Israel Finance Ministry, Yearly Pension Plan Report

THE ECONOMY

Overview

Israel's economy is industrialized and diversified. Gross domestic product ("GDP") per capita in 1998 was $16,400. From 1990 to 1998, GDP growth has averaged 5% per year, with the highest growth, 6% per annum, occurring during the 1990 to 1995 period. Growth was based largely on increased domestic demand (due to the large volume of new immigrants) and the growth of high value-added industries such as electronics and high-tech medical equipment. The GDP growth rate in 1998 slowed to 2% as a result of cyclical factors, a decrease in the number of immigrants, the global financial crisis, restrictive monetary and fiscal policies, and other factors.

The composition of Israel's trade sector reflects the industrialized nature of its economy. Exports consist primarily of manufactured goods, while raw materials and investment goods comprise approximately 85% of goods imports. Exports have played a significant role in Israel's economic growth. In 1998, Israel's exports of industrialized goods (excluding diamonds) increased by 10% and total exports of goods and services increased by 6%. Notwithstanding the steady growth in Israel's exports, Israel continues to experience deficits in its balance of civilian trade, although they have been decreasing in size since 1997. See "Balance of Payments and Foreign Trade-Foreign Trade."

Historically, the Government has had a substantial involvement in nearly all sectors of the Israeli economy. In the past decade, however, a central aim of the Government's economic policy has been to reduce its role in the economy and to promote private sector growth. In order to advance these goals, the Government has pursued a policy of privatizing State-owned enterprises, including banks. See "Role of the State in the Economy." The Government has also pursued stability-oriented monetary and fiscal policies. These policies build upon the economic stabilization program established by the Government in 1985 (the "Economic Stabilization Program").

The Economic Stabilization Program was a comprehensive plan designed mainly to reduce the high rates of inflation and the chronic balance of trade deficits experienced by Israel as a result of high levels of defense expenditures, rising Government spending and rising oil prices. The principal elements of the Economic Stabilization Program were: (i) a devaluation and subsequent stabilization of the Israeli currency, (ii) a reduction in the deficit through a reduction in Government subsidies and other expenditures, (iii) a tax surcharge, (iv)the restriction of wage increases, and (v)
following an initial increase, a temporary freeze in prices of most goods and services followed by price controls.

Since the adoption of the Economic Stabilization Program, Israel has made significant progress in stabilizing inflation through effective implementation of monetary policy by the Bank of Israel, and fiscal restraint and trade liberalization by the Government. During the period 1986 through 1991 inflation stabilized to an annual average rate of 18.1%. From 1992 to 1996 the annual rate decreased to an average of 10.8%. In 1997, the inflation rate decreased to 7.0%. The inflation rate in the 12 months ending in July 1998 was 3%. From August to October 1998, following Russia's announcement of default, the NIS has depreciated by 19% vis-a-vis the basket of currencies. Consequently, inflation rose by 5.8% within three months. 1998 ended with an inflation rate of 8.6% at the midpoint of the Government's target range of 7-10% for the year.

Table No. 4

Main Economic Indicators
(in millions of NIS unless noted)

	Year
	1994	1995	1996	1997	1998
Percent Change:
Real gross domestic product	6.9%	6.8%	4.7%	2.7%	2.0%
GDP per capita.	4.2%	4.0%	2.1%	0.1%	-0.4%
Inflation
(% change in CPI)	14.5%	8.1%	10.6%	7.0%	8.6%
Industrial production	7.5%	8.4%	5.4%	1.7%	2.8%

Constant 1995 Prices:
GDP	244,077	261,582	273,936	281,219	286,740
Business sector product	159,568	174,272	184,007	188,727	192,193

Permanent average population
(thousands)	5,399	5,545	5,685	5,829	5,969

Current Prices:
GDP	222,617	261,582	304,731	340,717	372,038
GNP	221,509	257,273	298,171	331,898	362,855
Business sector product	150,663	174,272	202,437	226,667	248,222

__________________

Source: Central Bureau of Statistics.

GDP equals GNP minus income of Israeli residents from investments abroad, earnings of Israeli residents working abroad, and other income from work and leases abroad, less corresponding payments made abroad (after deduction of payments to foreign companies with respect to production facilities located in Israel). Business sector product in Israel equalsGDP less general Government services, services of private non-profit institutions, and housing services (representing the imputed value of the use of owner-occupied residential property).

Gross Domestic Product

From 1990 through 1995, Israel's aggregate real GDP grew by 41.7%, which reflects an annual real growth of 6.0%. GDP growth in 1996-1998 slowed to an annual rate of 3%. The lower rates of GDP growth are attributed to cyclical factors, a decrease in the number of immigrants, a drop in growth of world trade volume, restrictive monetary and fiscal policies, and other factors. The GDP per capita declined 0.4% in 1998.

The most notable changes in the economy's use of domestic resources in 1990-1995 were the rise in private consumption, reductions in the level of defense expenditures as a percentage of GDP, an increase in investments in fixed assets and, since 1992, a significant increase in exports.

In 1998, total private consumption increased by 3.3% and per capita private consumption increased by 0.9%, a decline from the average annual growth during 1990 through 1997. During that period, private consumption had increased as a result of the purchase of durable goods by immigrants and others, increased wages and expected future wages, and the rapid decline in unemployment. The slower growth in consumption in 1998 was due to a decline in the number of immigrant arrivals, an increase in the unemployment rate, and higher interest rates.

Israel's gross national savings rate as a percentage of GDP has increased from 17.4% in 1997 to 18% in 1998, primarily as a result of the increase in private savings, while public saving did not change.

Domestic defense expenditures as a percentage of GDP declined from 10.3% in 1990 to 7.3% in 1998. These levels of defense expenditures as a percentage of GDP represent a significant decrease from the 12.2% level prevailing in 1986.

In 1998, total gross domestic investment decreased by 7.6% in real terms, following a 6.1% decrease in 1997, and an average annual increase of 14.3% during the 1990-1996 period. Investment in fixed assets decreased by 3.3% in 1998 after decreasing by 2.3% in 1997. Investment in residential construction in 1998 decreased by 7.2% over the prior year, and had a significant impact on the slow economic growth for the year. Gross domestic fixed capital stock per employee in the business sector, which is stock of production equipment, machinery, and commercial buildings, rose by approximately 5-7% each year from 1995 to 1998.

Table No. 5

Resources and Use of Resources
(in millions of NIS at constant 1995 prices)

	Year
	1994	1995	1996	1997	1998
Resources
GDP	244,077	261,582	273,936	281,219	286,740
Imports of goods and services⁽¹⁾	116,192	124,588	134,723	138,451	141,309
Total	360,269	386,170	408,659	419,670	428,049
Use of Resources
Private consumption	150,449	161,217	169,311	176,274	182,033
Public consumption	76,961	77,199	81,617	83,149	85,076
Gross domestic investment	58,741	66,159	70,589	66,309	61,239
Exports of goods and services⁽¹⁾	75,401	81,595	87,142	93,792	99,373
Total⁽²⁾	361,552	386,181	408,659	419,524	427,721

____________________

(1) Imports (c.i.f.), exports (f.o.b.), excluding factor payments and Government interest from or to the rest of the world.

Source: Central Bureau of Statistics.

Business Sector Product

From the beginning of 1990 through the end of 1995, business sector product grew at an average annual rate of 7.2% in real terms. Business sector product growth has since declined to an average of 3.1% in 1996 through 1998.
In 1998, the economic slowdown was reflected in a decrease in gross domestic investment in absolute terms, although capital stock per employee was approximately 7% higher at the beginning of 1998 than it had been a year earlier. The growth in capital stock is attributable to increased investments from 1993 to 1996, which was encouraged by improved profitability in the preceding years and optimistic expectations of sustained high levels of economic growth for the coming years.
Table No. 6

Composition and Growth of the Business Sector Product

						Percentage of total
	Real Annual Sector Growth
	1994	1995	1996	1997	1998	1998
Trade and services	9.8%	9.7%	8.6%	3.5%	3.2%	49.5%
Manufacturing⁽¹⁾	7.4	8.4	5.4	1.7	2.8	23.4
Transport and communications	8.8	12.9	6.4	7.0	7.1	11.8
Construction	8.7	11.6	11.7	(1.7)	(4.2)	10.4
Agriculture.	1.8	14.6	11.3	(0.8)	3.7	2.8
Water and electricity	8.2	6.6	5.5	5.8	7.7	2.1
Total business sector	8.4%	10.1%	7.7%	2.8%	3.1%	100.0%

____________________

Excluding diamonds

Source: Bank of Israel.

Trade and Services. The trade and services sector consists of retail and wholesale sales, professional services, banking, hotels, and other services. In 1998, the trade and services sector's rate of real growth of 3.2% was similar to that of the total business sector. Furthermore, the sector's share of total business sector product, approximately 50%, is similar to the share of the trade and services sector in the total business sub-product in other developed economies.

Manufacturing. During 1998, gross capital stock in the manufacturing sector increased by 6.9%, labor inputs decreased by 1.6% and total manufacturing productivity increased by 1.4%, following a 0.3% decrease a year earlier. The main area of growth in the manufacturing sector has been in export products. Exports of high value added industries, such as electronics, software and high-technology medical equipment, have expanded and offset a post-1990 decline in the export of military equipment. Five industries accounted for approximately 51% of total industrial exports (excluding diamonds) in 1998: electronic equipment; communication equipment; electric motors; transport equipment; and machinery & equipment. Real growth of industrial exports, excluding diamonds, totaled 10% in 1998.

Table No. 7

Manufacturing Production by Category

	Annual Real Percentage Change					Percentage of Total
	1994	1995	1996	1997	1998	1998
Food, beverages, and tobacco	6.3%	8.9%	0.1%	3.0%	1.0%	15.1%
Mining of minerals and quarrying of stone and sand	2.8	10.3	7.8	(2.6)	3.2	3.4
Textiles and clothing	10.2	4.4	(5.6)	(3.9)	1.8	6.0
Leather and leather products	9.2	(2.0)	(9.0)	(13.6)	(15.8)	0.5
Wood and wood products	12.9	5.9	3.8	(0.5)	(8.9)	4.4
Paper and paper products	4.5	1.9	0.7	(1.3)	1.7	2.4
Publishing and printing	3.2	3.8	3.6	(0.1)	3.5	6.6
Chemicals products and refined petroleum	10.5	3.4	9.5	1.4	12.8	13.5
Rubber and plastic products	11.9	16.8	5.9	(1.1)	2.7	7.0
Non-metallic mineral products	6.8	24.1	10.0	(9.2)	(13.0)	4.1
Basic metal	14.2	19.6	5.9	1.4	(6.4)	2.6
Metal products	9.9	12.1	5.2	5.2	(0.7)	1.3
Machinery and equipment	9.4	1.5	3.6	(8.8)	(1.2)	4.5
Electric motors	(1.0)	8.1	(2.3)	(1.0)	10.4	3.1
Electronic components	7.8	9.2	7.1	5.5	3.9	4.9
Communication equipment	9.2	9.3	18.8	12.5	10.5	11.4
Transport equipment	(8.0)	0.6	6.6	5.8	5.5	7.1
Jewelry and goldsmiths	9.3	1.3	18.9	(1.5)	(7.2)	1.1
Others	13.4	31.6	(3.2)	(8.5)	(2.2)	1.0
Total excluding diamonds	7.4%	8.4%	5.4%	1.7%	2.8%	100.0%

____________________

Source: Bank of Israel.

Transport. Buses are the major form of public transportation. Bus routes exist in all cities in Israel and connect Israel's major cities, smaller towns, and rural areas. Israel also has a network of over 15,000 kilometers of roads, including highways that link Tel Aviv with Haifa, Jerusalem, and Beersheva. During the period from 1991 through 1998, the transport and communications sector product increased by an annual average of 8.1%. Government-owned railways run from Nahariya on the northern coastline to the Dead Sea in the south, linking some of Israel's major cities and the southern part of the country. In April 1996, the Government established a special State-owned company for the purpose of planning and promoting a mass transportation system in metropoliTel Aviv.

In 1997, the Government made initiatives to increase efficiency in the field of transportation. Following a tender, the first privatized bus lines went into operation in 1997. It is expected that further tenders for other bus lines will be announced. In January 1998, the Government decided to implement a reform in the procedure for obtaining taxi licenses, eliminating fixed quotas and gradually reducing license fees by 2007. As a result, the number of taxi licenses increased by more than 10% in 1998.

Since 1993, the Government has identified infrastructure improvement as one of its priorities. From 1993 through 1998, the Government spent NIS 15.3 billion (in 1998 prices) on infrastructure improvements. From the beginning of 1993 through the end of 1997, NIS 12.8 billion (in 1998 prices) were spent on road projects. Traditionally, the Government financed the entire cost of all Israeli highways, whereas the cost of local roads was financed jointly by the Government and local authorities. The Government has approved a number of road construction projects, including the Israeli North-South toll highway and the Carmel Tunnel, which, unlike existing highways, are expected to be privately funded. In January 1998, a company was selected for the construction of the North-South toll highway, which is expected to be completed in 2003.

Israel has three major seaports: Haifa and Ashdod on the Mediterranean coast and Eilat on the Red Sea. In 1998, 20.3 million tons of freight were unloaded and 13.5 million tons of freight were loaded at Israeli ports. The Government has approved in principle an expansion of either the Haifa or Ashdod port. Definitive plans for the improvement of either port will require further Government approval. The cost of any such proposed expansion is expected to be financed by the Ports and Railways Authority. In December1996, the Government decided to create a separate Railways Authority, and to create a State-owned company to develop and promote rail transportation. In addition, the Government is exploring various alternatives to involve the private sector in rail infrastructure and operation.

Israel has three international airports. The main airport is Ben Gurion Airport in Lod, which is located approximately 40 kilometers from Jerusalem and 20 kilometers from Tel Aviv. Ben Gurion Airport served approximately 7.6 million passengers in 1998, compared to 7.3 million in 1997, with flights to most major cities in Europe, Asia, and North America. Air traffic to Israel has increased by more than 90% since the beginning of the decade. Plans are underway to expand Ben Gurion Airport, in order to increase the annual capacity for passenger arrivals and departures to approximately 16 million. The financing for this expansion is expected to be derived exclusively from Airports Authority revenues and project financing.

Communications. As of September 30, 1998, 96% of Israeli households had at least one direct telephone line. In addition to the wire telephone network, Israel is served by three cellular telephone networks. More than 2.2 million cellular phones were in use in Israel in 1998. Since 1997, two consortia, in addition to the previous monopoly, have been operating international communications services. The Government decided on January3, 1997, to open the local telecommunications market to full competition in 1999.

Until 1990, the Public Broadcasting Authority had an official monopoly on television broadcasts. In 1990, a second, privately-run television station began to operate. In addition, in 1990 a number of private local radio stations began to serve certain urban areas. In 1990, the first licensed cable television stations went into operation in Israel and, as of December 1998, more than 90% of Israeli households had access to cable television. On January1, 1998, the Government decided to authorize another private television station and to issue a direct broadcast satellite (DBS) television operating license to one or two operators. The DBS license was granted in January 1999.

Construction. In 1998, investment in residential construction decreased by 7.2%, following a 4.5% decrease in 1997. The CPI adjusted price of owner-occupied apartments decreased by 0.7% in 1998, following a 1.4% decrease in 1997. From the end of 1993 through 1996, the demand for housing in the central regions of Israel increased substantially. This resulted in a sharp increase (12%) in the CPI-adjusted prices of owner-occupied apartments in 1994 and a further increase of 6% and 3% in 1995 and 1996, respectively. Residential construction investments rose by 11.5% in 1996, while non-residential construction investments were stable.

Agriculture. In 1998, the major categories of agricultural production were livestock (42% of total revenues), vegetables (21%), non-citrus fruits (15%), ornamental plants (8%), field products (7%), and citrus fruits (7%). In 1998, 2.3% of all Israeli employees were employed in agriculture. In 1998, 2% of total non-residential investments in capital formation were made in agriculture.

In 1998, agricultural exports totaled $825 million, representing only 4.9% of total merchandise exports (excluding ships, aircraft and diamonds).

The Government has implemented structural reforms in the agricultural sector, including the elimination of production quotas for the major categories of agricultural products, designed to increase competition and productivity in the sector. These reforms encouraged a large shift from manufacturing, marketing, and financing of agricultural products through large cooperatives, which were heavily subsidized by the Government, to a system in which decisions regarding these matters are made by individual production units, which receive fewer subsidies from the Government.

Water and Electricity. In 1998, the water and electricity sector grew by 7.7%. The scarcity of fresh water is a major problem in the Middle East, and Israel is conducting discussions with various parties in the region with respect to the allocation of water resources. The primary sources of fresh water in Israel are the Sea of Galilee, the mountain aquifer (a portion of which is under the West Bank) and the coastline aquifer along Israel's western border. Water from these sources is distributed by pipeline throughout Israel, including the arid areas in the south.

Approximately 60% of Israel's fresh water is supplied through Mekorot Water Co. Ltd. ("Mekorot"), a State-owned company. See "Role of the State in the Economy." The remaining 40% of Israel's fresh water is supplied by private water associations established by agricultural users, and by certain municipalities. From the beginning of 1992 through the end of 1998, Mekorot spent approximately NIS 2.5 billion on capital investments related to water.

Approximately 60% of Israel's total water use is attributable to agriculture. The Government subsidizes approximately 30% of the cost of water used by the agricultural sector. Because of the utilization of practically all of Israel's existing fresh water resources, further development of agriculture involves intensifying the yield from land already irrigated and intense reuse of treated wastewater to reduce the use of fresh water that is needed for household consumption. Accordingly, in recent years, there has been a reduction in the size of agricultural crops, such as cotton, that require large amounts of water. To address the relative shortage of water, Israeli companies have developed a number of sophisticated irrigation systems, including micro-drip systems that permit efficient irrigation.

Israel has also increased its investment in purification and improvement of wells and sewage treatment plants. The 1999 Government budget includes provisions for both grants and loans to stimulate capital investment in these programs. The Government has also taken steps to facilitate the establishment of regional companies to assume responsibility from Israel's municipalities for the treatment of water and sewage.

Almost all electric power in Israel is provided by the Israel Electric Corporation ("IEC"), a State-owned company that gevirtually all its own power. See "Role of the State in the Economy." In 1996, the Knesset approved the Electricity Industry Law. According to the law, separate licenses for each type of activity in the electricity industry (generation, distribution and transmission) replace a concession that had been given to IEC. The new law enables independent power producers to sell up to 20% of Israel's electricity to users through the existing transmission infrastructure of IEC. IEC has an exclusive license to distribute and transmit electricity through March2006. A public utility commission has been established to supervise electric utility services, including the regulation of prices of electricity.

Energy

Israel's main sources of energy are oil and coal. Israel is almost totally dependent on imported fuel for its energy requirements, since domestic production of crude petroleum and natural gas is negligible and Israel has no domestic production of coal. Most of Israel's foreign oil is purchased in the open market. Israel has two arrangements that secure its oil supply. Egypt has committed to sell Israel at least 2 million tons of oil each year (at market prices), through an arrangement established as part of the peace treaty between the two nations. In addition, the United States has agreed to supply Israel with oil pursuant to the Oil Supply Arrangement with the United States, in the event of a failure of Israel's oil supply.

Israel has succeeded in significantly reducing its dependence on oil for the production of electricity by switching to coal-fired power stations located along Israel's coastline, and by expanding a facility in Ashkelon. All of the coal used in Israel is imported. Israel purchases most of its coal from South Africa, the United States, Colombia and Australia, but it also purchases coal from other countries, including China. The shift to coal has not had a significant environmental impact in Israel, because the majority of coal used in Israel is low sulfur coal.

In 1997, the Government and IEC jointly decided to establish a natural gas infrastructure in Israel. As the first stage of this initiative, IEC is negotiating the purchase of natural gas to be used in IEC's power stations. The second stage will include the selection by Government tender of a company to establish and operate the natural gas infrastructure in Israel.

Israel continues to pursue alternative energy sources, such as solar energy. However, to date, the only widespread commercial use of solar power is for solar-powered water heaters, which provide less than 1% of all Israeli electric power requirements.

Table No. 8

Imports and Production of Crude Oil, Natural Gas, etc.
(in thousands of tons oil equivalent)

	Year
	1994	1995	1996	1997
Imports:
Crude Oil	12,700.2	13,413.6	12,307.8	14,081.1
Coal	3,815.8	4,416.3	4,543.0	5,063.0
Production:
Crude oil	3.5	7.3	4.5	4.7
Natural gas	19.4	19.4	12.3	13.0
Hydroelectricity, solar and other solid fuel	473.7	502.8	524.1	559.8

____________________

Note: 1998 figures not yet available.

Source: Central Bureau of Statistics.

Tourism

Tourism, particularly religious tourism, plays an important role in the Israeli economy. The major tourist centers are Jerusalem, other significant religious sites, the Eilat area, the Dead Sea and its environs, and the Mediterranean coast.

During 1992 through 1996, aided by the peace process, the number of tourist arrivals to Israel increased by an average annual rate of 25%. Following terrorist attacks in central Israel, the number of tourist arrivals decreased by 6.8% in 1996 from the record high set in 1995. The tourism industry has found it hard to recuperate since then. In 1998, 2.2 million tourists visited Israel. Receipts from foreign tourism were approximately $2.7 billion in 1998, a decline from a peak of $2.9 billion in 1995. The 1998 receipts represent 7.7% of total exports, and about 2.8% of GDP.
Table No. 9

Tourist Arrivals by Area of Origin and Receipts
(arrivals in thousands and receipts in millions of USD)

	Year
	1994	1995	1996	1997	1998⁽¹⁾
Asia	143.6	239.1	213.8	204.9	119.3
Africa	64.5	85.3	64.5	56.8	31.9
Europe	1,102.7	1,256.2	1,212.5	1,146.9	707.7
Americas
United States	385.1	452.7	435.1	420.7	307.1
Other	105.6	129.1	123.9	127.7	78.2
Oceania	24.6	29.9	27.9	29.4	15.7
Other	12.6	23.2	22.3	24.0	23.4
Total arrivals	1,838.7	2,215.6	2,100.0	2,010.4	1,283.3
Total receipts	2,408	2,930	2,874	2,741	2,671

____________________

(1)Arrivals by area are published figures as of August 1998. Receipts are published figures as of December 1998. As of December 31, 1998, total arrivals were 1,936.5 thousand.

Source: Central Bureau of Statistics.

Research and Development

The Government encourages investment in industrial research and development through support and incentive programs created under the Law for the Encouragement of Industrial Research and Development. The objectives of the Government's support for industrial research and development are to foster the development of technology-related industries, to create employment opportunities for Israel's scientific and technological labor force, and to improve Israel's balance of payments by increasing exports of high-technology products and reducing reliance on imports of such products. In 1997, 2.3% of GDP was invested in civilian research and development. Government support of civilian research and development (not including general university funds financed by the Government) totaled NIS 1.5 billion in the 1997 budget, NIS 1.4 billion in the 1996 budget and NIS 1.2 billion in the 1995 budget.

Israel participates in 13 international and bi-national research and development joint ventures, of which four are with the United States, and one each with Germany, India, China, Canada, France, Japan, South Korea, Singapore, and the EC research and development program. The annual activity of these joint ventures totaled NIS 320 million in 1998. Five of these joint ventures are funded through an interest bearing fixed deposit by the participants. The annual interest income finances the fund's activities.