MAIN ECONOMIC DEVELOPMENTS
Growth
The National Accounts data for the second quarter of 1998 indicate that the slowdown in
economic activity that began in the second quarter of 1996 has continued. Gross Domestic
Product expanded by 1.4 percent (annualized) in the first half of 1998 as against growth
rates of 2.2 percent in 1997 and 4.6 percent in 1996.
The slowdown in GDP growth in the first half of the year was observed in most economic
indicators, e.g., a decrease in the level of investment (especially in housing
construction), a slowdown in the growth rate of private consumption; a slowdown in export
growth, especially in the aftermath of the Eastern Asia crisis; a continued slump in
incoming tourism, and a decrease in the growth rate of employment, resulting in sharply
higher rates of unemployment. In contrast, imports rose by 4.4 percent.
The slowdown in activity is the result of endogenous processes, economic policies, and
exogenous processes, including:
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the diminishing expansionary influence of the mass immigration that Israel has
experienced since the beginning of the decade;
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the "natural" changeover of business cycle to a downturn phase;
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application of monetary restraint (especially in the first seven months of the year,
when real interest rates climbed to an average of 7.5 percent);
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security events and political developments, mainly with respect to the incoming tourism
slump that has persisted since the second quarter of 1996;
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the crisis in Eastern Asia, which has slowed economic activity in most countries,
including Israel.
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Sectors of the Economy
Following the downtrend in economic activity of the past two years, economic growth
continued to be sluggish in the first half of 1998.
Gross Domestic Product of the business sector (seasonally adjusted) expanded in the first
half of the year at an annual rate of 1.3 percent relative to the corresponding period in
1997, pursuant to a steep decline in the growth rate of business product, from 5.4 percent
in 1996 to 1.9 percent in 1997.
The precipitous real decrease of 4.8 percent in imports of capital goods in 1997-an
indicator that attests to some extent to the expectations of the business sector-halted in
the first half of 1998, as a real increase of 2.6 percent relative to the first half of
1997 was observed.
Industry
The Industrial Production Index climbed by 3 percent in the first six months of 1998
relative to the corresponding period in 1997, after an increase of 1.7 percent in 1997 all
told.
The restructuring of Israel's industrial production continued to have its effects in 1998.
Product of high-tech industries-such as electronics and chemicals-grew at an impressive
10-13 percent pace in the first five months of the year relative to the corresponding
period in 1997. Concurrently, however, product of labor-intensive industries increased
slightly and, in several cases, actually contracted.
High-tech continued to drive industrial exports by achieving impressive real growth rates
in the first eight months of the year relative to the corresponding period in 1997.
Examples are communications, control, and medical equipment (28 percent) and motors and
electrical equipment (39 percent). The exports of traditional industries have been growing
much less vigorously, and those of some industries have declined, e.g., food and
beverages, in which exports decreased by 11 percent in January-August 1998 relative to
January-August 1997.
Construction
Most indicators in the construction industry point to continued contraction of activity in
1998. The reasons for this, on both the supply side and the demand side, include:
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a decrease in the growth rate of households, from 60,000-65,000 new households per year
in the first half of the 1990s to 44,000 new households today;
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an accumulation of projects that were finished in the past two years, causing the
supply of housing and the inventory of unsold dwellings to expand;
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A protracted uptrend in mortgage interest rates, which peaked at 6.7 percent (in real
terms) in the first half of the year.
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Expectations of continued declines in housing prices.
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Release of land: In the first eight months of the year, the Ministry of Construction and
Housing and the Israel Lands Administration released enough land for the construction of
12,800 dwellings-19,400 in annualized terms-compared with 26,600 dwellings in 1997.
Construction starts: Countywide construction starts decreased steeply by 28 percent in
January-May 1998 relative to the corresponding period in 1997.
Construction completions: In contrast to the uptrend in 1997, residential completions
decreased by 14 percent in the first five months of 1998 relative to the first five months
of 1997. The reasons for this include a protracted downturn in construction starts in
previous periods and an increase in construction time.
Housing demand: Data for the first half of 1998 point to a 17 percent decrease in housing
transactions relative to the corresponding period in 1997. However, real housing prices
were stable because of the decrease in supply.
With respect to government housing loans, uptake of loans decreased by 16 percent in the
first half of the year, mainly because fewer immigrants exercised their entitlement to
these loans (reflecting the diminishing uptake potential of immigrants), mortgage interest
was rising, and potential purchasers expected an upward adjustment in government housing
loans and a continued decline in housing prices.
Tourism
Incoming tourism by air decreased by 7 percent in the first seven months of 1998 relative
to the corresponding period in 1997. This sharp downturn was occasioned by the Gulf crisis
in February-March 1998, after which, in April-July, incoming tourism climbed back to the
level observed in the corresponding months in 1997 (which was also low).
In contrast to the steep decrease in incoming tourism, domestic tourism (expressed in
person-nights of Israelis in hotels) expanded by 14 percent in the first seven months 1998
relative to the corresponding months in 1997. Since this increase offset the decline in
overseas tourist person-nights, total person-nights hardly changed. The increase in
Israeli person-nights was prompted mainly by falling hospitality prices in response to the
decline in overseas tourists' person-nights.
Private Consumption
Private consumption rose by 2.2 percent in the first half of 1998 relative to the
corresponding period in 1997. Consequently, per-capita private consumption did not
change-an especially salient development in comparison with 1997, in which private
consumption climbed by 4 percent (signifying a 1.5 percent increase in per-capita
consumption). Several factors explain the slowdown, including the tough monetary
constraint applied in the first seven months of the year, a continued decline in the
effects of the mass immigration that Israel experienced in the first half of the decade,
and factors connected with the cyclicality of economic activity.
Consumption of durables did not increase in a first six months of 1998 relative to the
corresponding period in 1997. It is worth bearing in mind that this indicator climbed at a
rapid annual pace of 13.3 percent in 1990-1996, reflecting the recent immigrants' need to
equip themselves with durables. This effect has long since petered out.
Investment
The National Accounts data for the first half of 1998 indicate that investment is
continuing to decline. Investments in fixed assets decreased by 3 percent in 1997 and
slipped again by 6 percent in the first half of1998 relative to the first half of 1997.
The decline originates in a precipitous 8 percent decrease in residential investment in
the first half of 1998 relative to the corresponding half in 1997, coupled with a 5
percent decrease in nonresidential investment. Both indicators reflect a natural process
of adjustment of the high level of investment in recent years to the current level of
demand.
Notably, even though nonresidential investment have been declining for the past two years,
capital stock per person employed continued to rise at an annual rate of 7 percent. This
is because investments attained a level nearly three times higher than at the beginning of
the 1990s. Consequently, in contrast to the beginning of the decade, capital stock per
person employed is not a limitation in increasing the economy's output.
Employment
The slowdown in economic activity has caused the unemployment rate to rise. The data from
the Central Bureau of Statistics Manpower Survey for the second quarter of 1998 indicate
that unemployment rose steeply. The number of unemployed, seasonally adjusted, climbed to
213,000 in the second quarter-9.4 percent of the civilian labor force-and increased by
24.8 percent in the first half of 1998 relative to the first half of 1997. This occurred
because the civilian labor force expanded by 2.8 percent while employment increased by
only 1.16 percent.
Data from the Government Employment Service show that the number of jobseekers rose from
an average of 143,000 in the first half of 1997 to 158,700 in July 1998-a 16 percent
increase.
The groups affected most severely are unskilled workers, the poorly schooled, and those
who live in peripheral areas and work in traditional industries. These industries are
downscaling their activities because their competitiveness-in both the domestic and the
export markets-has slipped, mainly due to the slump in domestic economic activity (which
depresses domestic demand), high Shekel interest rates, and the high minimum wage.
Data for the first half of 1998 point to a phenomenon that is typical in times of economic
downturn: a slowdown of employment growth in the business sector and stability in this
indicator in the public sector, which is less affected by the state of the economy. In the
first seven months of 1998, business-sector employment stagnated relative to the first
half of 1997 while public-sector employment increased.
It is business-sector growth, of course, that will pull the economy out of its trough.
Expansion of the public sector not only fails to help the economy recover but impedes this
recovery by drawing on resources that the business sector needs.
Wages
The national average wage rose by 3.7 percent in real terms in the first half of 1998-4.9
percent in the business sector and 1.1 percent in the public sector-relative to the first
half of 1997. Notably, the sharp increase in the business sector follows a real increase
of 3.6 percent in 1997.
The aberrant real growth of business-sector wages in the past two years traces mainly to
the following factors:
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Misalignment between the inflation expectations on the basis of which wage accords were
concluded and the decline in the rate of inflation.
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An amendment to the Minimum Wage Law, implemented in April 1997, that raised the
minimum wage by 5.3 percent in real terms relative to the level originally stipulated in
the law.
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The growth in unemployment, which, by affecting those at low wage levels more severely
than others, pushed the national average wage upward for technical reasons.
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Rising demand for, and shortage of supply of, trained personnel in technological
industries-both of which generated upward pressure on wages in these industries.
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The restructuring of production has reduced the share of labor-intensive industries (in
which wage levels are low) and raised that of knowledge-intensive industries (which pay
high wages). Here, too, the resulting increase in the national average wage is only
technical.
The public employers and the Histadrut concluded a new wage accord in September 1998, most
of the old agreements having expired in the second half of 1997. The new agreement gave
public-sector employees a wage increase of 1.56 percent for each month in 1998. It was
agreed that this increase would be paid as a nonrecurrent grant in the September paycheck
and that new negotiations would be held with respect to 1999.
Balance of Payments and Foreign Trade
The deficit on balance-of-payments current account fell to $536 million in the first
quarter of 1998 as against $885 million in the corresponding period in 1997. The decrease
was prompted by a $415 million decline in the trade deficit and $66 million in total
unilateral transfers. Within the trade-deficit decline, expenditure for imports of goods
(not including ships, aircraft, and diamonds) decreased slightly by 1.2 percent, as
imports of consumer goods and capital goods increased and imports of raw materials
slipped, and income from exports of goods (not including diamonds) rose by 9.3
percent-mainly due to high-tech exports. Several factors contributed to the improvement in
Israel's trade balance: the slowdown in domestic demand, an improvement in terms of trade,
and the expansion of world trade.
In response to the Eastern Asia crisis, a redirection of exports of goods to the West
became visible in the second half of 1998. Income from nondiamond exports to European
Union and North American countries rose by 13 percent during this period relative to the
corresponding period in 1997, and income from nondiamond exports to Southeast Asia
declined by the same percentage.
Net short-term capital imports rose by $126 million in the first quarter of 1998 as
against $3.4 billion in the corresponding quarter in 1997. The main reason for the decline
is a steep decrease in foreign-currency credit taken by the private sector, in response to
sheqel depreciation and greater uncertainty in the foreign-currency market.
The May 1998 foreign-currency liberalization lifted restrictions on foreign-currency
transactions with nonresidents except for a small list of prohibitions and matters in
which compulsory reporting is in effect. Notably, the liberalization did not change the
direction of the capital flows.
Monetary Policy
A combination of rapid disinflation and less-than-complete adjustment of nominal interest
rates raised the real interest rate on central-bank sources to an average of 7.5 percent
in the first seven months of 1998 as against 5 percent on average (itself a high rate) in
1997.
In August 1998, after the monetary lending rate was lowered by 1.8 percentage points and
accelerated currency depreciation elevated inflation expectations, the real interest rate
fell to 4.5 percent.
In 1998, as in 1997, the Bank of Israel managed interest rates mainly by auctioning time
deposits to the banks. In the first half of the year, the balance on deposit in this
rubric rose by NIS 6 billion to NIS 36 billion (of which, about NIS 3 billion was on
account of interest paid on the deposits), as against an NIS 20 billion increase in the
corresponding period in 1997. The steep decline in the growth rate of these deposits
reflects, in the main, the fact that the Bank of Israel did not need to buy foreign
currency.
Money supply (the M1 aggregate) expanded by 11 percent in the first eight months of the
year and by 10.3 percent over the past twelve months (August 1997-August 1998).
Budget Deficit
According to the Government's multi-annual deficit target, as enshrined in an amendment to
the Deficit Reduction Law (1997), the total deficit-not including net allocation of
credit-will be 2.4 percent of GDP in 1998, 2.0 percent in 1999, and 1.5 percent in 2001.
In 1997, the Government met the total-deficit target of 2.8 percent of GDP by holding its
deficit to 2.78 percent-3.14 percent in domestic activity and -0.36 percent (a surplus) in
activity overseas. In domestic activity, both expenditure and revenue were underperformed.
On the basis of developments in the first eight months of 1998, the Government is expected
again to meet its deficit target, set this time at 2.4 percent of GDP. The total deficit
in January-August (not including net allocation of credit) was NIS 7.7 billion-NIS 4.8
billion in domestic activity and NIS 2.9 billion on account of activity abroad. Notably,
the overseas deficit is expected to contract substantially by the end of the year as
seasonal payments from abroad arrive.
Inflation
The steep deceleration of price increases in late 1997 brought the inflation rate for that
year to the bottom of the inflation target (7 percent). The downtrend continued in the
first eight months of 1998, as the annual inflation rate (each month vs. the corresponding
month one year previous) came to 3.2 percent in August and the Consumer Price Index rose
by 2.6 percent in the first eight months of the year.
The precipitous disinflation that began in the second half of 1997 was occasioned mainly
by the downturn in domestic demand, tough monetary restraint (manifested in an increase in
real interest rates), recession in the construction industry, fiscal restraint, and
falling import prices.
All components of the Consumer Price Index participated in the disinflation, their prices
rising at rates approximating those of the CPI as a whole. This uniformity supports the
hypothesis that the inflation environment has indeed ebbed.
Housing prices, which account for about one-fourth of the CPI and have contributed much to
its rise in the past two years, increased in January-August 1998 at a rate similar to that
of the total CPI. This stabilization of real housing prices is attributable to concurrent
decreases in both demand and supply.
Exchange Rates
In 1998, after several years of real currency appreciation, the sheqel exchange rate
depreciated in real terms (relative to the Consumer Price Index) against the dollar and
the five-currency "basket"-by 2.3 percent and 1.5 percent, respectively, in
January-August.
With the exception of a few days early in the year, the Bank of Israel did not intervene
in foreign-currency trading, in a departure from 1997, in which the central bank purchased
$7 billion from the public to allay appreciation pressure and defend the lower limit of
the diagonal band.
In April, expectations of the implementation of a foreign-currency liberalization that
would make the sheqel into a convertible currency created lively demand for
foreign-currency. The demand was met by market forces-with no central-bank intervention in
trading-and the dollar and the "basket" gained about 5 percent against the
sheqel. After the liberalization plan was declared, the turbulence in the foreign-currency
market ebbed and the exchange rates appreciated by about 1.5 percent.
In early August, as the inflation environment declined and converged toward that of
Israel's trading partners, it became possible to reduce the slope of the lower limit of
the diagonal band from 4 percent to 2 percent-coupled with a 1.5 percentage point
reduction in interest on central-bank sources.
In late August and early September, the dollar exchange rate depreciated by a steep 3
percent in response to economic crises in emerging economies generally and in Russia
specifically. In response, nonresidents created a capital outflow as they reduced their
investments in emerging markets.
Several factors contributed to the creation of conditions for real currency depreciation
in 1998, including a cumulative 4 percentage-point decrease in monetary lending rates by
August, which made foreign-currency credit riskier; the foreign-currency liberalization,
which exposed the economy to almost unrestricted capital flows and, for this reason, made
foreign-currency investments riskier; and the low inflation environment, which helped
preserve the real effect of the depreciation.
