9
Goods and services imports 1.7 14.3 -3.4 25.0 28.2 19.3   0.9 16.6 9
Public-sector product
2.0 3.5 -1.2 -3.3 21.1 4.7
1.4 4.9 9
*
a
Last month for which data available.
Compared with same period in preceding year.

Contents



The Labor Market

During the period reviewed the labor market remained slack. The unemployment rate, which began to rise in mid-1996, continued to grow, reaching 9.2 percent in November, and the rise in real wages in the business sector outstripped that in productivity. Nonetheless, there is evidence that alongside the increase in the supply of labor, and given the structural delay in the response of demand due to economic activity, the recovery of the last few months has had an effect on this market, too.

Although in 1999:III the number of work-seekers rose, and with it the unemployment rate, the gradual increase in the participation rate of the civilian labor force that had begun in 1998:II (seasonally-adjusted figures) persisted, and in not seasonally adjusted figures reached its highest level in the last two years. This development, which is not expected at a period of recession (when the discouraged worker effect-with unemployed persons leaving the labor force as they despair of being able to find work-is at its highest) is apparently one of the signs of economic recovery; another sign is increased utilization, expressed in the substantial rise in the number of employees in full-time work, while the number of those in part-time work or temporarily absent from work declines. In 1999:III the supply of labor grew by about 20,000 persons, and the number of employed persons increased by about 14,000-a more rapid pace than in either of the preceding quarters. Thus, the number of hours worked per employee rose in 1999:III, reaching its highest annual level-37.3 hours worked (seasonally-adjusted figures), compared with 36.8 in 1999:II.

The response of the various sectors to the expansion of the labor supply, on the one hand, and to the rally in economic activity, on the other, is indicated by the contribution of each of them to unemployment (or to the failure to take up the incremental labor force). According to calculations of the Bank of Israel's Research Department, the business sector (and manufacturing in particular) did not employ the incremental labor force to an extent commensurate with its relative size, while the public sector did, and even exceeded it.

In 1999:III the average unemployment rate rose to 9.1 percent, and in the period reviewed (until November) the number of work-seekers rose to 166,000 and was 3.1 percent higher than in the equivalent period in 1998. The number of requests for unemployment benefit fell by about one percent, and real wages increased in the first three quarters of the year, although the rate at which they rose slowed in 1999:III.

The number of Israelis employed in the business sector rose consistently, albeit slowly; the number of persons employed in manufacturing fell to a level unknown in the recent past, and there was an increase in the number of persons employed in transport and communications, as has been the case in the last two years, as well as in construction. In the public services, employment in education services fell and rose in health and social services. Labor inputs of Israelis (original data) were 3.6 percent higher in 1999:III than in 1998:III as a result of the increase in both the number of employed persons and the number of hours worked per employee.

The rise in real wages per employee post evident in the first half of the year persisted in the period reviewed, although trend data indicate that the rate of growth fell from 0.3 percent in the first half of the year to 0.1 percent in 1999:III. The total real wage per employee post was 1.3 percent higher in the period reviewed (until October) than in the equivalent period in 1998; in the public sector, because of the delay in finalizing wage agreements, it fell by 3 percent in real terms, while in the business sector it rose by 3 percent (inter alia apparently because of the inflation rate surprise). In manufacturing, the wage per hour worked rose even more steeply, by 4.5 percent in annual terms, until September.

In the second half of 1999, after strikes and sanctions, wage agreements were concluded for the main grades in the public services, in accordance with a framework agreement reached in the first half of the year (the principal agreements signed were for employees classified as belonging to the uniform and administrative grades, social sciences and humanities graduates, technicians, journalists, jurists, engineers, and medical and para-medical employees). The agreements apply mainly to 1997:IV and 1998, and not to 1999, and their finalization was accompanied by industrial action (in the Mekorot water company, the National Insurance Institute, the Employment Service, and members of the General Federation of Labor (Histadrut) and the local authorities). No agreements have yet been reached with the physicians and teachers (the latter went on strike at the beginning of 2000).

The annual growth rate of immigration was 33 percent higher in 1999 (until November) than in the equivalent period in 1998, and accelerated to 51 percent from July. The share of the immigrants in the labor force is gradually rising, and in 1999:III reached 16.5 percent; the gaps between the immigrants and the veteran population regarding participation rates, on the one hand, and unemployment, on the other, widened in 1999:III to higher levels than ever before-56.4 and 13.5 percent respectively, among the immigrants compared with 53.8 and 8.9 percent among the veteran population (original data).

In 1999:III the number of unemployed persons reached 213,000 (seasonally-adjusted data), up bv about 6,000 over 1999:II, most of it among males. According to statistical indicators of the depth of unemployment, this has eased somewhat. Thus, compared with the first half of 1999, the rate of young persons unemployed rose, that of married persons fell, and the period spent looking for work and in unemployment shrank, as did the number of refusals to accept the work offered through the labor exchange.

The total number of requests for unemployment benefit, which was relatively high in 1999:II (seasonally adjusted), declined in the period reviewed, so that the share of first requests in total requests also fell-data which bear out the assessment that there has been some recovery from the slack previously evident in the labor market.


 

Figure 6. The labor market (thousands)
Figure 7. Real wage per employee post (NIS, 1995 prices)

 

Table 3. Indicators of Labor Market Developments, 1998-99
(seasonally adjusted)


1998
1999
July-Deca
*

1998
1999
IV
I
II
III
IV
1998
1999
('000s)
Civilian labor force 2,266 2,326 2,287 2,309 2,324 2,344
2.2 3.3 9
Israelis employed 2,073 2,119 2,101 2,109 2,117 2,131
1.9 2.3 9
   Business sectorb
1,444 1,480 1,451 1,475 1,479 1,486
0.6 2.7 9
   Public sectorb 628 641 647 638 637 648
5.9 1.9 9
Average weekly hours
worked per employee
b

37 37 37 37 37 37
-2.9 1.4 9
Claims for
unemployment benefit
108 108 106 107 110 107 108 7.3 -0.7 12
Work seekers 156 159 152 156 159 154 165 3.5 3.3 12
Real wageb per employee post (NIS) 4,489 4,529 4,445 4,483 4,555 4,551 4,528 1.8 1.2 10
   of which: Business sector
4,464 4,654 4,479 4,599 4,725 4,661 4,632 2.5 2.6 10
Unemployment rate (%) 8.6 8.9 8.2 8.7 8.9 9.1


9
*
Last month for which data available.
a
Percent change compared with same period in preceding year.
b
At January 1995 prices.

Contents
 

 

The Balance of Payments

In 1999:III the current-account deficit in the balance of payments fell to $ 850 million due to the sharp increase in the deficit on the goods account, the smaller deficit on the services account (due largely to the rise in tourism), and marked increase in unilateral transfers. The current-account deficit is financed by capital transfers from abroad to an extent similar to that of 1998-$ 0.4 billion-by investments of nonresidents of about $ 0.5 billion (up by about $ 100 million over 1998), while on the other hand investments abroad by residents amounted to $ 290 million. The implied capital exports of the private sector amounted to $ 700 million in 1999:III, and were lower than in the two preceding quarters ($ 750 million and $ 1 billion respectively).

In the first half of 1999 goods imports increased (by 9 percent), goods exports rose more steeply (12 percent), and the trade deficit, which had widened in the first half of the year, fell by some 3 percent in the second half, despite the slight deterioration in Israel's terms of trade in 1999:III. Imported intermediates, which serve as a partial indicator of current activity, rose consistently throughout the year, and were 5 percent higher in the period reviewed than in the equivalent period in 1998. Imports of capital goods, serving as an indicator of future activity, were 21 percent higher in the period reviewed than in the equivalent period in 1998; imports of consumer goods rose by 4.3 percent, after fluctuating during the year.

Manufacturing exports were up by 13 percent in the period reviewed (current dollars) over the equivalent period in 1998. This increase, which encompassed most industries and is the most marked in the last three years, is one of the signs of Israel's economic recovery, which stems inter alia from the upsurge in world trade. Notable increases were evident in the high-tech industries, which have led exports in the last few years (incorporating communications equipment, machinery and equipment, electronic components, and computers), while in mining and quarrying, wood and furniture, and textiles and clothing the growth of exports slowed.

An analysis of the trend shows that, after adjusting for seasonal effects and irregular factors, the growth rate of goods exports and imports slowed in the period reviewed, although they continue to be high: from September to December 1999 exports rose by 13 percent, compared with 22 percent in February-August 1999-a slowdown that encompassed most export industries-while goods imports rose by 11 percent, compared with 14 percent from March to August 1999.

In 1999 the diversion of goods imports towards the US (which accounts for about one quarter of Israel's non-diamond imports) is notable, and since exports to the US grew only relatively slightly, Israel's trade deficit with the US grew by 150 percent, to stand at about $ 1 billion.

There were mixed trends on the foreign-currency market during the period reviewed. The shekel depreciated (against both the dollar and the currency basket) in 1999:III and appreciated slightly in 1999:IV, and since these changes occurred within the exchange-rate band the Bank of Israel did not intervene in trading, in accordance with its policy. The depreciation in 1999:III appears to have derived inter alia from uncertainty regarding the government's decisions on the inflation target and the national budget, and this was reflected in a slight rise in the standard deviation of the price of the Bank of Israel's dollar/shekel options and the widening of interbank spreads in foreign-currency trading. In 1999:IV capital inflow increased, due to large share offerings abroad by high-tech and communications firms (chiefly in October), developments in the political process, the accelerated upsurge in stock markets in Israel and abroad, and foreign investors' long-term considerations. This expansion led to the appreciation of the shekel despite the narrowing of the interest-rate spread between it and the currencies in the basket.

The Bank of Israel's foreign-exchange reserves rose in dollar terms by $ 587 million during the period reviewed-less than the rate by which they had fallen in the first half of the year ($ 743 million)-and at the end of the period stood at $ 22.5 billion.


 

Figure 8. Foreign trade ($million per month)
 

Table 4. Balance of Payments, Foreign Tradea, and the Reserves, 1998-99
($ milllion, current prices)


1998
1999
July-Dec
*

1998
1999
IV
I
II
III
IV
1998
1999
Monthly averages
Trade deficit 362 375 370 400 365 383 354 380 368 12
Goods imports 1,768 1,854 1,764 1,767 1,825 1,920 1,903 1,758 1,911 12
   Consumer goods 322 330 314 332 316 348 325 322 336 12
   Capital goods 378 446 409 410 434 476 463 387 469 12
   Intermediates 1,068 1,077 1,041 1,025 1,074 1,096 1,115 1,049 1,106 12
Goods exports 1,406 1,478 1,394 1,367 1,459 1,537 1,549 1,378 1,543 12
   Manufacturing 1,337 1,411 1,331 1,306 1,390 1,470 1,477 1,309 1,474 12
Quarterly averages
Net current account -167 -816 1,138 -705 -890 -853
-296   9
Long- and medium-term
capital flows
878 777 449 880 1,250 202
826   9
   of which: Private sector 594 746 282 916 876 446
865   9
Short-term capital flowsb -504 364 -520 585 688 -181
100   9
   of which: Private sectorb -498 413 -563 621 537 80
125   9
Net foreign debt (% of GNP) 12.42 11.96 12.42 12.18 11.71 11.96
19.30   9
End-period Bank of Israel reserves 22,674 22,518 22,674 21,983 21,931 21,854 22,518 22,674 22,518 12
*
Last month for which data available.
a
Foreign trade data are seasonally adjusted monthly averages (excluding ships, aircraft, diamonds, and fuel).
b
Including the banking system.

Contents
 

 

World Developments and Their Effect on Israel's Economy

The slowdown in the growth of world output in 1998 halted in 1999, and global macroeconomic estimates by various entities, including the IMF, which as early as the first half of 1999 had indicated positive developments (see Recent Economic Developments, 87), improved considerably towards the end of the year. Some of the negative predictions were adjusted positively, and the prediction of a stable rate of growth was amended to one of acceleration, especially in the forecast for the year 2000 (Table 5).

Among the factors leading to the improved estimate for 1999, the forecasters include the faster than expected emergence from the Asian crisis, and the faster than expected recovery from the side effects of the crises in Russia and Brazil. These positive developments restored faith in the financial markets of most emerging countries, leading to a loosening of monetary restraint and greater economic activity. One prominent upward adjustment was in the forecasters' assessment of the rate of growth in Japan's and Europe's economies. The assessment that the impressive level of activity in the US - for the third year in succession - would continue became even firmer, despite some signs of pressure on prices and wages. The downward trend in global inflation continued in 1999, in industrialized as well as developing countries, although in emerging countries it rose markedly. These developments had a positive on Israel's economy in relation to growth, foreign trade, and inflation.

The global macroeconomic forecast for 2000 also seems favorable to Israel's economic activity: the prediction is that world trade will accelerate in 2000, particularly imports of developing countries, and their inflation will continue downwards (the forecasts for these countries for 1999 were overestimated by about 2 percent on average). Nevertheless, fuel prices, which surged in 1999 (by some 32 percent), are expected to continue rising in 2000. So too, although at a slower rate, are prices of unprocessed goods, following their steep falls in 1998-99, and this will have a negative effect on Israel's terms of trade and inflation rate. Short-term interest rates, which fell in 1997-99, are expected to rise slightly, necessitating caution in reducing the rate of interest in Israel.

The exchange rates of most currencies in relation to the NIS were lower at the end of the year than at the beginning: the dollar rate declined by 2 percent, the euro by 16.3 percent, and the currency basket by 5.5 percent.


 
Table 5. Indicators of Economic Development in Advanced and Developing Countriesa, and Forecast for 1999-2000


1997 1998 Estimate
1999
Forecast
2000
Annual rate of changeb
World GDP
   Total 4.2 2.5 3.0 3.5
   Advanced countries 3.2 2.2 2.8 2.7
   Developing countries 5.8 3.2 3.5 4.8
World trade
   Total 9.9 3.6 3.7 6.2
   Advanced countries
      Imports 9.2 4.8 5.9 5.9
      Exports 10.3 3.2 3.0 6.2
   Developing countries
      Imports 11.4 -1.3 1.1 7.2
      Exports 11.4 4.9 2.4 5.6
Inflation (CPI) </TD<
   Advanced countries 2.1 1.5 1.4 1.8
   Developing countries 9.2 10.3 6.7 5.8
Prices of unfinished goods (in dollars)
   Oil -5.4 -32.1 27.7 7.8
   Other -3.3 -14.8 -7.2 3.4
Short-term interestc (%)
   Dollar deposits 5.8 5.5 5.4 6.1
   Yen deposits 0.7 0.6 0.2 0.2
   Euro deposits 3.5 3.7 3.0 3.5
Unemployment rate
   OECD countries 7.4 6.9 6.7 7.4
a
According to "World Economic Outlook", Israel is classified as an advanced economy.
b
Apart from interest and unemployment rates, which are shown as percentages.
c
6-month LIBOR rate.
SOURCE: World Economic Outlook, (IMF), updated December 1999.

 
Contents
 

Prices

The CPI rose by 3.5 percent, annual rate, in the second half of 1999, compared with a 12.9 percent rise in the equivalent period in 1998. The moving twelve-month rate of inflation fell almost every month, till in December it reached 1.3 percent, annual rate, its lowest level since the recession of the 1960s.

The main reason for the low rate of price increases was the tight monetary policy aimed at achieving the inflation target, and this included preventing the price rises at the end of 1998 from being translated into a higher inflation rate. The tight policy was not eased significantly during the year due to the uncertainty regarding the inflation environment and its relation to the target.

In most months from July to December, the lower limit of the range of price increases forecast by various economic entities was higher than the actual rise of the CPI, indicating that the price reductions at the beginning of the year were perceived as being temporary. Inflation expectations derived from the capital market fell in July, to 4.35 percent, approaching the inflation target, but they rose again in August and September to 6 percent, and did not reach below 4 percent until November (3.7 percent) and December (2.9 percent). In line with inflation expectations derived from the capital market, the Bank of Israel Survey of Companies also showed inflation expectations above the 1999 target, and then falling in 1999:IV. Global inflation was also below the forecasts in 1999; the forecasts for developing and emerging economies prepared in the middle of 1999 had an upward bias (see World Economic Outlook).

The CPI rose relatively steeply in 1999:III, adding to the uncertainty regarding the achievement of the target. The rise was moderated somewhat in the last quarter, mainly in November (a decline of 0.2 percent) and December (no change), and the inflation rate in the quarter remained relatively low.

Among the components of the CPI, housing, which has a high weighting, was most notable: for the whole of 1999, the housing index went down by about one percent, and in the second half of the year - it rose steeply in 1999:III and declined in 1999:IV - it rose by 4.2 percent, contributing about 0.9 of a percentage point to the rise in the overall CPI. Housing prices rose by less than the devaluation of the dollar in the second half of the year, a fact which may reflect the continued slowdown in the real estate industry.

There was nominal depreciation of the NIS against the currency basket of 6.1 percent, annual rate, in the period reviewed, while in the whole of 1999 it appreciated by a nominal 2.5 percent. (Against the dollar, the NIS depreciated by 5.1 percent in the second half of the year, and by 0.4 percent in the whole of 1999.) The wholesale price index of manufacturing output for the domestic market rose by 6.8 percent in the period reviewed (mainly due to the rise in prices of oil refining and its products), with a slower rise, 5.5 percent, in prices of nontradables, and stable prices of tradables - a rise of half a percent.

In August 1999, the government set the inflation target for 2000-01 at 3-4 percent a year.
 


 
Table 6. Selected Price Indicies, 1998-99
(annual rates of change during period, percent)


1998
1999
July-Dec
*

1998
1999
IV
I
II
III
IV
1998
1999
CPI 8.6 1.3 18.8 -5.5 4.3 5.1 1.9 12.9 3.5 12
CPI excl. housing, fruit and vegetables 8.5 1.7 23.8 -1.4 2.7 1.1 4.6 12.5 2.9 12
CPI excl. housing, fruit and vegetables, controlled goods, clothing and footwear 8.8 2.4 22.6 2.9 2.2 3.7 0.7 14.1 2.2 12
Index of housing prices 8.8 -0.9 13.4 -17.9 8.3 23.5 -12.1 13.3 4.2 12
Wholesale price index 8.2 3.5 31.7 -3.4 4.1 7.3 6.3 15.1 6.8 12
NIS/$ exchange rate 18.2 0.4 39.2 -13.2 5.9 16.3 -5.0 29.9 5.1 12
NIS/currency-busket rate
20.6 -2.5 45.8 -20.2 0.6 21.5 -7.4 37.0 6.1 12
*
Last month for which data available.

Contents



The Public Sector

The government's domestic deficit in 1999 was significantly lower than the estimates during the year, estimates which constituted a factor in determining the target deficit for 2000. The government's total deficit also deviated from the target set in the budget - 2 percent of GDP - by a quarter of a percent of GDP, and was 0.15 percent of GDP lower than the 1998 deficit, as a result of the improvement in the domestic deficit and the increase in the surplus with abroad. Estimates of actual performance, based as they are on a cash basis and not on an accrual basis, which would be more appropriate from an economic aspect, do not include deferred wage payments arising from agreements already signed, or payments for defense imports planned for 1999 but received in 2000.

Both income and expenses were lower than the budget forecast. Domestic income was some 3.6 percent below the budgeted amount, and only about one-fifth of the deviation can be attributed to lower-than-forecast economic growth. Domestic expenses were some 2 percent less than the budgeted figure, due among other things to the fact that teachers' and doctors' wage agreements had not been finalized, and to slower than expected price rises.

Estimates of the Central Bureau of Statistics (accrual basis) indicate that public consumption, seasonally adjusted, rose by 4.2 percent in real terms in the second half of the year; most of the increase occurred in the last quarter and was the result of a rise in defense imports. Total transfer payments (based on data up to September) rose in real terms by 2.5 percent in the period reviewed compared with the second half of 1998; in 1999:III the rise was 1.2 percent, compared with steep increases in 1998:III and 1997:III. All the major categories of social allowances showed a slower rise, and in the category of work accidents and victims of hostilities there was a 9 percent decline, and in unemployment a 3 percent decline, annual rates.

The estimate of the Accountant-General, mainly based on cash basis data, shows that the government's domestic deficit was low in every month from July to November, and jumped in December; in the whole of the second half of the year it amounted to about 4 percent of GDP. The domestic deficit, including the deficits of the government, the Bank of Israel, and the Jewish Agency, totaled 4.2 percent of GDP in the period reviewed, down from 5.3 percent of GDP in the second half of 1998; the decline was due to a rise in government income and a fall in its expenses. The greater part of the deficit was financed by borrowing from the public - mainly via deposits and the sale of bonds (there was no income from privatization in this period) - and by a low level of public-sector injection (Table 7).

According to data from the State Revenue Administration (accrual basis), total government tax receipts in the period reviewed were 6.8 percent higher than in the equivalent period in 1998, after rising by only 2 percent in the first half of the year. Receipts in all tax categories rose in real terms in the first half of the year, based on original data without seasonal adjustment, and rose even faster in the second. This supports the assessment that there was a recovery in the level of activity in the second half: domestic gross VAT receipts were 6 percent above their level in the second half of 1998, civilian import taxes rose by 13 percent, and transfer payments from the public doubled in real terms. On the other hand, transfer payments to households, up to October, rose by a real 4 percent, faster than the real rise in wages. Unemployment benefits were unchanged in real terms, despite the increase in the number of unemployed persons; this is apparently due to the stricter application of eligibility criteria defined in the Social Security Law, although the increase in the number of those seeking employment for more than 27 weeks must have contributed to a rise in the number of recipients of income support payments. The Economic Arrangements Law (legislation supplementary to the Budget Law) passed at the end of 1999, tightened up the criteria for receipt of unemployment benefit according to age and family situation, shortened the period of eligibility, and lowered the level of unemployment benefit for those unemployed repeatedly.
 

Budget policy: plan versus performance

The government's total deficit fell in 1999 from 2.4 percent of GDP to 2.25 percent, continuing the decline from 4.1 percent in 1996 to 2.8 percent in 1997. Despite the fact that the decline in 1999 fits in well with the declared strategy of long-term reduction in the deficit, i.e., fiscal consolidation, the path of the deficit during the year and government decisions taken during the period reviewed regarding the deficit for the year 2000 and beyond create difficulties in continuing this strategy. When the government started discussing the budget in August 1999, it was estimated that at the end of the year the deficit would total 3 percent of GDP. Consequently, the government raised the target for 2000 from the 1.75 percent specified in the original law to 2.5 percent of GDP, a rate which reflected a decline from the then prevailing estimated deficit for 1999. Since then the planning environment has changed: a) tax income has increased as a result of economic recovery, enabling the deficit in 1999 to fall from 3 percent to 2.25 percent of GDP, so that the plan fixed in August 1999 now represents a rise in the deficit, in opposition to the long-term strategy described above, and b) the probability that growth in 2000 will exceed 3 percent - the assumption on which the budget for 2000 was based - has risen. It is important to avoid a situation in which this growth finances additional government expenditure made possible without exceeding the budget deficit target for the year; such expenditure is liable to become permanent, and in the future will require a rise in the tax rate.

The change in the planning environment is likely to weaken the strategy of fiscal consolidation. Policymakers are faced with the objective of preventing a recurrence of the process which took place in 1995-96. In those years the Budget Deficit Reduction Law was breached after the government passed a Supplementary Budget in 1994 based on high tax receipts, the result of the boom set off by the influx of immigrants. Dangers of this type are not unique to Israel's economy: a paper by Hercowitz and Strawczynski (1999)1 showed that in the 1970s, 1980s, and the first half of the 1990s, OECD countries would spend all the income received in periods of rapid growth, and this led to the significant and continued rise in the share of public expenditure in GDP. The rise incorporated all three main components of public expenditure - public consumption, transfer payments, and public-sector investment.

These results, combined with the new planning environment described above, paint a threatening picture for the strategy of reducing the share of government expenditure and deficit in GDP. The year 2000 will provide an important testing ground, as wage agreements for 1999 and beyond are signed. Wage agreements in the public sector signed in 1993 were, in retrospect, the main cause of deviations of the deficit. Another test is expected in 2001 and thereafter, years for which a deficit declining by at least 0.25 percent of GDP per year has been set; this is given as a function of growth, but without specifying the rate of growth required to achieve this reduction, and without a government undertaking not to raise taxation. The success of fiscal consolidation depends on the extent to which it is based on reducing the share of public expenditure in GDP, and not on raising the tax burden. A reduction in the deficit of 0.25 percent of GDP, as required by the law, by means of lowering the share of public expenditure in GDP without raising tax rates is consistent with maintaining the long-term volume increase in public expenditure of about 3 percent, with GDP growth of 3.5 percent. If the rate of growth reaches 5 percent, and the rate of volume increase in public expenditure remains constant, this will be reflected in a cut of one percent of GDP in the share of public expenditure, with a more rapid return to the original path specified in the Budget Deficit Reduction Law.

1 Cyclical bias in government spending: evidence from the OECD, Working paper 6-99, Tel Aviv University.
 

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

Table 7. The Budget and its Financing, 1998-99
(cash flows, as percent of GDP)


1998
1999
July-Dec
*

1998
1999
IV
I
II
III
IV
1998
1999
1. Government domestic expenditure 38.8 38.0 42.4 39.1 36.8 36.9 39.4 39.5 38.2 12
2. Government receipts 35.5 35.0 34.5 37.4 32.9 35.0 35.0 34.7 35.0 12
3. Domestic budget deficit (2-1) -3.2 -3.0 -7.8 -1.6 -3.9 -1.9 -4.5 -4.9 -3.2 12
4. Public sector domestic deficita
(5+6)
3.6 3.6 8.1 2.5 3.3 1.2 7.2 5.4 4.2 12
5. Government net borrowing from the public 2.7 2.1 5.4 0.7 2.8 2.4 2.5 4.0 2.4 12
6. Public-sector injection (9-8-7) 0.9 1.5 2.7 1.8 0.5 -1.1 4.7 1.4 1.8 12
7. Bank of Israel injection
-1.1 -0.4 -4.0 1.7 -2.3 0.4 -1.4 -0.7 -0.5 12
8. Private-sector foreign-currency conversions 0.3 -0.1 -0.1 -0.4 0.1 -0.1 -0.0 -0.2 -0.1 11
9. Change in monetary base
0.1 1.0 -1.4 3.2 -1.7 -0.8 3.3 0.5 1.2 12
* Last month for which data available.
a Budjet deficit plus Jewish Agency injection, plus non-budgetary injection.


Contents
 

 

The Money and Capital Markets

In the second half of 1999, with the continued calm in the foreign-exchange market, and based on an analysis of the inflation environment compared with the target, the Bank of Israel's nominal rate of interest for August and December was cut by a cumulative 0.8 of a percentage point, and for January and February 2000 by almost 1 percentage point (by 0.5 and 0.4 of a percentage point respectively). At the same time, inflation expectations fell faster, so that the ex-ante short-term real interest rate - which affects individuals' decisions in choosing between consumption and investment - rose, reaching 8.7 percent at the end of 1999, its highest level in the year, and the ex-post short-term real interest rate, which is adjusted by the actual rise in prices and affects companies' profits, inter alia, also reached a high level, 11.7 percent.

Relative calm was maintained in the foreign-currency market throughout the year, and in the second half the nominal rate of the dollar moved within the exchange-rate band, well away from its limits, despite the fact that the interest rate differential narrowed from month to month. (This can be seen, for example, from the differential between the average LIBOR rate on the currencies of the basket and the Bank of Israel's effective rate, which was 9.76 percentage points at the beginning of the period, and 6.41 percentage points at the end.) The calm seems to be connected with among other things the development of long-term factors due to Israel's improved geopolitical standing resulting from the peace process, liberalization, the consistent disinflation process which raises the economy's growth potential, the trend of Israeli high-tech companies being bought, and greater foreign investment of risk capital in Israel.

The monetary base expanded very markedly in the period reviewed, by about 31 percent, annual rate. The M1 money supply grew even faster, by 37 percent. In both of these aggregates the main increase occurred in December, apparently due to preparations for the transition to the new millennium, with individuals and companies opting to hold liquid assets, and wage payments being brought forward. Until November, the two aggregates grew by 14 percent and 12.6 percent respectively, slower than in 1998 (Table 8), but higher than in the first half of 1999. The other monetary aggregates rose relatively rapidly in the second half of the year: local-currency deposits (mainly short term), and Treasury bills increased faster than the rise in the money supply, and the M2 aggregate rose by about 20 percent. In the period reviewed, bank's deposits in the Bank of Israel in the framework of the auction increased by NIS 5.4 billion to NIS 48.7 billion. The increase of these deposits and the rise in the interest on them contributed to the rise in the central bank's expenses. The stock market showed renewed buoyancy in July to December; along with the worldwide boom, the index of shares traded on the Tel Aviv Stock Exchange rose by about 20 percent (shares fell by about 4 percent till mid-October, and then surged by 24 percent). The rise in the share-price index encompassed all the stock exchange categories except for real estate and mortgage banks. Capital raised via risk-capital funds increased to $ 640 million in the period reviewed, with software and communications accounting for the whole rise. Indexed bonds yielded a total real return of about 2.5 percent, while unindexed bonds yielded some 5 percent. Turnover, which fell at the beginning of the period, rose again towards the end, and the value of the stock market also rose. Nevertheless, the extent of new offerings in Israel went down considerably.
 

Figure 10. Monetary aggregates and credit (change in last 12 months)
Figure 11. Nondirected bank credit (NIS billion per month)
Figure 12. The sheqel exchange rate against the currency basket


Table 8. Monetary Indicators and Nondirected Bank Credit, 1998-99
(annual terms, percent)


1998
1999
July-Dec
*

1998
1999
IV
I
II
III
IV
1998
1999
Rates of change Average
Compared with preceding quarter
During perod
M1a
12.1 10.2 13.1 -4.9 11.1 28.9 -3.5 23.3 12.6 11
M2b 22.6 20.0 6.9 32.7 22.5 17.8 18.5 13.5 19.8 11
M3c 22.1 20.9 23.6 25.5 19.6 19.2 20.0 23.9 20.8 11
Nondirected bank credit 15.9 17.1 35.7 12.3 11.9 15.1 21.3 27.9 18.9 11
   Unindexed local-currency 16.3 17.2 26.1 20.7 13.8 5.3 18.5 23.6 16.8 11
   CPI-indexed 14.1 17.6 25.2 22.9 10.2 18.4 20.9 18.7 16.6 11
   Foreign-currency indexed and denominated 17.9 16.3 64.0 -8.0 11.6 23.7 25.4 46.1 24.7 11
*
Last month for which data available.
a
Narrow money supply (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.

 
Figure 13. Yield on Treasury bills (end-period figures)

Table 9. Interest Rates, Yields, and the Share-Price Index, 1998-99


1998
1999
July-Dec
*

1998
1999
IV
I
II
III
IV
1998
1999
Nominal interest rate
Nondirected local-currency credit 16.2 16.5 16.2 17.6 16.5 15.9 15.6 14.9 15.8 11
Average monetary loan 12.0 12.4 12.1 13.6 12.5 12.0 11.5 11.2 11.7 12
SROs 10.2 10.8 10.5 11.9 10.7 10.2 10.2 9.1 10.2 11
3-month Eurodollar 5.4 5.3 5.1 4.9 4.9 5.3 6.0 5.3 5.7 12
Yield to maturity on
Treasury bills
12.3 12.6 13.0 13.7 12.5 12.0 11.8 11.3 11.9 11
10-year bonds 4.9 5.2 5.0 5.2 5.1 5.2 5.3 4.9 5.2 12
5-year bonds 5.1 5.6 4.8 5.6 5.4 5.6 5.9 4.9 5.8 12
General Share-Price index (points) 137.5 181.5 135.1 146.8 181.2 187.7 210.4 136.0 199.1 12
*
Last month for which data available.