IMF: Israel Needs to Boost Housing Supply, Lower Budget Deficit

'Fiscal deficit needs to be reduced to bring debt firmly on a downward path and build fiscal space,' report says.

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Protesting in front of Bank Leumi's Tel Aviv headquarters, May 18, 2013.Credit: Tomer Appelbaum

Israeli home prices are about 30% overvalued and a correction in the property market could depress consumer spending, especially for people who have bought houses in recent years, the International Monetary Fund said in its annual report on Israel Wednesday.

The IMF critique came in a generally positive report on the state of the economy, but it didn’t overlook serious structural problems, including failure to reduce government debt and sluggish productivity growth.

“Israel’s economy has been doing well and near-term growth prospects are favorable,” the Washington-based IMF said. “Following growth of 2.6% last year, the economy is expected to expand by around 2.5% this year and 3-3.3% each year in the medium term. Employment creation has been remarkable — growing by 3.5% annually — and unemployment is at multi-decade lows.”

The IMF noted that Israel had passed through the global financial crisis starting in 2008 with little impact and that its high-technology sector, which accounts for 40% of its industrial exports, gave it a competitive advantage in the world economy.

While it noted inflation in Israel was currently negative, it doesn’t reflect domestic economic weakness but rather external factors, such as low global oil prices. The shekel is valued correctly and the government kept to its budget-deficit target of 2.8% of gross domestic product.

The IMF said home prices were rising at a rate of about 4% a year, a phenomenon it ascribed to record low interest rates, rising incomes and a growing population. The property sector is having trouble coping with high demand because the supply is highly concentrated, with the government owning 93% of all the country’s land and excessive red tape for building approvals.

The report urged the government to approve accelerated planning procedures, zoning changes and land sales as well as helping local authorities develop high-density housing and a further tightening of loan requirements. 

It expressed concern about Israeli banks’ exposure to mortgage loans, which account for close to a third of bank credit, and to the highly leveraged construction sector, which accounts for another 13%.

Meanwhile, the IMF warned that Israel’s labor productivity is low and its growth is not keeping pace with other developed economies, while income inequality is among the highest in the developed world.

It said slow productivity growth was responsible for Israel being among the poorest of the rich world’s economies. GDP per capita is similar to Korea and New Zealand, but well below Western Europe and the United States.

The IMF attributed the slow productivity growth to Israel’s rapidly expanding labor force and high rates of employment, which discouraged wage growth. Investment in machinery and equipment has not kept pace. Another factor, the report, said,. was an absence of competition in the domestic market.

“Competition and product market restrictions ... are among the highest in advanced economies. Boosting competition, lowering product market restrictions, and improving the quality of education and infrastructure would help boost productivity. Meanwhile, the IMF warned that Israel’s public debt burden will rise if it continues putting off plans to lower its budget deficit targets. “The fiscal deficit needs to be reduced to bring debt firmly on a downward path and build fiscal space,” the report said.

Israel’s debt-to-GDP ratio has stabilized after a period of decline, holding at around 67 percent. It is expected to rise to 69% by 2020 and could climb above 75% “under a growth-shock or sharp housing correction scenario,” the IMF said. Government finances leave “few buffers” to deal with shocks, such as a housing price correction, renewed military conflicts or a sharp recession.

The deficit is projected at 2.8% of GDP in 2015 while a 2.9% target has been set for next year. But those levels exceed the targets set out in a previous budget law, which the IMF said should be revived.

“This challenge should be addressed upfront, and not put off to the future,” the IMF said, urging the 2016 deficit target be lowered by at least a half a percentage point.

With regard to income inequality, the IMF noted that the income share of Israel’s top 10% is now about 13 times the share of the bottom 10%, a ratio that is exceeded only by the United States. Real disposable incomes of the top decile have increased since the 1980s, while incomes of the bottom decile have stagnated, it said

It blamed both high wage disparities as well as a tax system that is less redistributive than in most other developed economies.

The report said Israel should consider include raising the earned income tax credit, boosting education and skills and reducing transportation costs.

REUTERS - Israel's public debt burden will rise if it continues to defer plans to lower its budget deficit targets, the International Monetary Fund warned on Wednesday, while praising the Bank of Israel for its handling of monetary policy.

In a final report on Israel's economy, the Fund also said public finances leave "few buffers" to deal with shocks, such as a housing price correction, renewed military conflicts or a sharp recession.

"The fiscal deficit needs to be reduced to bring debt firmly on a downward path and build fiscal space," the report said.

"A stronger medium-term framework, with an explicit revenue and expenditure plan consistent with the deficit target, is critical."

Israel's debt-to-GDP ratio has stabilized after a period of decline, holding at around 67 percent. It is expected to rise to 69 percent by 2020 and could climb above 75 percent "under a growth-shock or sharp housing correction scenario," the IMF said.

The deficit is projected at 2.8 percent of GDP in 2015 while a target of 2.9 percent has been set for next year.

Those levels exceed the targets set out in a previous budget law, of 2.5 percent this year, 2 percent in 2016 and 1.5 percent in 2019, which the IMF said should be revived.

"Achieving these targets would go a long way towards addressing the fiscal problem, with the debt ratio converging to 50 percent of GDP over the longer term. This will, however, require substantial efforts," it said, recommending budget cuts and an expenditure ceiling.

"This challenge should be addressed upfront, and not put off to the future," the Fund said, urging the 2016 deficit target be lowered by at least a half a percentage point.

Parliament is expected to finally approve a 13-month budget, to run from December through 2016, in mid-November.

On interest rates, the IMF said "no monetary easing is needed at this point, as low inflation is largely imported and likely to be temporary".

The central bank has left its benchmark interest rate at 0.1 percent for six months, despite weak economic growth and a deflation trend for the past year. The annual inflation rate was -0.4 percent in August.

The IMF said Israel should boost the supply of housing to contain price increases and that concerted efforts among relevant ministries and local governments are needed. Housing prices have nearly doubled since 2007.

It noted that Israel's financial system appears sound but said risks emanating from exposure to real estate and construction should be carefully monitored.

The IMF forecasts economic growth of 3 percent in 2015 and 3-3.25 percent in the coming years, in line with potential growth.

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