Economy and Trade
Israel has a diversified, export-based economy with a strong high-tech bias. The main exports are software, electronics, biomedical goods, polished diamonds, military equipment, and agricultural products. Relatively isolated from its neighbors, its top trading partners are the Palestinian Territories (the West Bank and Gaza Strip, with which peace has been elusive), the United States, the European Union, and China. The Territories primarily export agricultural produce to Israel. The dotcom bust and the intensified Israeli–Palestinian conflict of the early 2000s prompted a short recession. Steady growth was then promoted through structural reforms and tighter fiscal controls, although public debt remained high. Foreign aid and loans, mostly from the United States, are sizable. The Territories, racked by poverty, have faced economic embargoes and extensive damage to capital due to the conflict.
Economic Policy over 12 Months
Although Israel was well placed economically when the global financial crisis started to unfold in 2007, the country’s vulnerabilities had come into sharp relief by mid-2008. A small, open economy, it had a total external gross debt of about 50% of GDP and public debt of some 80% of GDP in the third quarter of 2008, according to the International Monetary Fund (IMF).
However, the government adopted strong policy measures in response to the impact of the global crisis. Near-term fiscal targets for expenditure and deficit were relaxed in the 2009–2010 budget, even though an increase in some excises and a temporary 1% rise in the value added tax (VAT) rate—programmed to be reversed at the end of 2010—acted as a partial offset. In the event, the authorities reduced the VAT rate by half a percentage point to 16% from the end of December 2009, bringing forward by one year a half of the cut that had been planned for the end of 2010.
Meanwhile, as inflationary prices subsided, the Bank of Israel rapidly reduced policy rates, from 4.25% in February 2008 to 0.5% in April 2009. The central bank adopted unconventional monetary measures, intervening in the foreign exchange market and purchasing long-dated government bonds. It also launched initiatives to support the financial sector, setting up public–private bond funds and offering guarantees for banks’ capital raising.
In May 2010, Israel was admitted to the Organisation for Economic Co-operation and Development (OECD), membership of which should bring various economic advantages, including: lower borrowing costs on international markets; potentially attracting increasing flows of foreign direct investment and short-term investment; and encouraging more reforms in the economic and commercial environment.
According to a British Foreign Office report, the West Bank experienced a limited revival of economic activity in 2009, but overall standard of living measures remain worse than prior to the start of the second intifada in 2000. The almost decade-long downturn has been largely a result of Israeli closure policies, which have disrupted labor flows, manufacturing, and trade.
The report added that high population density, limited land and sea access, and strict internal and external security controls have kept economic conditions in the Gaza Strip even more degraded than in the West Bank. There are many shortages of goods, due to the severe restrictions imposed by Israel at its border crossings into Gaza. Some goods are smuggled through the tunnel trade under Gaza’s border with Egypt.
Economic Performance over 12 Months
Israel weathered the global economic downturn relatively well. Its economy expanded by 0.7% in 2009, when many more advanced economies suffered significant contractions. While the economy shrank by 1.5% in the first half of the year, there was 3.3% growth in the second half. Economic growth resumed in the second quarter of 2009, partly in response to the fiscal and monetary boost given to the economy. Moreover, in April 2010 the IMF said that Israel was one of the economies recovering fastest from the global recession. The organization raised its growth forecast for 2010 to 3.7% from 3.5%, citing a boost in exports.
Furthermore, Israeli economic growth unexpectedly accelerated to an annualized 4.7% in the second quarter of 2010. Officials said in August 2010 that they expected the economy to expand by 3.7% overall in 2010. However, the Bank of Israel said that it anticipated that the fiscal crisis in some European countries would impact upon Israel’s economy, due to its potential effect on demand for the country’s exports, and the effect on Israel’s capital markets, which have close links with financial markets around the world.
The strength of the recovery is underlined by the fact that the central bank has tightened monetary policy far earlier than in other countries. In March 2010, the Bank of Israel raised the benchmark interest rate for the fourth time since August 2009, as inflation expectations increased and the economy expanded. In July, it increased rates by a further quarter point to 1.75%, citing a rapid increase in housing prices. In August 2010, the central bank forecasted that inflation would average around 2.6% over the next 12 months, at the high end of the government’s 1% to 3% target range.
The strength of the economy has had a positive effect on the government’s finances. In 2009, the fiscal deficit amounted to around 5% of GDP, much better than had been expected, while the public debt level reached around 80% of GDP for 2009, also better than budgeted.
Unemployment peaked at 7.9% in mid-2009, but declined to 7.3% by the end of the year. The IMF expects Israel’s unemployment rate to fall from 7.7% in 2009 to 7.4% in 2010, and to 7.1% in 2011. It predicts that the average unemployment rate in developed economies will be 8.4% in 2010 and 8% in 2011. It also predicts that Israel’s inflation rate will be 2.3% in 2010 and 2.6% in 2011. Israel’s inflation was 4.6% in 2008 and 3.3% in 2009.
The current account balance will widen to 3.9% of GDP in 2010 from 3.7% in 2009, the IMF said. The forecast for 2011 is 3.7%.
The IMF said that Israeli banks—characterized by robust balance sheets—remained relatively resilient during the global financial crisis, although nonbank financial institutions and the domestic corporate bond market were strained. The Bank of Israel report for 2009 said that Israel’s “conservative and closely supervised banking system,” and the absence of mortgage-backed assets in its capital markets, had cushioned it from the worst of the storm.
Support for Inward Investment and Imports
Invest in Israel, part of Israel’s Ministry of Industry, Trade, and Labor, promotes investment to foreign-based individuals and companies interested in direct investment or joint ventures. The Palestinian Investment Promotion Agency similarly offers help to those interested in investing in the West Bank and Gaza Strip.
Israel has several free trade agreements, including ones with the United States and the European Union. The corporate tax rate was reduced to 25% in 2010, with further reductions planned over the next few years. Sizable tax benefits are available for foreign investment, venture capital, and expenditure on research and development. In the Palestinian Territories, companies and businesses are taxed at a rate of 20%. Companies with annual revenues greater than US$12,000 pay 17% VAT. The Bank of Israel’s website has information on tax rates for inward investors.
GDP growth: 0.7% (official, 2009)
GDP per capita: US$28,400 (2009 est.)
CPI: 3.3% (official, 2009)
Key interest rate: 1.75% (August 2010)
Exchange rate versus US dollar: INS3.93 (2009)*
Unemployment: 7.3% (official, 2009)
FDI: US$60.68 billion (December 31, 2009 est.)
Current account deficit/surplus: US$7.2 billion (2009 est.)
Population: 7,353,985 (July 2010 est.)
* Israeli new shekel
Source: CIA World Factbook except where stated