Israel Finance Ministry, Yearly Pension Plan Report

BALANCE OF PAYMENTS AND FOREIGN TRADE

Foreign Investment

After three years of growth net nonresident investments in Israel decreased in 1998 to $5.4 billion, compared to $8.1 billion in 1997, and $6.2 billion on average over the past three years. These figures include direct foreign investments, investments in securities traded on the Tel Aviv Stock Exchange, direct credit to residents, and nonresident deposits in Israeli banks.

Most of the investment decline in 1998 occurred in the portfolio of negotiable securities and direct credit to residents. This is the result of the global financial crisis, particularly the Russian Government's default in the second phase of the crisis, which prompted nonresidents to redeploy their international investments. Consequently, public offerings of securities abroad by Israeli firms declined from a peak of about $1 billion in 1997 to $300 million in 1998. In addition, some nonresident holdings in the portfolio of securities traded on the Tel Aviv Stock Exchange were realized in the last four months of the year. Nonresidents' investments in the portfolio were $0.1 billion in 1998 compared to $0.7 billion in 1997, and averaged $0.5 billion over the past three years.

The widening global interest spreads for loans, in response to the steep increase in perceived global risk, brought direct resident borrowings from nonresidents to a halt. The extent of such borrowing was $0.2 billion in 1998, compared to an average of $0.8 billion over the past three years.

In contrast, direct foreign investments continued to climb and attained a record $2.1 billion in 1998, compared to an average of $1.5 billion over the past three years. The increase was reflected both in securities traded on the Tel Aviv Stock Exchange, which reached 1.0 billion in 1998 compared to an average of $0.7 billion in the period from 1995 to 1997, and in non-negotiable investments which reached $1.1 billion in 1998 compared to an average of $0.8 billion in the period from 1995 to 1997.

Foreign Exchange Controls and International Reserves

On May 14, 1998, the process of removing foreign-currency restrictions on Israeli residents - individuals and businesses-which started in the late 1980s, was for the most part completed. As is customary in western countries, the expansion and enhancement of reporting procedures concerning external transactions have accompanied the process of removing foreign exchange controls in Israel.

At present, all activities and transactions in foreign currency between Israeli residents and nonresidents are permitted, except for a short list of restrictions on Israeli institutional investors and some transactions in derivatives made with nonresidents. The remaining restrictions on institutional investors include the prohibition of direct and portfolio investments abroad-except for provident funds, which may make portfolio investment up to a specified ceiling.

The freedom to engage in transactions with nonresidents is subject to the obligation, of either the person carrying out the transaction or the financial intermediary through which it is carried out, to report the nature of the transaction.

As part of the deregulation of financial markets, the reserve requirements on domestic foreign-currency deposits were also reduced, and currently are 6% for current accounts (up to 6 days), 3% for time deposit accounts with maturity of up to one year, and 0% for time deposit accounts with maturity exceeding one year. Since January 1998 local currency serves as the reserve requirement on domestic foreign currency deposits (replacing foreign currency)
Table No. 20

External Assets and Liabilities (Debt Instruments)
(in millions of dollars)

	Balance at Year End
	1994	1995	1996	1997	1998
External Liabilities
Public sector	$ 22,822	$ 23,782	$ 25,335	$ 26,228	$ 27,467
Nonfinancial private sector	5,023	5,971	6,687	7,759	7,946
Banking system	13,563	15,014	15,478	17,521	19,170
Total	$41,408	$44,767	$47,500	$51,508	$54,583
External Assets
Public sector	7,275	8,607	11,834	20,694	23,109
Nonfinancial private sector	3,411	4,321	4,437	5,038	6,376
Banking system	12,011	12,406	13,280	11,158	13,372
Total	$22,697	$25,334	$29,551	$36,890	$42,857
Net External Debt	$18,711	$19,433	$17,949	$14,618	$11,726

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Source: Bank of Israel.

Foreign currency reserves grew from $6.9 billion at the end of 1994 to $22.7 billion at the end of 1998. The $2.4 billion increase in reserves in 1998 (from $20.3 billion in 1997) was due to earnings on the reserves.

Foreign Exchange Rates

Until July 1985, the Israeli Shekel was periodically depreciated at a rate consistent with inflation. On September2, 1985, the Knesset approved the NIS, valued at 1,000 times the then existing Shekel. Since August 1, 1986, only the NIS has circulated, and the NIS has been stabilized by reference to a basket of major currencies (U.S. dollar, German mark, British pound sterling, French franc, and Japanese yen) rather than in relation solely to the U.S. dollar. On August 1, 1986, the date the basket was introduced, the weighting of the component currencies in the basket was 60% U.S. dollar, 20% German mark, 10% British pound sterling, 5% French franc, and 5% Japanese yen. This basket approximates the composition of Israel's external trade, including both imports and exports. On June 5, 1995, the Bank of Israel adopted a policy requiring an automatic adjustment in the weighting of the currencies in the basket in any future year in which a cumulative change of more than 2% occurs in the value of Israeli trade in any single currency in the basket, relative to the value of Israeli foreign trade in the othercurrencies in the basket. Following that decision, in April 1996 the weight of the dollar was increased by 3.3 percentage points, and those of the other currencies reduced accordingly. The review of the 1996 and 1997 trade figures carried out in April 1997 and 1998, respectively, showed no significant differences between the compositions of the basket and of the trade, so that no changes have been made to the number of currency units since 1996. On December 31, 1998, the currencies' weights were 62% U.S. dollar, 19.7% German mark, 8.2% Pound Sterling, 4.8% French franc, and 5.3% Japanese yen.

In December 1991, to reduce business sector uncertainty and speculative cycles that had caused sharp capital movements under the prior exchange rate systems, the Bank of Israel introduced the "diagonal band" or "crawling peg" system. The "diagonal band" is reset daily based upon a predetermined annual rate of nominal depreciation (the "slope"). The slope of the exchange rate band is intended to serve as an anchor for domestic prices and is determined by macroeconomic considerations, principally the difference between the target rate of inflation in Israel and the expected rate of inflation abroad.

The midpoint of the exchange rate band, the width of the band, and the slope of the band are determined jointly by the Bank of Israel and the Ministry of Finance. However, the Bank of Israel has sole responsibility for the daily management of exchange rates, which is accomplished through periodic interventions in the currency markets. Prior to February 1996, it was the practice of the Bank of Israel to use market intervention to maintain the exchange rate near the midpoint of the band. Since then, the policy has been to intervene only to prevent the rate from moving outside the band. In 1994, the width of the band was plus or minus 5%, and the slope of the band was an annual rate of 6%. On May 31, 1995, the Bank of Israel and the Ministry of Finance widened the exchange rate band to plus or minus 7% and increased the midpoint rate by 0.8%, but made no change in the slope of the band. The change in the midpoint rate was intended to offset the increase in port fees on exports. On June 18, 1997, the Government raised the upper limit of the exchange rate band by approximately 15%, while maintaining its slope at 6%. The lower limit remained unchanged, while its slope was reduced from 6% to 4%. On August 7, 1998, the slope of the lower limit was reduced further, to 2%, while the slope of the upper limit again remained unchanged at 6%. Since the slope of the upper limit, 6%, has not changed for several years, it is now only the slope of the lower limit which reflects the difference between the inflation target in Israel and expected inflation abroad.

In 1998, the NIS depreciated by 20.4% against the currency basket. Depreciation against the dollar was lower-17.6%-due to the weakening of the U.S. dollar against other currencies, a trend which was most apparent in the second half of the year.
Table No. 21

Average Exchange Rates
(NIS per currency unit)

	Year
	1994	1995	1996	1997	1998
U.S. dollar	3.011	3.011	3.188	3.449	3.800
British pound sterling	4.613	4.752	4.979	5.651	6.298
German mark	1.860	2.102	2.119	1.991	2.167
Japanese yen (per 100 yen)	2.951	3.218	2.933	2.854	2.928
French franc	0.544	0.604	0.623	0.591	0.646
Five currency basket	3.304	3.458	3.578	3.733	4.091

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Source: Bank of Israel.