IMF Concludes Article IV Consultation with Israel

by Ulrika Lomas, Tax-News.com, Brussels

20 February 2009

The Executive Board of the International Monetary Fund (IMF) has concluded its Article IV consultation with Israel, and reported its findings, noting a broadly positive performance since 2003, though warning of the significant economic challenges lying ahead.

The IMF noted that the economy grew rapidly following the 2001-03 downturn. Real GDP growth averaged over 5% in 2004-07, as strong export of goods and services spurred private consumption and investment. In this context, the current account remained in strong surplus.

Fiscal and monetary policies reflected and supported strong and stable growth. The central government fiscal accounts steadily improved from a deficit of 5.4% of GDP in 2003 to balance in 2007, and public debt was lowered from 100% of GDP to under 80% of GDP during 2003-07. Inflation climbed steadily after mid-2007, surpassing the upper bound (3%) of the inflation target in December 2007. In response, the Bank of Israel (BoI) raised policy rates by 75 basis points between August 2007 and February 2008, to 4.25 percent.

Trends changed in the Fall of 2008 as the deterioration of global financial conditions and the weakening of export markets took their toll. Exports and growth slowed, lowering the annual external current account surplus to 1.25% of GDP, and reducing growth to some 4.25% for the year. Alongside, fiscal revenue fell short in the fourth quarter, raising the central government deficit to 2.1% of GDP in 2008, with public debt at about 77.5% percent of GDP. In this context, with the prospective global growth slowdown reversing earlier food and energy price inflation and associated inflation expectations, the BoI rapidly reduced policy rates to 1% in February 2009. Inflation fell to 3.3% in January 2009 from the high of 5.5% in September 2008.

As the global crisis continues to unfold, activity is set to decelerate further, with inflationary pressures easing significantly alongside. And with fiscal revenues weakening in this context, fiscal deficits and public debt are set to rise.

In its executive assessment the IMF noted that the robust and balanced economic growth since 2003, was underpinned by sound macroeconomic policies, and supported by a stable banking sector and favorable global conditions. The IMF noted, however, that global strains and weakness in the corporate bond market weigh on credit and growth prospects, and accordingly, activity is set to slow markedly in 2009-10. Thus, significant economic challenges lie ahead, with the high level of public debt remaining a vulnerability.

The IMF commended the authorities for their disciplined budget execution in recent years, which had delivered strong budget outturns, secured significant debt reduction, and accordingly prepared fiscal policy for a supportive role in the current circumstances. In the near term, they agreed that automatic stabilizers should be allowed to operate fully, and welcomed efforts to bring forward planned infrastructure projects. While leaving the underlying structural fiscal balance close to its 2008 outturn, this would require a relaxation of the budget deficit ceiling. However, in light of the potential fiscal risks from the financial sector, the still-high debt ratio, and the need to maintain room for further fiscal manoeuvre if the economic outlook deteriorates further, the IMF cautioned against further relaxation at this stage.

The IMF emphasized the need to strengthen further the medium-term fiscal framework, anchored by a medium-term public debt goal and associated expenditure ceilings. The specifics of such a framework should balance the need for flexibility, given the uncertain global environment, with the need for sufficiently firm mechanisms to guide the political process. A debt objective defined over the medium term, supported by rolling multi-year ceilings on nominal annual spending, could strike this balance appropriately, although some Directors also saw merit in an automatic error correction mechanism and caps on real expenditures.

Recommended