ISRAELI ECONOMY AT A GLANCE

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1 EUROPEAN UNION - Delegation to the State of Israel האיחוד האירופי - המשלחת למדינת ישראל األتحاد األوروبي البعثة إلى دولة إسرائيل Trade and Economic Section ISRAELI ECONOMY AT A GLANCE SEPTEMBER 2016 Prepared by: Sàndor Szelekovszky sandor.szelekoszky@eeas.europa.eu Eyal Inbar eyal.inbar@eeas.europa.eu Uri Fishelson uri.fishelson@eeas.europa.eu Alexandra Meir alexandra.meir@eeas.europa.eu "Tel Aviv LEGO" by Ronsho is licensed under CC BY 2.0

2 SUMMARY The Israeli economy has demonstrated a duality in recent years. On the one hand, the economy showed strong resilience during the global economic downturn and Israel has maintained relatively strong GDP growth rates between resulting, mainly, from high industrial output and an increase of exports. Since 2012 the Israeli economy witnessed a relative slowdown from 3.2% in 2013 to 2.5% growth in 2015 and a so-far improvement to 3% in the 1 st half of At the same time, Israel's budgetary situation positively improved in 2015 and During most of 2015 the government acted on a provisional budget based on the 2014 budget. This led to low expenditure and combined with surprisingly high and consistent tax collection throughout the year has led to a high surplus which the government used to both lower the VAT by 1% and decrease the debt/gdp ratio by 1.8% to 64.9%, lower than most OECD countries. During the 2 nd quarter of 2016, Israel's balance of payments has slightly deteriorated as opposed to an improvement in the 1 st quarter. For the budget years, Israel will enact a bi-annual budget which will allow the government to be more stable. The government will put in place mechanisms aimed at dealing with unexpected changes and preventing an increase in governmental debt. Furthermore, the natural gas discoveries in Israel in recent years entail a large opportunity for the upcoming years as taxes are expected to provide a needed boost to the economy. However, this issue has been highly controversial in Israel as efforts are made to increase the government's income from the fields while dismantling the private monopoly controlling the exploitations. Unemployment has also remained one of Israel's strong indicators as it decreased in the 2 nd quarter of 2016 to 4.8%. The decrease along with the gradual increase in minimum wage is steadily leading Israel's income per capita to the level of the most advanced countries. On the other hand, despite these positive economic indicators, several factors are threatening Israel's economic performance. The recent OECD country survey flagged the lack of sufficient competition and productivity as the two main problems of the Israeli market. The market is highly closed in key sectors such as food and banking. An analysis of the market shows that sectors which are open to international competition, such as electronics, chemical products and textile have a high rate of productivity. Closed sectors such as food, agriculture and services have very low productivity. The low productivity combined with high market centralization position Israel's cost of living higher than in most OECD countries. This issue is high on the agenda of the Israeli government since 2011 and it is looking to implement market reforms to open the market. Other factors that further hamper Israeli competitiveness are the appreciation of the Shekel since 2012 and the restrictive business environment which deters businesses from entering the market. Israeli exports were thus hurt in recent years and saw a sharp decrease in 2015 which continued in the 1 st half of Since the late 90's, Israel has chosen the US model of economic stability and low tax burden at the expense of public social expenditures. This leads to relatively low spending on education and health and high rates of poverty and inequality. Poverty rate have reached 19% with the majority focused in the Haredi (Ultra-Orthodox) and Arab communities. Their low participation in the labour force along with high fertility rates and lower levels of education lead to this situation. Although the government is trying to tackle the issue through programmes for higher labour integration and dedicated social support programmes, this will remain one of the biggest challenges facing the Israeli economy for the perceivable future. 2 P a g e

3 MACRO-ECONOMIC INDICATORS On the fiscal front, Israel's position improved in The 2015 budget deficit amounted to 2.15% of GDP, lower than the planned deficit of 2.75% of GDP. The reasons for the good performance are twofold. First, state revenues reached ILS307.4 billion ( 71.3 billion), ILS3.7 billion ( 0.86 billion) higher than forecasted. Second, state expenditures amounted to ILS325.9 billion ( 75.6 billion), ILS 3.7 billion ( 0.86 billion) lower than forecasted, mainly due to the fact that the government acted on a provisional budget, limiting spending, for the first 11 months until the full budget was approved at the end of November. These results led to a sharp decrease of 1.8% in Israel's debt/gdp ratio from 66.7% in 2014 to 64.9% in The inflation rate in 2015 was -1%, far lower that the government's target of 1-3%. This marks the fourth time in Israeli history that a negative inflation rate has occurred (following 2003, 2006 and 2014). This decrease reflects the slowdown in economic activity in sees a continuation of the slow economic activity with the inflation reaching 0.1% since the beginning of the year. The record low prices of crude oil were the main contributing factor this this decrease as transport and energy prices declined. The increase in housing prices during this period was not enough to off-set the decrease. The Bank of Israel (BOI) is expecting inflation to be very low and possibly negative in Reacting to exchange rate pressures and in view of the low inflation expectations, the BOI lowered its key policy rate three times in 2014 and another time in 2015 to a record low of 0.1%. This is the lowest rate in Israeli history and came largely as an attempt to depreciate the Shekel and improve the Israeli industrial competitiveness. The Bank of Israel is aware that the low interest rate further increases housing prices as more people can afford cheap mortgages, but sees the ILS appreciation as a more urgent concern. As of August, the key policy rate remains 0.1% and an increase is not expected until the 1 st quarter of The financial system in Israel is dominated by banks and insurance companies. The recent OECD country survey 1 mentioned the banking sector as a key area that needs to be opened up for competition. The banking sector's exposure to international financial risks is relatively low, as banks are mostly linked to domestic market. During the 1 st half of 2016, several reforms of the banking sector have been implemented. These reforms are mainly concerned with separating the leading credit card companies from the large banks in an attempt to bring in more players who will lower the centralized situation in the sector. Israel's credit rating has been reaffirmed several times since 2014 at A1/A+ with a stable or positive forecast by the largest rating companies (S&P, Fitch and Moody's). All three agencies noted Israel's stable fiscal policy and debt ratio along with its monetary flexibility as strong points in its credit rating. The geo-political situation was mentioned as the main challenge for the future rating of the Israeli economy along with the overpriced housing market P a g e

4 TRADE, R&D & INVESTMENTS Israeli trade in goods decreased overall by 9% in This represents a 6.6% decrease in Israeli exports and a 10.7% decrease in imports. The balance towards Israeli exports has thus improved and Israel's trade deficit decreased by 40%. The 2 nd quarter of 2016 saw an 1.5% increase in exports and 4.5% increase in imports enlarging Israel's deficit. Israel saw decreases in its exports of manufacturing and agricultural products to the EU, in both areas the EU is Israel's largest export market. In addition, Israel's top export sectors, pharmaceutical, chemical compounds and electric components have all seen decreases in 2015 due to reduced competitiveness which resulted from the appreciation of the Shekel and temporary factors unique to those companies. The 1 st half of 2016 saw a reverse in this trend as the Israeli Intel production line, one of the largest exporters, has been reactivated after a long refitting process. The evolution of trade between the EU and Israel has been mixed in The EU's share of Israeli exports has decreased from 31.5% in 2014 to 29.1% in 2015 and This decrease comes as Israel attempts to diversify its export destinations to Asia and South America but so far no fundamental shift occurred. Despite the decrease the EU remains Israel's largest export destination while Asia (24.5%) and the US (23.8%) follow. The share of Israeli imports from the EU has increased from 34.7% in 2014 to 37.8% in 2015 and 39% in the 1 st half of This comes as the EURO/NIS exchange is preferable for European operators which are more competitive. The EU is far ahead of the next import origin, other countries group (25%), Asia (23.6%) and the US (13%). Trade in services with the EU in 2014 (latest figures available) show an increase in both imports and exports of services. The Israeli deficit in trade services leaped from 173 million to 2.1 billion due to a sharp increase in EU services exports which increased from 4.6 billion to 6.2 billlion. Investments in Israeli high-tech remain one of the strongest funding sources for the Israeli industry. According to an Israel Venture Capital (IVC) report, Israeli start-ups have raised 8.24 billion in 2015, 16% more than In the 1 st half of 2016, companies raised 2.5 billion, 35% more than in the 1 st half of The share of M&A increased while the number of IPOs decreased as the economic situation was deemed unfavourable. Recently, criticism has been raised towards Israeli funds for their limited investment in the local booming high-tech sector. Further investments would enable them to benefit from the successes of the Israeli high tech companies. EU investments, particularly VCs, are low compared to the US and other stakeholders. Israel has been associated to the EU's Framework Programmes for R&D, the largest R&D fund in the world, since It contributes to the FP budget at the same rate as the MS. In FP7, Israel made a net gain receiving 1.6 ILS for every 1 ILS contributed to the budget. Israeli participation in the current Horizon2020 programme continues to be strong. As of May 2016, Israel participated in 370 signed agreements involving 441 participations for which they will receive million. As in FP7, the bulk of funding has gone to academia with 52.54% going to European Research Council grants for cutting edge research. Israel's main collaborators are Germany, France, Spain, the UK and Italy. 2 All figures according to the Israeli Central Bureau of Statistics 4 P a g e

5 Israel has long been proud of its world leading share of R&D investments from GDP. However, a recent OECD report found that in 2014 South Korea has surpassed Israel in this share (South Korea with 4.3%, Israel with 4.1%). This change might be a sign for the erosion of the "Start-Up Nation" status as Israel dropped in ranking of its per capita R&D expenditure, global innovation index and its innovation outputs (academic spin-offs, number of patents and high-tech exports) and inputs (innovation infrastructure investment in human capital and research). Senior high-tech executives noted that one of the biggest hindrances for the sector is the shortage in qualified engineers. This is mainly due to decreased investments in education and research infrastructure in recent years and the restrictive immigration policy (See spotlight on page 7). Spotlight: Agricultural Reforms In recent years, mainly following the 2011 public protest against the high cost of living, the Israeli government decided to review and reform government policies conducive to high prices. An important part is devoted to increasing competition in the agriculture sector. The OECD country survey reinforced the need to take action recommending the government to replace quotas, guaranteed prices and customs tariffs with direct payments for farmers. In the 1 st quarter of 2016, the government announced a major reform in the spirit of the OECD recommendations. The reform, planned to be implemented in 2017, will cover all agricultural goods fruits, vegetables, fish, meat, eggs, dairy products and frozen vegetables. From the EU side we are trying to actively encourage the ongoing reform process mainly through sharing our best practices. In May 2016, an ENPARD seminar took place in the Ministry of Agriculture with EU experts. The seminar aimed at transferring EU best practices to the Israeli government, farmers and other stakeholders. The evolution of the CAP, which went through a similar shift from farmers price support to direct payments, was the model discussed. In recent months, the government has also occasionally increased duty free quotas on imports of meat, fish, fruits, vegetables and eggs, although those were temporary measures, until a "Grand Plan" is adapted. As could be expected, the agricultural sector expressed its objection to the government plan and has exerted heavy pressures on the government and on the Knesset. At the moment, negotiations between the government and the farmers are in a deadlock due to disagreements. 5 P a g e

6 LABOUR, POVERTY and COST-OF-LIVING The unemployment rate in 2015 was 5.3% (201,000 unemployed) compared to 5.9% in The rate of participation in the workforce was 64.2%, relatively low, mainly due to the low participation rate of Ultra-Orthodox Jewish men and Arab women. The highest rate of available jobs was identified in the sales, engineering and food & beverages sectors. The latest unemployment figure as of August 2016 is 4.8%. Despite the low rate of unemployment and strong macro-economic performance, poverty and inequality of income distribution continued to constitute a problem in According to the National Insurance Institute (NII) 3, 18.8% of the population was under the poverty line in 2014 (1.71 million) of which 776,500 are children. These numbers represent a deterioration compared to 2013 as the total poverty rate increased by 0.2 percentage points and the rate of poor children has increased by 0.2 percentage points. According to the latest State Comptroller report, there are 900,000 undernourished people in Israel (more than 10% of the population) among them 360,000 children. According to an alternative 2015 poverty report published by the NGO "Latet", among people who receive assistance from NGOs, 60% had difficulties financing medical treatment to their families, 58% had difficulties paying their mortgage or monthly rent and 70% were unable to use heating or air condition at home. Israel's choice of the US economic model led to lower social public expenditure on health, education and social security. This choice in contrast to the more social European model leads to the rising poverty rate and inequality. Latest CBS data indicates that inequality has increased in 2014 after four years of improvement. The net income of the two top percentiles amounted to 39.4% while the bottom two percentiles earned only 6.5%. The three bottom percentiles spent more than their net income and are largely dependent on the welfare system and exhausting their savings. These figures have led to deterioration in Israel's Gini inequality index from in 2013 to 0.37 in The divergence between the increasing prices of housing, food, transport and medical services, coupled with stagnant real wages have been key factors contributing to the growing inequality and the social protests erupted in summer 2011, led by Israel's middle class. Since then the topic of costof-living has been high on the agenda of the government. Despite this, few recommendations made by a committee on necessary reforms were implemented and most were watered down by strong lobbyists. Most proposed reforms on education, social security and housing have been dismissed or are stuck. Housing prices have been sky-rocketing 4 and actions by the government were not able to reverse the trend in The food sector has been the main one to be addressed through the "Cornflakes Reform" which aims to reduce import barriers and lower regulatory processes and associated costs. Reforms in the banking sector have also been implemented in order to increase competition. Other reforms in the fields of water, public transportation, cosmetics and medical devices have been announced but not yet implemented. 3 NII Poverty report According to an IMF survey, housing prices in Israel increased by 80% (in nominal terms) since P a g e

7 In an attempt to lower poverty and compensate for the high cost of living, an agreement has been reached between the Israeli government and the "Histadrut" workers union to increase minimum wage in Israel to NIS 5000 (~1060 ) in three installments from April 1st 2015 to January 1st In March 2015, a fourth instalment has been agreed upon which will bring the minimum wage to NIS5300 ( 1240) in December Spotlight: High-tech facing a talent shortage While Israel's low unemployment has been fairly consistent in recent years, a new challenge jeopardizes the continued growth of the high-tech sector a shortage of 10,000 trained experts in the coming decade. Israel's pool of technological talent benefitted from the advanced training of high-tech units in the Israel Defence Forces (IDF) and, since the 90's, from the educated immigration from the former Soviet-Union. As the manpower shortage grows it becomes a main hindrance to the continued growth and competitiveness of Israeli high tech. A combination of social, educational and business factors have led to the serious shortage. Israel's higher education system has been producing a decreasing share of science graduates, a problem reaching further into the high-schools system seeing the same problem. The inflow of international tech giants, while having many positive effects, puts another high manpower demand and those companies have the means to attract employees with lucrative benefits. Finally the very limited participation of the Arab and Ultra-orthodox communities in this sector is another limiting factor. The Israeli government is attempting to tackle the problem from various angles. A program to encourage children to major in scientific fields as early as middle-school has been introduced by the Ministry of Education. The Ministry of interior is considering a pilot to issue work visas for technological experts and the Ministry of economy is pushing to integrate the Arab and ultraorthodox communities in the high-tech industry. 7 P a g e

8 ECONOMIC FIGURES (CBS data) KEY FIGURES (H1) GDP Growth 3.2% 2.8% 2.5% 3% Business GDP Growth 3.4% 2.7% 2.3% 2.3% Private Consumption Growth 3.3% 4% 4.9% 7.2% Public Consumption Growth 3.5% 4.2% 3.1% 3.7% Inflation rate 1.8% -0.2% -1% 0.1% Unemployment rate 5.8% 5.6% 5.3% 4.8% Budget Deficit (% of GDP) 3.15% 2.8% 2% 2.2% Debt/GDP ratio 67.6% 66.7% 64.9% --- FOREIGN TRADE (Goods and Services) (H1) Imports Growth -0.1% 2.3% -10.7% 4.5% Exports Growth 1.5% 1.3% -6.6% 1.5% 8 P a g e