OVERVIEW

As in other developed countries, services make up the largest portion of the business sector product (40%), while industry accounts for another 30%, transport and communications make up 13%, construction 9.4% and water and electricity 4%. Agriculture, the mainstay of most developing economies, contributes the remaining 5% (these figures from 1994).

Israel's population of over 5.5 million is productive and prosperous as witnessed by 1995's per capita GDP of over $15,500. This level compares favorably with those of New Zealand, Spain and Ireland, and is far greater than that of Portugal and Greece.

Table 1: Main Economic Indicators

(Annual % Change)

1995 continued the trend set in 1994, a return to the growth rates of 1990-92, after a slight slowdown in growth rates in 1993. The economy grew alongside a moderate increase in the population and a steep rise in capital stock, in contrast to Previous years, when growth stemmed from a steep population rise.

Expenditure on private consumption grew in 1995 by 7.1%, which was the equivalent to a 4.4% per capita increase.

As a consequence of the inflationary pressures that have built up since late 1993, starting in November 1993, the Bank of Israel raised the rate of interest through the discount window, from 9% in October 1993 to 17.5% in December 1994. However, interest rates have gone back down, since then, to a level of 13%.

STRUCTURAL REFORM

Among some of the more important reforms:

The overall tax burden, which in 1995 stood at 40% of GDP (down from a peak of 45% of GDP in 1986) is lower than in the Scandinavian countries, where it is over 50% and stands at a level just below that of France and Germany where it is 42%.

As part of the 1994 and 1995 budgets the personal income tax system has been reformed. The absorption levy as well as the additional personal credit were cancelled, the initial rate of tax stands at 15% and the highest rate at 50%. The goal of the reform is to simplify the tax system and reduce the unfair tax burden on the middle class.

Over the course of 1994 the government introduced cuts in purchase tax on a variety of consumer electrical goods.

The country's export industries benefit from a more predictable and competitive environment under the new exchange mechanism. Previously, the shekel's periodic overvaluation hurt exports by decreasing Israel's international competitiveness. Furthermore, in the past, uncertainty regarding the timing and size of devaluations probably deterred foreign buyers of Israeli exports and caused fluctuations of foreign exchange reserves.

In September 1993, as part of Israel's declared policy of attaining full currency convertibility, Israel accepted the obligations of Article VIII of the IMF, that require acceding states not to impose currency controls on current account transaction. In an another important step towards full shekel convertibility, the Bank of Israel authorized banks in July 1994 to operate continuous bilateral currency trading at variable rates.

Furthermore, in August 1994, the Ministry of Finance and the Bank of Israel announced additional exchange control liberalization measures. Israeli companies will face no limitations on their direct investments abroad. Besides mutual funds which can invest up to 50% of their capital abroad (in the case of funds specializing in foreign markets), now provident and pension funds will be allowed to invest up to 2% of their total assets abroad. In addition, foreign companies will be allowed to issue securities on the Tel Aviv Stock Exchange and will be able to convert all sums raised into foreign currency.

The New Israeli shekel is for all business purposes convertible. All remaining foreign currency restrictions pertain to the movement of capital flows and not to trade in goods and services.

The five central recommendations adopted by the government were:

The government has already issued tenders for the purchase of the controlling interests in Bank Leumi and Bank Hapoalim.

The government has adopted a reform package for the pension funds, in order to open this Previously highly controlled field up to competition. The government realized that the continuation of the existing situation - where the pension funds received earmarked non tradable government bonds at preferred interest rates and at the same time the funds ran actuarial deficits - could not continue. Moreover, this situation implied that the government's future obligation to pensioners could reach up to tens of billions of dollars. The solution adopted involved offering new and existing funds earmarked bonds at lower rates. These bonds would cover only 70% of the funds for new members. The goal of this arrangement is to control the rising obligations of the government, while encouraging pension funds to be more active in the domestic capital markets. This will allow the funds to attain even higher returns through careful and thoughtful investment. Moreover, the capital markets will benefit as it will have access to greater sources of long term investment.

The present government has affirmed its commitment to privatization by reappointing a privatization committee consisting of the Prime Minister, the Finance Minister and the Justice Minister. The committee has the power to privatize state-owned enterprises without the consent of the minister responsible for the company. This step is significant since, historically, ministerial opposition to losing control of state-owned enterprises significantly inhibited the privatization process. Furthermore, the Knesset has enacted legislation, which have enhanced the powers of the body responsible for privatization (the Government Companies Authority).

Despite the initial slow pace, Israel is committed to the privatization of government enterprises. By mid 1995 the government disposed of its equity in 64 enterprises, subsidiaries and mixed ownership firms. Since 1986 the government had $3.4 billion through the sale of equity and debentures, while since 1994 alone over $740 million has been raised.

In 1994-95 the Government completed the privatization of the Shekem Department store as well as Malam Systems; shareholders of Fertilizers & Chemicals Ltd. were offered stock and convertible securities; Ormat Ltd. exercised its option to acquire control of Beit Shemesh Engines; a controlling stake in Bank Mizrahi was sold. In early 1995 the Government completed the sale of Housing & Development, as well as the sale of its controlling interest in Israel Chemicals. Great progress was also made in preparing various companies for privatization in 1995 including the issuing of tenders for Israel Chemicals and Bank Hapoalim; as well as making the necessary structural reforms that are needed to sell of shares in Bezeq and El Al.

In February of 1995, the Minister of Finance and the Ministerial Economics Committee endorsed the recommendations of a committee that proposed the mass distribution to the public of warrants that may be converted into shares in state owned corporations and banks. The plan aims to provide the government with the additional tools to speed up the privatization process. The government is in the process of preparing special draft legislation in order to make the warrants plan possible.

In 1993, the government eliminated the 2% import levy and the exchange-rate insurance for exporters (which also stood at 2%), as well as the levy on imported services.

Phase five of the program went into effect in September 1995, reducing tariffs on a lengthy list of products. The tariffs in effect since September 1 range from 10% to 30% on most products.

This policy in the short term has certain effects on the economy, in terms of increasing the trade deficit (the trade deficit jumped from $3.5 billion in 1990 to over $7.5 billion in 1994), pressures on currency reserves and its impact on employment. Nevertheless, it is an important element in Israel's structural reforms.

In addition, in April 1994 Israel participated in the signing of the Uruguay Round of GATT agreements, in which Israel made wide ranging commitments in a large number of fields. After Israel ratified the agreements it joined the World Trade Organization as a founding member in April 1995.

EMPLOYMENT

The current immigration wave is further contributing to the high quality of the work force, with 70% of the immigrants being professionals, scientists, engineers, and technical staff. This work force provides a sound basis for large scale economic growth and competitiveness.

The wave of immigrants since 1989 led to an even faster growth in the Israeli labor market, due to the composition of the immigrants (more people of working age and a higher participation rate for women). The immigrant participation rate in the labor force stood at 56% at the end of 1995, as compared to 53.9% for working age population as a whole. This affected Israel's unemployment rate, which peaked at 11.2% in 1992, but has since fallen to a level of 6%.

Since 1988 more than 250,000 new jobs have been created, an increase of more than 15% in the number of employed persons. Israel's labor force totalled 1,857,800 in 1992 and at the end of 1995 this figure had risen to 2.1 million.

Table 2: Population & Labor Force (%)

In 1995 unemployment fell to 6%, at the end of the year. Moreover, the level of unemployment among new immigrants dropped from 28.6% in 1992 to 12% at the end of 1994. There is a positive correlation between the length of time an immigrant is in the country and the rate of immigrant employment. Therefore, whereas immigrant unemployment among those who arrived in 1994 stood at 33%, the level of unemployment among those who arrived in 1991 is 9%. The new immigrants have been absorbed into the labor force through market mechanisms. In the first half unemployment continued to fall despite the continued strong growth of the labor force.

FOREIGN TRADE

In 1995, as in 1992, 1993 and 1994, there were great increases in Israeli exports of goods, which grew to $17.9 billion, an increase of 11% over 1994; while imports of goods grew by 20% over 1994 to $28 billion. Consequently, Israel's trade deficit grew by 39% to $10.2 billion. This is due to Israel's continued strong economic growth, increasing private consumption and the strong value of the shekel.

The US and the European Union account for over 62% of all Israel's exports. Israel has free trade agreements with these two blocs, as it does with the EFTA countries. The US in 1993 was the destination of 33% of all exports, slightly up on the level for 1993; while the European Union purchased 29.8% of Israel's exports, down from 34.5% in 1992. Export growth in the 1994 was made up predominantly of increased exports to the US (34%), new markets, mainly in Asia (35%) and the European Union (21%). These new markets were responsible for 59% of the increase in exports in 1992.

Export growth has played a significant part in Israel's economic growth and signifies the growing competitiveness of the economy.

Israel is primarily an exporter of manufactured goods. In 1994, 93% of all gross exports were industrial. As in 1992 and 1993, Israel demonstrated its ability to achieve export oriented growth, by developing and adapting to changing international conditions. The main economic branches that experienced significant export growth were machinery and electronics (14%) and chemicals (11%). Smaller branches that grew significantly were rubber and plastics (17%) and mining and quarrying 16%. Exports of diamonds grew from $3 billion in 1993 to $3.6 billion in 1994 (an increase of 18%). Israeli exports of agricultural products remained at a similar level to 1993, of $581 million, albeit after successive decreases of 2% and 14% in 1991 and 1992 respectively.

Parallel to expanding exports, Israel's imports have grown due to increased private consumption, a consequence of the influx of immigrants and of the government's trade liberalization policy.

The country's primary import sources are: the European Union 51% up from 49% in 1993; the US, 18%; and EFTA, 9%. In 1994, the increase in imports was mainly from the European Union (66%); 20% from the United States; and 14% due Asia and Eastern Europe.

Imports were predominantly made up of production inputs, which comprised 68% of imports, while the remainder was made up of investment goods (19%) and consumer products (13%). Production inputs (excluding diamonds and fuel) came to $10.4 billion, an increase of 15% over 1993. Investment goods imports totalled $4.5 million, 26% up on 1993 (1993 saw a 12% increase over 1992). Within the consumer products category, the greatest growth was in the import of non-durable food which grew by 27%.

Table 3: Israel's Foreign Trade

(Million Dollars)

THE BALANCE OF PAYMENTS

Since 1994 Israel's balance of payment position has been worsening. This is largely due to the growing trade deficit which has resulted from economic growth and the rapid increase in consumption. The balance of payment deficit in 1995 was $4.2 billion and is expected to moderate in 1996.

Table 4: Balance of Payments

(Billion Dollars)

The nature of Israel's long-term foreign debts and their repayment schedules enables it to maintain foreign exchange reserves at an operational level. At the end of 1995, Israel's foreign currency reserves, as held by the Bank of Israel, stood at $8.2 billion, compared to $6.8 billion at the end of 1994, which is equivalent to more than three months worth of imports. In 1995 Israel's foreign reserves have reached over $8.5 billion due to large inflows of foreign capital, in part due the relatively high rates of interest in the country.

In 1994 Israel for the first time received an international rating from the major credit rating agencies. Israel rating was BBB+. Last november this rating was improved to A-.

Graph 1 : GDP & Business Sector Growth

1990 to 1994

Graph 2 : Exports by Destination

Graph 3 : Labour Force - Growth and Unemployment