Emerging

Favourable prospects despite fiscal uncertainty

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Eco Emerging // 1 quarter 2021  
economic-research.bnpparibas.com  
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ISRAEL  
FAVOURABLE PROSPECTS DESPITE FISCAL UNCERTAINTY  
Fiscal support and the resilience of exports helped limit the economic recession in 2020. A strong recovery is likely  
in 2021, thanks primarily to a rapid vaccination campaign. The shekel has strengthened on the back of a growing  
current account surplus and massive capital inflows. The situation for public finances is more uncertain. In addition  
to the structural deterioration of recent years, the lack of a budget law against a background of repeated government  
instability is not helpful for budget consolidation. Although solid solvency indicators eliminate any short-term risk, a  
lack of reforms could weigh on potential growth over the medium to long term.  
RECOVERY EXPECTED ON THE BACK OF THE VACCINATION  
FORECASTS  
CAMPAIGN  
2
019  
2020e  
2021e  
2022e  
Economic activity held up pretty well in 2020, with a likely fall in real  
GDP of just 3.7% according to the latest Bank of Israel (BoI) estimates.  
After a drop in GDP of 1.1% year-on-year (y/y) in Q3, a second lockdown  
dented the country’s economic performance in the final quarter.  
Over the full year, and given the fall in household consumption and  
investment, the scale of the recession was limited by public spending  
and the positive contribution from foreign trade. With imports shrinking  
by 15% y/y in the third quarter, exports grew by 6%. The strong export  
performance in 2020 was due in particular to the competitiveness of  
high-tech services exports and the start of gas exports to Egypt and  
Jordan.  
Real GDP growth (%)  
3.4  
0.8  
-3.9  
60  
-3.7  
-0.6  
-11.5  
75  
6.3  
0.5  
-7.5  
79  
5.0  
1.0  
-4.5  
79  
Inflation (CPI, year average, %)  
Cent. Gov. balance / GDP (%)  
Cent. Gov. debt / GDP (%)  
Current account balance / GDP (%)  
External debt / GDP (%)  
3.5  
27  
4.2  
3.9  
30  
3.5  
31  
30  
Forex reserves (USD bn)  
126  
14  
168  
20  
200  
22  
210  
21  
Forex reserves, in months of imports  
Exchange rate USDILS (year end)  
3.5  
3.2  
3.2  
3.3  
e: ESTIMATE & FORECASTS  
SOURCE: BNP PARIBAS ECONOMIC RESEARCH  
The labour market deteriorated over the course of 2020, particularly  
during lockdowns. The Israeli statistical service has introduced a  
broad unemployment rate to better reflect the unusual economic  
circumstances. This definition adds to the standard definition  
of unemployment those people temporarily out of work due to  
coronavirus-related reasons and those who have withdrawn from the  
labour market because of the pandemic. From a level of less than 4%  
before the pandemic began, the broad unemployment rate hit a peak of  
TABLE 1  
ECONOMIC ACTIVITY (%, Y/Y)  
GDP  
State of the economy index  
5
6
4
2
0
2
4
6
8
3
7% during the first lockdown in April. According to the BoI, it probably  
4
3
2
1
0
averaged 16% in the final quarter of 2020.  
The economic recovery expected for 2021 is highly dependent on the  
speedandeffectivenessofthevaccinationcampaign.Sincethebeginning  
of the year, the country has the OECD’s highest rate of vaccination of  
its population. Some 20% of Israelis have now received the first dose of  
the vaccine, and the government aims to vaccinate everyone over 16  
by the end of January. This said, it would be wise to remain cautious  
about the timing of economic recovery. The acceleration of the second  
wave of infections in December forced the government to introduce  
new lockdown measures, from 6 January for at least two weeks. Under  
the BoI’s optimistic scenario, with a vaccination campaign that is  
completed in the second quarter, thus allowing the gradual removal  
of all restrictive measures, real GDP could grow by 6.3% in 2021. This  
scenario takes account of the uncertainties surrounding the recovery  
at a global level. Israeli exports account for around one-third of GDP  
and depend largely on the US and European markets. The BoI’s growth  
forecast for advanced economies (3.4%) remains cautious. All in all,  
provided that the vaccination campaign is effective, it is this favourable  
scenario that currently looks the most likely.  
-
-
-
-
-
1
-10  
-2  
2017  
2018  
2019  
2020  
SOURCE: BANK OF ISRAEL, BNP PARIBAS  
CHART 1  
RECORD EXTERNAL SURPLUSES SUPPORT THE SHEKEL  
The current account surplus could hit a record level in 2020 (at 4.2%  
of GDP, from 3.5% in 2019). On the one hand, imports collapsed. On  
the other, the growing share of high-tech services exports in total  
exports of goods and services makes the total figure less sensitive  
to international conditions. Over the first three quarters of the year,  
the volume of exports of goods and services grew by 0.3% on average,  
whilst that of imports fell by 10.5%. At the same time, capital inflows  
Against a background of a sharp fall in household consumption, lower  
oil prices and a stronger shekel, consumer price inflation was negative  
in 2020 (estimated at -0.6%).  
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Eco Emerging // 1 quarter 2021  
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were very substantial in 2020. Foreign direct investment reached  
USD 19.4 billion (up 56% on 3Q 2019), and portfolio investment  
was USD 17 billion (from USD -1.1 billion in 3Q 2019) thanks to the  
government’s Eurobond issue.  
GOVERNMENT BUDGET BALANCE (ILS BN)  
2015  
2019  
2020  
All of these elements contributed to an increase in the balance of  
payments surplus and the strengthening of the shekel against the US  
dollar. This trend was further strengthened by the weakness of the  
US dollar on international markets and by the rise of international  
asset markets, both of which are traditionally associated with a  
stronger shekel. The BoI continued to buy foreign currency in 2020  
20  
0
-
-
-
20  
40  
60  
(
USD 21 billion) to help limit the currency’s appreciation. It has  
announced its willingness to increase market interventions in 2021  
USD 30 billion scheduled). This should limit shekel appreciation in  
-80  
100  
120  
140  
(
-
-
-
a context of narrowing current account surpluses as the economy  
recovers.  
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec  
SOURCE: MINISTRY OF FINANCE, BNP PARIBAS  
THE FISCAL OUTLOOK IN AN UNCERTAIN POLITICAL CLIMATE  
Unsurprisingly, the budget deficit is expected to be significant in 2020,  
due to a fall in tax receipts (-9.6% in the first 11 months) and more  
importantly the increase in spending (20% over the same period).  
Exceptional fiscal measures to support the economy were worth some  
CHART 2  
7
% of GDP, according to the IMF. The total deficit for 2020 is thus likely  
to have been around 12% of GDP. In 2021 the reduction in the deficit  
will probably be modest, despite the return to growth. At least some of  
the economic support measures should be maintained. On the receipts  
side, continuing restrictions will reduce income from VAT (21% of total  
government receipts). All in all, we expect a budget deficit of 7.5% of  
GDP in 2021.  
addition, although the trend in government debt was not favourable in  
020 (from 60% of GDP in 2019 to 75% in 2020), its structure remains  
2
an element of strength of public finances. The average maturity of the  
stock of debt was 8.2 years in 2019 (6.8 in 2008). Debt service costs  
have fallen from 10.7% of total government receipts in 2010 to 5.6%  
in 2019. The majority of the budget’s financing comes from the local  
market. At the end of 2019, around 85% of government debt was in  
local hands, with 31% off the market. Israeli mutual and pension funds  
are significant holders of the tradable part of the debt (43% of the  
total).  
The lack of a budget law since 2019, due to political volatility, is a  
source of uncertainty over the future path of public finances. The  
government operates on the basis of a budget passed two years ago  
that is rolled over from month to month. However, this baseline budget  
was increased in 2020 in order to adapt to the economic context in  
The effect of political volatility on public finances could be more  
significant over the medium to long term. In order to boost potential  
growth, a number of structural reforms are needed, to improve  
productivity across the economy and reduce inequalities. These  
reforms will be costly and will require some difficult decisions to be  
made, particularly in terms of tax policy. For the time being, the lack of  
political stability limits the chances of putting such reforms in place.  
2
021.  
In the short term, we believe that the consequences of the absence  
of an approved budget can be managed and that the deterioration of  
deficit and debt ratios will not result in any increase in sovereign risk.  
The political trend remains favourable to the control of budget deficits,  
notably through the introduction of a mechanism for the control of  
spending that ties any new commitment to an identified source of  
revenue. However, the structural budget deficit, as calculated by the  
IMF, has been rising steadily since 2015. It reached 4.1% of GDP in 2019,  
from 0.7% of GDP in 2015, mainly due to higher social spending and  
investment. It is currently difficult to predict the trajectory of public  
spending over the coming years. Even if the government succeeds  
in controlling the spread of the virus in the short term, its economic  
consequences will be long-lasting and will require some form of fiscal  
support to be maintained.  
Completed on 14 January 2021  
Pascal DEVAUX  
pascal.devaux@bnpparibas.com  
The fiscal position benefits from significant sources of support, which  
should allow any increase in the cost of financing to be contained. In  
the short term, the BoI looks set to continue its policy of purchasing  
government papers and private-sector securities. In November  
2
020, the BoI held 7% of the tradable Treasury bonds issued by the  
government (from 0.4% at the end of 2019). The impact on money  
supply is negligible (money supply increased by 0.7%). This is likely to  
help limit possible upward pressure on the rates at issuance. In  
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