The Bank of Israel on Wednesday lifted its growth forecast for this year to 3.7 percent, from 3.5%, as exports are expected to accelerate faster than had been forecasted, although private consumption and investments are projected to increase more slowly.
“This year will be a much better year than last year, which will improve the economic situation of citizens. Expectations are that economic growth will be higher than population growth,” Bank of Israel Governor Prof. Stanley Fischer said at the presentation of the central bank’s annual report in Jerusalem. “The economy emerged out of this crisis relatively well compared with other countries. But now we are at the stage where we have to focus on the question of how we achieve sustainable growth for the years to come.”
This year, the average unemployment rate is expected to drop to 7%, up from the previous forecast of 7.1%. The change resulted partly from the relatively sharp decline in unemployment in the last quarter of 2009. Next year, gross domestic product is expected to increase by 4%, and the rate of unemployment to fall to 6.7%.
GDP grew by 0.7% in 2009, the result of a 1.5% decline in the first half of the year and 3.3% growth in the second half. Unemployment reached 7.9% around the middle of the year, and fell to 7.3% by the end of the year.
At the same time, though, Fischer cautioned that the country’s growth rate in the next few years will be heavily influenced by the rate of recovery of the global economy.
In the report, the central bank concluded that the factors contributing to the relatively mild effect of the global economic crisis here included a conservative financial system, and in particular a conservative and closely supervised banking system, a balanced housing market and a successful economic policy.
The central bank also revised this year’s forecast for exports – not including diamonds – which are now projected to expand by 9.2%, up from the previous forecast of 8.6%. In 2011, exports are expected to grow by 7.4%.
In the report, the central bank cautioned that the economy’s ability to grow in the long-term hinges on the expansion of exports and the ability of exporters in the years to come to develop products that satisfy demand in emerging markets and strengthens its marketing systems in this sector.
“Despite the rapid development of the emerging markets, Israeli exports still depend heavily on demand in advanced economies, which accounted for about 60% of total Israeli exports in 2008,” stated the report. “In the 2000s, the emerging markets’ imports grew vigorously; Israel’s exporters, however, did not manage to exploit this fully. Instead, their market share in these countries fell gradually despite real depreciation of the shekel against these countries’ currencies, and no diversion of trade took place even during the crisis.”
Furthermore, Fischer said that despite the sharp price in property prices there was no housing bubble last year.
“The development of construction activity and the housing market was very different in Israel from typical development in developed countries, where the crisis originated in precisely these sectors,” stated the report. “Housing prices relative to rent levels and relative to the national average wage – ratios that furnish indicators of the existence of a bubble – have also held steady over the past decade, while prices in other countries ballooned at rates exceeding those that can be explained by market fundamentals.”
However, central bank economists indicated that if housing prices continued to rise much further in 2010, they could exceed those that can be explained by market fundamentals such as the cost of housing, demand and supply, or interest rates.
Fischer praised the Treasury’s fiscal discipline, which moderated the increase in Israel’s debt/GDP ratio to about 80%, which no longer appears high compared to that in other advanced countries. Nevertheless, the central bank emphasized that reducing it would make the economy more robust, strengthen its ability to withstand future crises while maintaining stability, and ease the burden of servicing the debt.
“Further reduction of the debt/GDP ratio is inconsistent with the tax reduction program and with the provision of proper public services,” stated the report.
The Finance Ministry last year announced plans for a tax-reduction program for income and corporate taxes until 2016. Corporate tax is expected to fall to 18%, low by international standards, and income tax rates are expected to fall commensurately.
Fischer said that once the economy returns to strong growth rates of over 5%, the government will have more room to take decisions, but until then if the government implements the tax cutting plan, it will be necessary to reduce the share of government expenditure in GDP.
“A further reduction of the share of government expenditure in GDP, however, raises serious questions,” stated the report. “Today, Israel’s ratio is lower than the OECD average despite its onerous defense burden and relatively high rate of interest payments. By implication, expenditure for civilian purposes-education, health care, and infrastructure is low by the standards of developed countries. Developments in the field of education are especially troubling.”
In addition, the report states that the higher education system, too, is deteriorating according to international rankings.
“Today’s Israeli economy is based on human capital, but current trends
in its education system will not allow it to maintain its comparative
advantage,” stated the report. “A faster increase in public expenditure
while evaluating and adjusting priorities can help in dealing with
issues that are important for economic growth and in addressing social
At the same time, Israel’s tax burden is slightly lower than the OECD
average and since some developed countries are expected to raise their
tax rates in the next few years, Israel’s relative competitiveness will
improve even without further tax cuts, it was argued in the report.
“Without more rapid growth than that in the last decades, the deficit
target will be met only if the increase in expenditure is kept lower
than planned, or by a more modest reduction in taxes than envisaged in
the announced downward path,” stated the report.