1

Strengths and Challenges

of the Israeli Economy

Prof. Zvi Eckstein

IDC Herzliya and Tel Aviv University

30 September 2013

Philadelphia Israel Chamber of Commerce

2

Topics

• The Macro Picture

• Monetary Policy

• Comments on Industry and Export

3

The Macro Picture

4

-12

-10

-8

-6

-4

-2

0

2

4

6

8

10

%

Crisis begins

Lehman Brothers collapse

Back to growth

1.2

2.5

4.9

-0.6

2.2

3.6*

Growth rates - Israel, US and Europe

0.9

3.0

3.4*

Euro area (17 countries)

US

Israel

Quarterly rates in annual terms. * excluding “TAMAR” gas, growth is 2.6 in 2013 and 2.7 in 2014.

Source: CBS and OECD data, forecasts by BOI (September 2013), Federal Reserve (September 2013) and IMF (July 2013).

5

7.47.2

6.66.3

6.9

7.4

12.112.312.3

4

5

6

7

8

9

10

11

12

13

4

5

6

7

8

9

10

11

12

13

Israel

Euro area

US

Unemployment signals that the real crisis remains in US and EU - less so in Israel

%

Source: OECD and BOI data, forecasts by BOI (September 2013), Federal Reserve (September 2013) and IMF (April 2013).

6

47

50

53

56

59

62

65

3

5

7

9

11

13

15

unemployment - left

employment - right

Is unemployment back to normal?Would employment keep rising?

Source: BOI.

7

Israel’s Economic Strength

• Financial markets

• Fiscal policy - Government budget

• Balance of payments

• Monetary policy and price stability

8

Financial Markets are functioning well, but…

• Private and public debt are reasonable, with no exceptional growth - except for corporate debt

• Banking capital level at world average (14.9%; core tier 1 8.7%): Banks are stable - but continuous decrease in ratio of credit to business sector product

• Savings rate relatively high (18.3%)

• No exposure to advanced financial instruments (MBS, CDO, CDS); small inter-banking market; No real estate bubble

• Capital requirements from banks, non-bank credit restrictions and lack of securitization - create limits on business credit

9

39.4 40.7 39.8

68.370.6 71.2

3.9 4.65*

3.0*

0

2

4

6

8

10

12

14

16

18

20

0

10

20

30

40

50

60

70

80

90

100

Public spending (% GDP) - left

Public debt (% GDP) - left

Deficit (% GDP) - right

Fiscal policy: Conservative and credible(?) (2015?)

Data for 2012 and forecasts are according to the new GDP definitions. Deficit for 2013 and 2014 is the target.

2012 according to the old GDP definitions: Debt 73, spending 42.1, deficit 4.2.

Source: BOI and CBS.

10

• Failure in managing 2012/13 budget due to increase in expenses beyond the target and decline in tax revenues (deficit target - 2%)

• 2013 budget increased by 7% in real terms compared to 2012, deficit target is - 4.65%.

• 2014 budget will rise by around 1.1% compared to 2013, deficit target is 3%. Few adjustments needed

• 2015 - need to adapt expenses and examine tax ratesto stay within the budget rules.

2013-2014 Budget

11

25

30

35

40

45

50

25

30

35

40

45

50

Balance of payments: Back to surplus% GDP

export

import

Total goods and services, calculated from current prices series.

Source: CBS.

12

-5.0 -4.9

-3.0

-0.8

-1.7 -1.7 -1.6-1.1

0.6

1.7

3.1

4.7

3.3

1.5

3.9

3.1

1.3

0.3

2.52.1 2.0

-6

-4

-2

0

2

4

6

Current account: Growing surplus, pressure on Shekel% GDP

Source: CBS, estimated forecast calculated from BOI (September 2013).

13

Monetary Policy

14

Monetary Policy Goals

• Main goal: Price stability, inflation target 1-3%

• Secondary goal: Support employment and growth (subject to price stability)

• Tools: Interest rate and FX market interventions

• Additional goal: Support financial stability

• Tools: Financial markets interventions and “macro-prudential” actions (e.g. restrictions on the expansion of the real estate market and restrictions on purchasing bonds and foreign currency derivatives)

15

-3

-1

1

3

5

7

9

Annual Inflation

1-year market-derivedinflationary expectations

10-year market-derived inflationary expectations

Inflation below mid-target

Source: CBS and BOI.

16

0

1

2

3

4

5

6

Interest rate policy: Expansionary in the west - how long? Slightly expansionary in Israel -

how long?

Recent changes:13.5.2013 BOI reduces the interest by 0.25 to 1.5%27.5.2013 BOI reduces the interest by 0.25 to 1.25%23.9.2013 BOI reduces the interest by 0.25 to 1%

Israel

EU

USUK

17

Shekel too strong? Intervention during unusual trends affecting market; Accumulating balances; In

the long-term - avoiding intervention

Source: BOI.

3

3.25

3.5

3.75

4

4.25

4.5

80

85

90

95

100

105

110

NIS/$ (right)

Nominal effective(left)

Daily $ 25M purchase

Daily $ 100M purchase

Purchase according to

market fluctuations

Intervention stopped

Interventions renewed

18

Comments on Industry and Export

19

Output per worker Capital per workerR&D expenses as % from

branch output

1995-2000 2003-2007 1995-2000 2003-2007 1995-2000 2003-2007

by technology intensity:

Low Technology Industries

45 43 74 86 71 35

Medium-Low Technology Industries

55 57 135 161 62 139

Medium-High Technology Industries

60 74 114 119 38 59

High Technology Industries

78 83 116 137 85 105

Israeli vs. US industry - output, capital and R&D

(ratio between Israel and US, %)

Source: Applied Economics supported by OCS.

?

20

All industries

High Technology Industries

40,000

50,000

60,000

70,000

80,000

90,000

100,000

110,000

120,000

output per worker ($, 2005 PPP)

Israel US Europe small countries Europe large countries

70,000

90,000

110,000

130,000

150,000

170,000

190,000

210,000

230,000

capital per worker ($, 2005 PPP)

Israel US Europe small countries Europe large countries

50,000

60,000

70,000

80,000

90,000

100,000

110,000

120,000

output per worker ($, 2005 PPP)

Israel US Europe large countrties

80,000 100,000 120,000 140,000 160,000 180,000 200,000 220,000 240,000 260,000 280,000

capital per worker ($, 2005 PPP)

Israel US Europe small countries Europe small countries

Source: Applied Economics supported by OCS.

21

0

200

400

600

800

1000

1200

1400

1600

1800

2000

2200

0

200

400

600

800

1000

1200

1400

1600

1800

2000

2200

High Technology Industries

Medium-Low Technology Industries

Medium-High Technology Industries

Low Technology Industries

Source: CBS.

$ monthly millions

Exports by technology intensity: “The growth engine is stuck”

22Source: CBS.

Export by technology intensity: Transition to High-Tech exports

High

Technology

37%

Medium-

High

Technology

28%

Medium-

Low

Technology

21%

Low

Technology

15%

1995

High

Technology

45%

Medium-

High

Technology

35%

Medium-

Low

Technology

14%

Low

Technology

7%

2012

23

Export destinations (ex. Diamonds): Transition to Asia

European

Union 32%

Asia 16%

USA 30%

Rest 21%

2000

Source: CBS.

European

Union 31%

Asia 21%

USA 23%

Rest 24%

2012

24

Challenges

• Employment, poverty and inequality

• Invest in productive human capital

• Encourage employment

• Education and human capital - employment skills

• Peace and the economy

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Thank You!