Israel's economy continued to grow in 1996, although at a slower rate than in previous years. Gross domestic product (GDP) rose by 4.4% last year to NIS 305 billion ($94 billion) compared with a 7.1% increase in 1995 and an average annual rate of 6% from 1990 through 1995. Business sector GDP increased by 5% in 1996 to NIS 203 billion ($62.5 billion), compared with 8.9% in 1995 and an average annual rate of 7.2% from 1990 through 1995.
The lower economic growth rate last year resulted primarily from a reduced export growth rate and from slower growth in investment in construction. The economic slowdown was exacerbated by the decrease in the number of tourists visiting Israel following terrorist attacks that occurred in the beginning of 1996. In addition, the closure of the territories in response to those events caused labor shortages in agriculture and construction.
Notwithstanding these factors, the overall condition of the Israeli economy was favorable in 1996. Indeed, the factors responsible for the economy's high growth rates during recent years - mass immigration from the former Soviet Union, the peace process and the technological revolution - are still present, and provide the potential for future economic growth.
Israel's consumer price index (CPI) rose by 10.6% in 1996, slightly exceeding the upper limit of the government targeted annual inflation range of 8% to 10%. The annual inflation rate reflected two distinct trends: a higher annualized inflation rate of 14.5% during the first half of 1996 and a lower annualized inflation rate of 6.8% during the second half of 1996. In response to the higher inflation rate, the Bank of Israel gradually raised the cost of funds to commercial banks from an average of 14.6% at the beginning of 1996 to 18.4% in July 1996. As the inflation rate slowed, the central bank gradually cut its average interest rate to 15.6% at the end of 1996.
In 1996, the New Israeli Shekel was devalued by 3.7% against the dollar, from NIS 3.135 to NIS 3.251, and by 1.6% against the currency basket, from NIS 3.578 to NIS 3.635.
Private consumption expanded by 6% in 1996, a lower rate than the 7.3% increase in 1995. The growth in private consumption resulted from three main factors: withdrawals from provident funds (caused by the public's disappointment with poor yields); the decline in private saving; and the rise in disposable private income.
In addition, private consumption was bolstered by the real appreciation of the shekel in 1996 which made imported consumer goods less expensive, and the expansion of large retail chains, which spurred sales of consumer goods.
Public consumption, the main component of public sector demand, increased by 3% in 1996 compared with 2% in 1995. The resulting growth in overall domestic demand contributed to the rise in GDP during 1996.
Investment in machinery and equipment, the major capital investment item, grew by 9.6% in 1996 compared with 3.5% in 1995. However, building investment overall rose by only 5.6% in 1996 compared with 16.7% in 1995, while investment in housing construction increased by 10.6% in 1996 compared with 20% in 1995.
Foreign trade continued to expand, but at a slower pace than in prior years. Exports rose by 6.3%, compared with 9.3% in 1995. Imports increased by 6.2% in 1996, the lowest rate of increase since 1990. The civilian import surplus (imports of goods and services less exports of goods and services) increased from $9.8 billion in 1995 to $10.7 billion in 1996.
The continued growth of the Israeli economy in 1996 was also reflected by Israel's employment data. The number of employed persons rose by 60,000 to 2.0 million, an increase of 3.3% compared with 1995. At the same time, the unemployment rate showed a small decrease from an average of 6.7% in 1995 to an average of 6.4% in 1996. Israel's unemployment rate in 1996 was among the lowest of any Western country other than the United States. The decrease in the unemployment rate is all the more significant in view of the arrival of 70,600 immigrants to Israel in 1996.
Israel's labor force increased at a faster rate than the growth in Israel's population due to the employment of new immigrants and foreign workers. For the fourth consecutive year, the proportion of Israelis and foreign workers within the total labor force increased while the proportion of workers from the territories declined. While the employment of foreign workers helped solve a short-term labor shortage in certain sectors, it may lead to social problems in the long-term. At the end of 1996, there were approximately 106,000 foreign workers legally employed in Israel, although estimates of the total number of legally and illegally employed foreign workers are much higher.
Inflation
Israel's CPI rose by 10.6% in 1996 compared to 8.1% in 1995, which was the lowest annual inflation rate since 1969. The inflation rate slowed during the second half of 1996 as a result of smaller increases in housing prices and in response to the Bank of Israel's tight monetary policy.
This policy also favored a slower pace of devaluation of the shekel against the dollar, which helped limit increases in dollar denominated housing prices, but hurt export oriented businesses.
The Budget
The government's domestic budget deficit in 1996 amounted to $4.6 billion, or nearly 5% of GDP, compared with an originally projected deficit of 2.5% of GDP. The large budget deficit in 1996 resulted primarily from lower than forecast government revenues. The revenue shortfall, in turn, resulted from lower than forecast economic growth, decreased activity in highly taxed sectors such as real estate, and large transfer payments to the Palestinian Authority.
The budget deficit was financed by government borrowings of $2.4 billion in the Israeli bond market and $2.1 billion in foreign bond markets. Revenues from the sale of government-owned businesses totaled only $92 million. The government's plan to raise more privatization revenue in order to finance the budget deficit was unsuccessful, due in large part to the weakened state of the capital markets.
Foreign Trade
Exports of goods and services grew by 5.5% in 1996 to $30.4 billion. Exports of goods excluding ships, airplanes and diamonds totaled $14.1 billion in 1996, an increase of 6.5% compared with an increase of 9.3% in 1995. Exports by older, established industries, such as textiles, cardboard containers and other wood and paper products, fell due to lower cost products of foreign competitors. However, large increases in exports were achieved by high-technology industries as a result of their technological edge on world markets.
Revenues from tourism, Israel's main service export, increased by only 1.8% in 1996 compared with a 13.4% increase in 1995. This small increase resulted primarily from less tourists visiting Israel during 1996 as the number decreased 5.5% from the 1995 level to 2.1 million tourists.
Export industries generally reported a decrease in profits, which many exporters attributed to the real appreciation of the New Israeli Shekel against foreign currencies. The appreciation of the shekel created controversy, with exporters demanding a devaluation of the shekel in order to increase the profitability and competitiveness of their businesses on world markets and the Bank of Israel responding that the shekel exchange rate should generally remain unchanged in order to control inflation. While both sides held strongly to their views, the stronger shekel did in fact reduce the cost of imported raw materials, which in turn accounted for a relatively high proportion of the input cost for many exported goods.
Moreover, high-technology industries, whose exports are usually dollar-denominated, benefited from the strengthening of the dollar against European currencies.
Imports of goods and services grew by 6.2% to $41.1 billion. Imports of goods and services excluding ships, airplanes and diamonds totaled $24.5 billion in 1996, an increase of 5.2% from 1995, the lowest rate of increase since 1990. The decrease was particularly apparent in imports of raw materials and consumer durables.
The civilian import surplus rose from $9.8 billion in 1995 to $10.7 billion in 1996. The balance-of-payments current account deficit reached $4.6 billion in 1996 compared with $3.9 billion in 1995. However, the continued inflow of long and short-term foreign capital was more than enough to cover the 1996 deficit. Short-term inflows of foreign capital resulted from attractive interest rates offered on shekel investments in money market funds.
Long-term foreign capital inflows derived from long-term government loans and the sale of long-term government bonds. These inflows grew in 1996 as a result of the improvement in Israel's credit rating and economic standing among foreign investors.
The Capital and Money Markets
Monetary Policy
The Bank of Israel adopted a policy of monetary restraint during 1996 in order to adhere to the targeted annual inflation range of 8% to 10%. As a result of this policy, the inflation rate in 1996 was 10.6%, which was low in view of the government's expansionist fiscal policy and resulting high budget deficit. The Israeli government has adopted a targeted inflation range in 1997 of 8% to 10%, which it plans to achieve through a $2.2 billion cut in government spending which, if implemented, would allow the central bank to loosen its policy of monetary restraint.
The Bank of Israel implemented its monetary policy by controlling the rate of interest it charges on loans to commercial banks, and by maintaining its diagonal band exchange rate regime for a basket of currencies in relation to the shekel. Over the past three years, control of interest rates has been the central bank's principal monetary policy instrument.
At the beginning of 1996, the real interest rate (the nominal interest rate deflated by the CPI) was quite low for borrowers. However, as the rate of inflation climbed during the first half of 1996, the Bank of Israel raised the cost of funds to commercial banks. As the inflation rate slowed during the second half of 1996, the central bank in turn gradually cut its interest rate. The interest rate policy adopted by the Bank of Israel enabled it to control the money supply in the economy, which had a direct effect on the level of inflation. This policy also reduced the level of demand in the economy, particularly for new investments.
The Capital Markets
The capital markets last year responded to the marked change in the public's investment preferences. Investors shifted from long-term CPI-linked investments to short and medium-term holdings, particularly unlinked shekel investments.
The stock market was weak in 1996, and share prices fell in real terms, while the local market for public offerings was practically dormant. As a result, the public spent more of its disposable income and withdrew funds from the capital market, principally from the provident fund sector, and deposited the funds in short-term saving plans and bank deposits. Beginning in July 1996, the withdrawal of funds from provident funds intensified to such an extent that the Bank of Israel decided to purchase bonds in order to help the provident funds finance their members' large-scale withdrawals.
The bond market had a highly successful year at the expense of the stock market. Prices rose moderately in real terms, while trading in government bonds increased by 50%. Trading in zero-coupon bonds ("treasury bills׃) rose by 36%. During 1996, unlinked bonds accounted for 52% of total bond issuances, compared with 41% in 1995. CPI-linked bonds accounted for 36% of total bond issuances in 1996 compared with 49% in 1995. At the end of 1996, following two years during which the total market values of the bond market and stock market were approximately equal, the bond market's value of $40 billion was 16% higher than the stock market's value of $34.5 billion.
The public's lack of interest in the stock market, as evidenced by the low trading volume on the Tel Aviv Stock Exchange (TASE) - a daily average volume of $24 million compared with $28 million in 1995 - depressed the amount of public stock offerings. Companies raised a total of $770 million of equity in public offerings in 1996, of which half was raised in Israel and half in the United States.
While Israeli companies raised $800 million of equity in 1995, only 25% of this amount was raised outside Israel, of which the public offering by Koor Industries Ltd. in the United States and Europe was the largest. Although the TASE was weak, Israeli companies were clearly successful in selling equity abroad, primarily in the United States.
Moreover, foreign investors continued to be interested in Israeli companies through acquisitions and direct investments. Examples include the Italian insurance company Generali's purchase of a controlling stake in the Migdal insurance company; Nestle's acquisition of control in Osem; and foreign investors' involvement in the purchase of 15% of the shares in Israel Discount Bank.
Another notable development during 1996 was the purchase of stock in major companies traded on the TASE by the controlling shareholders of such companies in response to very low stock prices, with the stock of many companies trading below book value.
The public's portfolio of financial assets grew by 5% in 1996 to $183 billion. The proportion of unlinked shekel assets rose to 22% in 1996 compared with only 10% five years ago. However, the proportion of equity securities fell to 15% at the end of 1996 from 33% at year end 1993.
The proportion of assets held with banks rose to 49% at the end of 1996 compared with 45% at year end 1995, mainly due to the transfer of money from the provident funds to shekel deposits and saving plans.