Local officials repeatedly boast about strong domestic economic growth, which is currently in the 5 percent range, but Morgan Stanley on Wednesday called even that figure an "underperformance" given Israel's huge potential. The missing piece, the firm said, is peace.
"The challenge is not macroeconomic policy adjustments, but developing a comprehensive peace agenda that would allow Israel to take advantage of its incredible human capital endowment and entrepreneur capacity," analyst Serhan Cevik wrote in a note to clients.
In another country, he told The Jerusalem Post, all those factors in its favor could easily put growth in the 8 to 10% range, the major obstruction in realizing that potential, however, is the lack of direction in the peace process.
Cevik said the Israeli economy recovered robustly out of the recession triggered by the burst of the global hi-tech bubble and the eruption of violence of the Intifada. As fiscal correction and structural reforms cleared the path for private sector-led expansion, he noted that real GDP grew at an annual rate of 5% in the past three years.
Yet, even though the state of the economy has improved in terms of job and income growth, Cevik said it would be "a mistake" to overlook the influence of above-trend global growth on Israel's technology-intensive sectors.
Furthermore, Cevik noted that the shekel's recent strength puts pressure on low-tech, labor-intensive sectors, which are already struggling, with almost no export growth, against competitors from the developing world.
"The continuing rise in exports that has been the leading growth engine could become a challenge if we end up with a US-led slowdown," he said.
For the time being, he said, the Morgan Stanley global economics team was forecasting a "manageable" deceleration in the global economy from 5% in 2006 to 4.3% in 2007.
But the growth risks, he said, are to the downside and countries lacking strong domestic demand may face a troubling period.
"Israel's domestic economy, albeit gaining strength, is still not robust enough to compensate for the export engine. This is why we believe that the country needs an unambiguous agenda for peace, not so much for shielding against shocks, but, more importantly, for realizing its true, unappreciated potential," he said.