Bank of Israel Annual Report 2006

Presentation to Knesset Finance Committee

May 2007

2006 was an excellent year for Israel's economy:

The economy grew rapidly for the third year in succession, with growth led by the business sector;

Employment increased, labor force participation rose, and unemployment went down; real wages rose moderately.

The current account surplus increased to an unprecedented level, and capital inflows and outflows continued to increase;

The financial markets remained stable, with a rise in share prices, and with the continued trend of portfolio adjustment following the reforms of the last few years.

The economy made notable achievements in 2006, both on the real side and the financial side, remarkably so in light of the Second Lebanon War that took place in the summer.

2006 was an excellent year for Israel's economy:(continued)

Macroeconomic policy supported growth:

Fiscal policy was reflected by the relatively small public sector deficit (1.8 percent of GDP), and by a reduction of the public debt to 87.8 percent of GDP.

Public expenditure increased by 4.5 percent, and, excluding interest, by 5.5 percent (civilian expenditure by 4.8 percent, and domestic defense expenditure by 7.5 percent).

In the first half of the year inflation was higher than the upper limit of the inflation target range, and in the last few months of the year was below its lower limit, under the effect of the course followed by the exchange rate and fuel prices.

Monetary policy acted to return inflation gradually to within the target range.

GDP Growth(1990-2007)

3.62.7 2.5 2.5 2.4 2.6 2.7 2.4 2 1.8 1.8 1.8 1.8 1.7

2.4 3.8

3.0

0.3

1.70.3

5.9

-2.9 -2.9

-0.3

3.03.4 3.2 3.3

-4

-2

0

2

4

6

8

10

per capita GDPpopulation

5.15.24.8

1.5

0.6-

2.9

4.2

2.8

5.6

6.66.1

•SOURCE: Based on Central Bureau of Statistics data

8.7

0.9-

5.1

Bank of Israel forecast

Growth Rate of GDP & Business Sector Product(Quarterly, annual rates of change, 2000-2006)

7.3

-0.8

6.45.7

10.0

-4.1

8.77.9

-10

-7

-4

-1

2

5

8

11

14

17

20

00-I00

-II00

-III

00-IV 01

-I01

-II01

-III

01-IV 02

-I02

-II02

-III

02-IV 03

-I03

-II03

-III

03-IV 04

-I04

-II04

-III

04-IV 05

-I05

-II05

-III

05-IV 06

-I06

-II06

-III

06-IV

GDP Business sector product

%

•SOURCE: Based on Central Bureau of Statistics data.

Labor Productivity and Total Factor Productivity

of the Business Sector (1995-2006)

-5.0

0.5

-0.2

2.7

0.0

6.0

-0.6

-3.1

2.2

5.6

4.13.5

-3.4

-0.6

-2.3

0.6

-1.5

5.1

-3.1

-4.7

0.9

5.0

4.03.5

-6

-4

-2

0

2

4

6

8

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Labor productivity*

TFP**

%

•*GDP per hour worked (real percentage change on previous year).

•**A factor input unit is weighted as 68 percent labor and 32 percent capital (real percentage change on previous year). Labor input includes foreign workers.•Source: Based on Central Bureau of Statistics data.

Per Capita GDP in Israel relative to the OECD, and to the U.S., 1991-2006

(by PPP 2005)

60

61

62

63

64

65

66

67

68

69

70

80

82

84

86

88

90

92

94

96compared to USA

compared to OECD countries

87.3

62.9

91.5

64.71

69.51

94.1

65.78

87.2

Source: OECD Statistics and Central Bureau of Statistics data.

GDP per Employee, International Comparison, 2005 (by PPP 2005, Israel=100)

86.4

100.0

0

20

40

60

80

100

120

140

%

Source: OECD Statistics.

Labor Force Participation Rate, International Comparison, 2005

46.5

39.3

0

10

20

30

40

50

60

%

Source: OECD Statistics.

How Growth was Reflected in the Labor Market:

The economy's rapid growth increased the number of employees, reduced unemployment, and raised real wages.

The rise in wages was again accompanied by a rise in labor productivity in 2006, and a reduction in unit labor costs.

Unemployment among the highly educated declined and approached its natural level; this was reflected in a rise in wages among human-capital intensive industries.

For those with low educational levels unemployment declined, and the downward trend in the rate of participation in the labor force halted, but there was only a moderate rise in real wages in the unskilled-labor industries.

Real Wage per Employee Post (2004 prices) (seasonally adjusted, 12-month moving average)

5700

6200

6700

7200

7700

6/99

9/99

12/9

93/

006/

009/

00

12/0

03/

016/

019/

01

12/0

13/

026/

029/

02

12/0

23/

036/

039/

03

12/0

33/

046/

049/

04

12/0

43/

056/

059/

05

12/0

53/

066/

069/

06

12/0

6

Total Public sector Business sector

Shekel

85

95

105

115

125

135

145

155

165

Nominal Unit Labor Costs in the Business Sector in Israel, 1997-2006

(Quarterly data, seasonally adjusted)

Product per labor hour

Labor cost per hour

Unit labor cost

•SOURCE: Central Bureau of Statistics.

Employment, Unemployment and Participation Rates (quarterly data, 1997-2006)

%

SOURCE: Central Bureau of Statistics, Manpower Surveys.

6.5

7

7.5

8

8.5

9

9.5

10

10.5

11

11.5

03/1

997

09/1

997

03/1

998

09/1

998

03/1

999

09/1

999

03/2

000

09/2

000

03/2

001

09/2

001

03/2

002

09/2

002

03/2

003

09/2

003

03/2

004

09/2

004

03/2

005

09/2

005

03/2

006

09/2

006

46.5

47.5

48.5

49.5

50.5

51.5

52.5

53.5

54.5

55.5

Unemployment rate Participation rate Employment rate

Unemployment Rate by Education Level(annual data, 1995-2006)

%

SOURCE: Central Bureau of Statistics, Manpower Surveys.

2

4

6

8

10

12

14

16

18

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

0-10 11-12 13-15 16+ TotalNumber of years of education

14.1

11.2

8.4

6.6

4.0

16.1%

14.2%

12.7%

15.6%

16.6% 16.9%17.5% 17.7%

18.8% 18.8%19.6%

20.0%

21.6%

23.2% 23.4%23.4%

26.3%

23.8%

24.4%24.5%

20.9%

23.2%

24.8%

26.7%

13.0%

17.5% 17.4%

23.7%

10.0%

12.0%

14.0%

16.0%

18.0%

20.0%

22.0%

24.0%

26.0%

28.0%

1997 1998 1999 2000 2001 2002 2003 2004 2005 2005/06*

By mixed Market Basket Method (MBM) By absolute poverty (1997) By relative poverty

Incidence of Poverty Among Individuals, by Various Measures

(1997-2005 )

*Excluding East Jerusalem Arabs.

*The 2005/06 data are according to the decline in relative poverty including among Arabs of East Jerusalem.

SOURCE: Central Bureau of Statistics Income and Expenditure Surveys.

Incidence of Relative Poverty among Individuals, 1997 and 2005a

38.5

22.5

13.710.2 10.9

51.5

33.9

24.2

18.7

11.7

0

10

20

30

40

50

60

0-8 9-10 11-12 13-15 16+

1997 2005

26.1

11.917.5

30.935.6

23.0

14.8

24.9

51.1

65.3

0

10

20

30

40

50

60

70

1 2-4 5-6 7-8 9+

1997 2005

12.3

39.335.9

13.9

64.1

54.2

0

10

20

30

40

50

60

70

Others Ultra-orthodoxJewish

Arabs

1997 2005

a Excluding Arabs of East Jerusalem.

SOURCE: Central Bureau of Statistics Income and Expenditure Surveys 1997 and 2005.

By family sizeBy education of head of household

By number of wage earnersBy population group

60.1

20.4

2.1

77.2

33.2

3.9

0

10

20

30

4050

60

70

80

90

0 1 2+

1997 2005

Rate of Employment and Average Wage per Employee Post, by Population Group,1 2005

Men Women Men Women

Total 60.9 52.2 8,565 5,417Arabs 55.6 15.9 5,347 4,101

Ultre-orthodox2 23.4 44.2 5,476 3,791Others 65.8 60.9 9,228 5,494

Employment rate Average wage

(percents) (₪)

1) Up to 65 years old.

2) The ultra-orthodox are identified by enrollment in an ultra religious high school. SOURCE: Central Bureau of Statistics Income and Expenditure Surveys.

Incidence of Poverty among Ethiopian Immigrants (by Family, 2000-2005)

43.3

49.951.5

55.152.9 51.7

17.5 17.7 17.7 19.2 20.3 20.3

0

10

20

30

40

50

60

2000 2001 2002 2003 2004 2005

Ethiopian immigrantsTotal

%

SOURCE: National Insurance and Household Expenditure Survey 2005.

Total VeteransImmigrants

from

USSRb

Ethiopian

immigrantsc

Proportion of single-mothers 11.5 9.4 21.2 22.5Educational level (highest qualification or degree)d

No qualification 0.9 0.8 0.5 20.4Elementary school 10.0 11.2 4.0 19.5High school/matriculation certificate 39.9 42.2 29.9 38.4Higher education 49.2 45.8 65.6 21.7Participation rated 82.5 82.4 86.6 65.7

Employment rated 76.4 76.2 80.9 57.0

Unemployment rated 7.4 7.6 6.6 13.2Hourly gross median monthly wage (NIS) 34.5 39.6 25.2 22.0Incidence of poverty:Families 15.8 14.5 16.9 51.7Children 24.4 23.4 15.2 65.3Housing density (persons per room) 1.0 1.0 1.0 1.6Share who are satisfiede with their lives 83.1 86 71.6 80.3

Socioeconomic Characteristics of Veteran Jewish Israelis,a and New Immigrants, 2005

a) And “others” (mostly non-Jewish immigrants).

b) Those who immigrated in 1990 or after.

c) Those who immigrated from Ethiopia or who have at least one parent who did so.

d) Among those aged 25-54.

e) Those aged 20 or above who are satisfied or very satisfied.

SOURCE: Based on Central Bureau of Statistics data.

Cost of the Encouragement of Capital Investment Law as Percentage of GDP, by Grant or Alternative Track,

1992-2006

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Alternative trackGrant track

SOURCE: Based on data from the Central Bureau of Statistics, State Revenue Administration and the Budget Books of the Ministry of Finance.

Use of Various Means of Transport by Country, in Terms of Kilometer per Passenger, 2003

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Passenger vehicles Bus Trams, subway trains Trains

1) Use of public (road and rail) and private transport is calculated as the number of passengers multiplied by the average number of kilometers per passenger.2) Israel: 1996 data are according to Travel Habits Survey 1996/7, and 2005 data are estimates based on 1996 data and rates of change of real turnover (in buses) and of travel (private transport) in 1996-2005.

SOURCE: For Israel, Travel Habits Survey 1996/7 and the Central Bureau of Statistics; for the other countries, Eurostat – Transport Statistics in Focus 9/2006.

Exchange Rate, Export Competitiveness and Balance of Payments

Shekel / Dollar Exchange Rate2/1/2004 - 8/5/2007

3.9

4

4.1

4.2

4.3

4.4

4.5

4.6

4.7

4.8

Shekel / Euro Exchange Rate08/05/2007 – 02/01/2004

5.3

5.4

5.5

5.6

5.7

5.8

5.9

6

Index of Real Exchange Rate by Trading Partners (01/1995-04/2007)

•A rise in the index signifies a real depreciation.

•SOURCE: Based on IFS data.

85

90

95

100

105

110

115

120

125

%

117.4

Israel’s Manufacturing Exports to US and EU Compared to US and EU Imports

1995-02/2007

0

0.2

0.4

0.6

0.8

1

1.2

1.4

03-9

5

12-9

5

09-9

6

06-9

7

03-9

8

12-9

8

09-9

9

06/0

001

-07

01-0

7

02-0

7

03-0

7

04-0

7

04-0

7

05-0

7

06-0

7

00.1

0.20.30.40.5

0.60.70.8

0.91

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

03/9

503

/96

03/9

703

/98

03/9

903

/00

03/0

103

/02

03/0

303

/04

03/0

503

/06

Total USTotal EU

High-tech industries: USHigh-tech industries: EU

00.2

0.40.60.8

1

1.21.41.6

1.82

•SOURCE:Based on data from Central Bureau of Statistics, United States International Trade Commission and COMEXT-EUROSTAT.

Level of Openness of Israeli Economy: Exports and Imports

($ million, 1995-2006)

30,000

35,000

40,000

45,000

50,000

55,000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

ImportsExports

•Goods and services excluding diamonds.

•SOURCE: National Accounts, Central Bureau of Statistics.

Current Account of the Balance of Payments(as share of GDP in annual terms)

-5.1 -5.0

-3.0

-0.9-1.3

-0.7 -0.9 -0.6

1.4

2.6 2.9

4.9

-6.5

-4.5

-2.5

-0.5

1.5

3.5

5.5

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

%

•SOURCE: Central Bureau of Statistics.

Nonresident Investments in Israel$ million

0

2000

4000

6000

8000

10000

12000

14000

2000 2001 2002 2003 2004 2005 2006

Direct investmentsPortfolio investments

Israeli Investments Abroad $ million

0

2000

4000

6000

8000

10000

12000

14000

2000 2001 2002 2003 2004 2005 2006

Direct investmentsPortfolio investments

SOURCE: Central Bureau of Statistics, Balance of Payments.

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