Israel Economy outperforms as investment and exports rally

Economist Intelligence Unit

— Surging investment aswell as stronger external demand and continued robust consumption have ensured that the Israeli economy has continued to outperform government expectations and most other developed economies.

Fourth quarter 2016 annualised real GDP growth of 6.2% according to the Central Bureau of Statistics (CBS) has left annual growth at 4% for the year as a whole, its strongest performance since 2013. However, some elements of Israel’s growth are unlikely to be sustainable at the levels seen in 2016 in the longer term, and the strength of the economy also poses its own challenges.

The new data have led the CBS to revise its figure for overall growth in 2016 to 4% from an earlier estimate of 3.6%, which itself was considerably higher than government growth projections earlier in the year of below 3%. These relatively gloomy forecasts followed on from the sluggish performance of 2015 when the economy grew by 2.5% in real terms. The main factor behind the surge in growth in the fourth quarter was the continued high
level of consumer expenditure, which has characterised much of the year, but which also drew in imports at a rapid pace, putting a brake on the overall rate of GDP growth. However, although private consumption growth rates peaked earlier in the year-private consumption was 7.4% higher in the first half of the year compared with the second half of 2015 but rose less sharply, by 4.9%, between the first half and the second half of
2016-investment and exports of goods and services have stayed high.

Growth in investment and exports bodes well

Although private consumption growth moderated to more sustainable
levels in the second half of the year, it was still up 6.3% for
2016 as a whole. Private consumption expenditure per head on
consumer durables was 17.6% higher in 2016 than in 2015. Imports
of goods and services, which were rising at breakneck speed in
mid-year, driven by high consumer demand particularly for
consumer durables and especially cars, continued to grow strongly
but at a slightly slower pace later in 2016, and with the
composition of those imports beginning to be more evenly balanced
between consumer and investment goods. Overall, imports of goods
and services were up by 9.7% in 2016. Government consumption
growth also remains high at 3.6% for the year (although it was
slower in the final quarter of 2016), driven by a number of
coalition spending pledges, although the government was still
able to undershoot its deficit target of 2.9% of GDP thanks to
rising revenue (driven by earnings from vehicle import taxes).

Investment in both industry and residential construction-which is
finally seeing an end to a long period of underinvestment and
insufficient supply-has been strengthening throughout the year,
with gross fixed capital formation up by an annualised 7.4% in
the fourth quarter of the year and by 11% for the year as a
whole, in stark contrast to negligible growth of 0.1% in 2015.
For the year as a whole the industrial investment component of
fixed capital formation was up by 12.4% while residential
building was 8.1% higher.

Exports of goods and services-which account for 30% of total
GDP-grew by 11.2% at an annualised (seasonally adjusted) rate in
the fourth quarter of 2016 and by 3.9% for the year as a whole,
in marked contrast to the 4.3% fall seen in 2015. Industrial
output in export industries has been rising. Goods exports data
indicate strengthening export earnings in late 2016 and into the
beginning of 2017, with some of the largest export sectors
including electronic components, pharmaceuticals and
chemicals-which fell sharply for much of 2016 partly because of
global price trends-leading the recovery in value terms.
According to data released by the CBS on February 22nd, exports
of services rose by 10.3% in value terms to US$39.3bn in 2016,
with much of the pick-up in the latter months of the year.
Exports of high-tech industry services, which account for close
to half of all services exports-were up by 13.8% in 2016 to
US$19.5bn.

But troubles ahead?

However, Israel’s strong economic performance is also posing
challenges for the government and the Bank of Israel (BOI, the
central bank). The BOI remains concerned about house prices,
although there are indications that the prolonged boom in the
sector is easing off. It has also noted that the level of
consumer spending was raising household debt, although it remains
at manageable levels thanks in part to strong jobs
growth-unemployment is at a 30-year low-and higher disposable
incomes. The BOI has taken a number of measures in recent years
aimed at avoiding spillover into the financial system, including
tightening regulations on mortgage lending. However, with
inflation in negative territory-the BOI has a target range of
1-3% inflation-as a result of falling global commodity prices and
a strong domestic currency, and amid concerns that raising
interest rates would further aggravate the upward pressures on
the Israeli shekel, it has felt unable to raise its key policy
interest rate, which is at a record low of 0.1%.

Manufacturers have repeatedly raised concerns over the strength
of the shekel, which has appreciated further for much of
February, crossing the NIS 3.70:US$1 threshold and also reaching
NIS 3.9:EUR1 against the currency used by much of its largest
trading partner, the EU. The stronger than expected national
accounts data have put further upward pressure on the currency.
This led the BOI to make ad hoc foreign-currency purchases of
around US$200m in mid-month over and above its planned programme
of purchases, aimed at keeping currency appreciation at
manageable levels. The Israel Export Institute, a business group
representing exporting firms, has said that the exchange rate is
at its worst level-that is strongest-since 1999.

The national accounts data suggest that the currency’s strength
is not an obstacle to all exporters as the shekel was relatively
strong for much of 2016. However, the main recovery in exports
has been in high-tech goods and services where foreign buyers may
be less price sensitive for niche products that are not easily
substitutable. Other industries in Israel may begin to suffer as
the shekel’s strength makes their products less competitive
globally. The shekel’s strength may also have a similar dampening
effect on overseas investment in Israel, although natural gas and
specialised high-tech industries should continue to attract
foreign interest.