Recent Developments and Outlook Ministry of Finance January 2011 State of Israel Ministry of Finance

Recent Economic Developments

3 GDP Growth Quarter-on-Quarter at Annual Rate, 2004Q1-2010Q3 Rapid recovery since the second half of 2009.

4 GDP Growth Annual Percentage Change, *Budget estimates.

5 GDP Growth in Israel, USA, UK and the Euro Area The 1st, 2nd, 3rd Quarters of 2010 at annual rate Source: EuroStat, BEA, CBS.

6 The Global Economic Crises had a Moderate Impact on Israel: A strong starting position: Israel experienced 5 years of high GDP growth led by the private sector Low levels of unemployment in an historical perspective and steady improvement in the participation rate in the last few years Maintaining fiscal discipline A continues surplus in the current account A bubble did not develop in the real estate market The Israeli capital market did not offer complex financial instruments A stable banking system A timely and targeted reaction by policy makers

7 Exchange rates US$ vs. Others Currencies, 31/12/2010 vs. 31/12/2009

8 Balance of Payments - The Current Account US$ Billions & As Percent of GDP, * 2010 first 3 quarters annualized. The current account surplus contributed to the appreciation of the shekel.

9 Exports and Imports of Goods US$ billions per month, excl. diamonds, ships & airplanes Exports recovery began in the second half of 2009, although in recent months exports of goods had slowed.

10 Composition of Industrial Exports % 65% 23% 24% 76% 77% 28% 73% 25% 27% 75% 73% 27% 72% 75% 25% 75% 78% 22% 27% 73% 78% 22%

11 Destination of Exports Excluding diamonds, aircraft & ships, US$ billions Diversification of export destinations continued during the years

12 The Unemployment and Participation Rates Participation rate (right axis) Since the second half of 2009 there has been a significant decrease in the unemployment rate.

13 Real Wages , 2004 prices, CPI-adjusted *Jan – October average, seasonally adjusted. In the last decade there has been very little change in real wages.

14 Housing Starts and Fixed Investment in Residential Construction q3 The increase in building permits led to a rise in housing starts. This is expected to expand supply in the residential market. Units Per Q Mil NIS

15 Thousand NISApartments sold New Apartments Prices and Sales Since the second half of 2009 there has been a gradual decrease in sales. During 2010 there was also a decrease in prices.

16 Historical Inflation and Forecasts, , End-of-Period The average inflation rate during the last decade was in the middle of the target range (1%-3%). Inflation forecast is based on 3 components: Housing, Food and Other.

17 BOI Interest Rate, Short-Term Real Interest Rate and Inflation Expectations, Although the BOI rate is rising, real interest rate remains negative

18 Official Reserves (Held by the Bank of Israel)

19 Market Indexes, January 2006=100, Monthly Average Source: TASE, Bloomberg Israeli stock and corporate bonds markets exhibit positive correlation with global counterparts.

20 Risks to the Global Economic Recovery Since mid-2009 there are clear indications that the global crisis is subsiding. But global downside risks remain a concern: Deterioration of Global Fiscal Positions. Premature Exit from Accommodative Fiscal and Monetary Policies. Potential of Asset Price Bubbles Abroad. Remaining Stress in the Financial Sector. Imbalances in the Global Economy. Potential for Protectionist Policy. Long Term Effects in the Labor Market. Israel, as a small and open economy, is largely affected by developments in the global economy.

Policy Issues

22 The budget deficit in 2010 was 3.7 % GDP (compared to budget ceiling of 5.5%). According to two-year budget, the deficit is projected to be close to the ceiling in Central Government's Budget Deficit as Percent of GDP, Source: CBS, MOF *EST. ** PROJ

23 Fiscal Rule – Expenditure Side 1.Adoption of the New Fiscal Rule into the Budget –Spending growth cap calculated as follows: –An increase in expenditure depends on a decrease in the Debt/GDP ratio. –When the Debt/GDP ratio declines to 60%, expenditures can be raised by the average real GDP growth of the last 10 years. Debt/GDP Target (Maastricht Criteria) Current Debt/ GDP Average GDP growth in the last 10 years * = * 3.5% = 2.6% 60% %

24 Fiscal Rule - Deficit Ceiling Reduction of Deficit/ GDP ratio according to a deficit ceiling law. YearDeficit Ceiling % Target, 3.7% Actual % % % 2014 and on1.0% The government must implement the more effective of the two rules.

25 Income and Consumption Taxes )Billion of Nis, December 2010 prices, Seasonally adjusted( Taxation revenue in 2010 was BN NIS, 12.3 BN NIS higher than planned.

26 General Government Expenditure as Percent of GDP, * Weighted average; Source: OECD The government cut expenditure in order to divert resources to the private sector.

27 General Government Expenditure, as Percent of GDP, 2009 * Weighted average; Source: OECD

28 *General government expenditure excluding military expenditure. Source: Sipri Yearbook 2010, OECD. General Government Civil Expenditure*, Percent of GDP, 2009

29 Public and Government Debt, as percent of GDP, *MOF Estimate. Strong fiscal discipline and high growth rates in led to a reduction in the Debt/GDP ratio.

30 Increase in Public Debt between 2007 & 2010, as Percentage of GDP Maastricht: 60% Debt Source: OECD, Israel MOF estimates The rise in the Israeli public debt is relatively moderate. The current public debt-GDP ratio is close to OECD average.

31 Public Debt, as percent of GDP, Debt GDP ratio is expected to decline steadily to 60% around 2020.

Key Economic Policies Internal Growth Engines Insuring the Future of Advanced Sectors Human Capital - Maintaining the High Level of Education Improving Infrastructure Active Labor Market Policies Improving the Public Sector's Efficiency Responsible Fiscal Policy Bi-annual Budget Fiscal Rule