IMF Concludes 2022 Article IV Consultation with Israel

Washington, DC: The Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation[1]with Israel.

Israel's economy has weathered the pandemic exceptionally well. The Bank of Israel's (BOI) monetary and prudential measures provided liquidity, kept credit flowing, and prevented undue tightening of financial conditions. Fiscal measures supported households, businesses, and the public health system. Israel's world-leading vaccination campaign boosted confidence and helped mitigate the impact of the pandemic in the face of new, virulent variants. Banks' solid capital, liquidity, and asset quality also allowed them to support the economy.

After a mild downturn in 2020, real GDP exceeded its pre-pandemic level reaching growth of 8.2 percent in 2021. Consumption and the high-tech sector led the recovery. The 2021 fiscal deficit-4.3 percent of GDP-was significantly smaller than expected due to buoyant tax revenues, and public debt declined to 69 percent of GDP. The current account reached a surplus of 4.6 percent of GDP, driven by exports of high-tech services. Unemployment declined to near pre-pandemic levels, and job vacancies are high across all sectors. Thus far, the war in Ukraine has had a limited impact on Israel's economy given its low direct exposure to Ukraine and Russia. Nonetheless, the economic outlook is subject to significant uncertainty.

Executive Board Assessment[2]

The economic recovery is projected to solidify in 2022 and over the medium term . Growth will be supported by strong private consumption, investment, and net exports. With temporary factors winding down, inflation is projected to ease and stay within the BOI's target band over the medium term. The external position is assessed as moderately stronger than the level implied by medium‑term fundamentals and desirable policies. The policy mix should remain agile in the face of high growth and still significant uncertainty.

The planned 2022 fiscal stance is appropriate, and the medium-term fiscal path aims to put debt on a downward path . In 2022, pandemic support should target the most affected sectors and vulnerable population groups. Refocusing medium-term policy on reducing public debt and rebuilding pre-pandemic buffers is also appropriate. However, the authorities' planned expenditure restraint may be challenging to implement given Israel's already low civil spending, and a review of public spending efficiency would therefore be useful. There is scope to increase tax revenues by broadening the tax base and making the tax system more progressive. This would also support a needed increase in growth-enhancing spending.

The fiscal framework should be strengthened . A review of the framework should assess the appropriateness of the fiscal rules, the necessary size of fiscal buffers, the ability to face exceptional events, and the potential usefulness of establishing an independent fiscal council.

Inflation pressures have risen, calling for commencing data-driven monetary policy tightening . Inflation has exceeded the BOI's target range despite appreciation of the shekel, which continues to restrain price growth. Signs of underlying inflationary pressures are strong, and inflation expectations have increased quickly in line with CPI. The conditions are in place for the BoI to start raising the policy rate gradually. Foreign exchange purchases should taper off, allowing the shekel's value to be determined by market forces, without precluding future purchases should appreciation pressures threaten to move inflation or inflation expectations below the target band.

Emerging risks in the financial system need to be addressed . Housing risks stress the need to advance structural measures to ease housing supply. Further tightening of macroprudential measures could help stem banks' exposures to housing market risks and prevent potentially unsustainable borrowing. While Israel's financial regulatory architecture has served the economy well, the establishment of a committee to review it is welcome in view of the push for greater competition and financial innovation.

Well-targeted structural reforms could foster productivity, labor reallocation, and inclusiveness . Active labor market policies should seek to expand vocational training and improve its quality. A greater adaptation of the different education streams will be needed to help align student qualifications with labor market needs. Continued efforts to reduce trade barriers and red tape would promote efficient resource allocation, investment, and innovation. Accelerating digital and physical Infrastructure would improve job accessibility.

Further efforts are needed meet the authorities' climate objectives. Options could include larger increases in carbon prices and providing greater regulatory and fiscal support for Israel's innovative green technologies.