Israel WT/TPR/S/58
Page 1
I. ECONOMIC ENVIRONMENT
(1) INTRODUCTION
1. The Israeli economy has slowed in recent years after rapid growth in the first half of the
decade.  In the period 1990-95 GDP rose at an annual average rate of 6%.1  A significant factor
affecting the economy during this period was the large number of immigrants arriving mainly from
the former Soviet Union.  These large inflows of immigrants provided additional flexibility in thelabour market and greater opportunities for investment.  GDP was led by growth in construction,
especially in the residential sector, private consum ption and export.  The rate of growth has slowed
significantly since then and was 2% in 1998.  This slowdown reflects disciplined monetary policy,
recently tightened fiscal policy, as well as a cyclical downturn in the growth of both private
consumption and residential construction as the immigration wave of the first half of the 1990s fadedout.  It also reflects the slowdown in world grow th, and the negative impact of domestic security
concerns on tourism.  The economic slowdown contributed to a decline in GDP per capita of some
0.4% in 1998 to US$16,405.
2  Preliminary forecasts indicate that GDP growth in 1999 will remain at
around 2%.
2. Since Israel's previous Trade Policy Revi ew in 1994, the structure of the economy has
continued to shift slowly toward services, away from agriculture and manufacturing (Table I.1).
In 1998, farming accounted for 2.3% of NDP (net domestic product) while the contribution of
services amounted to some 70%.  The services sect or employs about 70% of the labour force, almost
four times that of manufacturing.  The contraction of manufacturing is driven by developments in the
traditional labour-intensive industries, which have  been confronted by increasing competition from
developing countries (with relatively low unit-labour costs), as trade barriers have been lowered.3
Also, the increased demand from the large influx of immigrants in the early 1990s, mainly on
products from the traditional sectors, has faded out.  While manufacturing and agriculture have
contracted, the services sector has prospered.  The fastest growing services sub-sectors have been
personal services, and finance and business services, reflecting Israel's highly educated work force.
Another factor affecting the services sector is the recent deregulation and privatization, which has
improved the private sector environment. The salient features of the sector are described inChapter IV.
(2) R
ECENT ECONOMIC PERFORMANCE
3. The period under review (1994-99) was characterized in its early years by high demand, with
an expansionary fiscal policy in 1995-96 playing an  important role.  Demand pressures were initially
addressed by a tightening of monetary policy, which slowed growth, strengthened the exchange rate,and brought a surge in capital inflows.  Beginning in 1997, fiscal policy was tightened.  Recently,
against the backdrop of the global financial crisis, private sector flows in the balance of payments
reversed directions to an out-flow in the second half of 1998 and the currency depreciated in real
terms.  At the same time, economic activity has continued to remain below its potential.
                                                     
1 The data in this report refer to the sovereign area of Israel, excluding the West Bank and the Gaza
areas.
2 Israel's GDP per capita is higher than some OECD countries, such as Portugal (US$10,593),
New Zealand (US$14,012) and Spain (US$14,147), (OECD (1999)).
3 However, in parallel with the decline of traditional labour-intensive industries, high-tech industries
have become very successful in recent years and have benefited from more liberal foreign investment rules.WT/TPR/S/58 Trade Policy Review
Page 2
Table I.1
Israel at a glance, 1980-98
1980 1990 1994 1998
GDP per capita (US$)a5,614 11,264 13,829 16,405
Population (million) 3.9 4.7 5.4 6.0
Growth of population (percentage change)b2.6 1.8 2.8 3.2
Fertility rate (births per woman) 3.1 2.9 2.9 2.9c
Life expectancy at birth (years) 74 77 77 ..
Female participation (%) 36 41 45 46
School enrolment ratio, secondary (%) 73 83 89 92c
Share of NDP (Net Domestic Product)d:
    Agriculture 6.1 3.3 2.5 2.3
    Industry 27.4 29.6 29.0 27.5
          Manufacturing 16.8 21.9 20.3 18.9
          Electricity, construction and water 10.6 8.7 8.7 8.6
    Services 66.5 67.1 68.5 70.2
Share in employment:
    Agriculture 5.7 3.9 3.2 2.5
    Industry 29.5 26.4 27.2 28.0
    Services 64.8 69.7 69.6 69.5
.. Not available.
a Current prices, not including net taxes on imports.
b Annual average for the previous ten years.c 1997 data.
d GDP minus depreciation.  Imputed value of bank services and the subsidy component in government loans are not allocated by
branch in services.
Source : Data provided by the Israeli Central Bureau of Statistics.
4. In 1990-95 the Israeli economy grew rapidly, helped by a large inflow of immigrants
(Box I.1) and by the confidence infused by the peace process;  GDP expanded at an annual average
rate of 6%.  Unemployment almost reached its pre-immigration level of 6.7%.  In the context ofrapidly increasing demand, a shift towards an expansionary fiscal policy (including increases in public
sector wages and social services, and tax cuts), in late 1994, led to overheating during 1995-96.  The
current account deficit widened sharply, from 4.6% of GDP in 1994 to 6% of GDP in 1995
(Table I.2).  Monetary policy was used to address excess demand;  it was aimed at achieving an
inflation target set by the Government while simultaneously maintaining a crawling peg for theexchange rate, subject to the rate fluctuating with in margins, which have been gradually widened over
time.
4  High real interest rates were the main policy tool used to curb inflation.
5. The tight monetary policy had several side-effects.  It kept the domestic currency strong
within its crawling band, which had implications for the competitiveness of exports, as well as the
performance of the economy.  Moreover, credit became more expensive, and high real interest rates
played a role in a surge of capital inflows, especially short-term (see discussion below).5
                                                     
4 The Israeli currency, the shekel, is linked to a basket of five major currencies (U.S. dollar, pound
sterling, French franc, the Deutsche mark, and Japanese yen).  In 1991 the Bank of Israel (the central bank)introduced a "diagonal band" or a "crawling peg" system.  The band is based on a pre-determined annual rate ofnominal depreciation, the so-called "slope".  The slope of the exchange rate band is the difference between theinflation target and the expected rate  of inflation abroad.  The width of the band was originally 5% around the
mid-point, but has been gradually broadened;  the band is now 15% about the mid-point.
5 Bank of Israel (1998a).Israel WT/TPR/S/58
Page 3
Box I.1:  Labour market features
           Israel has a highly educated workforce.  In 1997, about 34% of the Israeli population (of 5.9 million)over age of 15 years had university or other advanced degrees.  More than one quarter of the work force wascomposed of scientific, academic, other professionals, technical, and related work force and 5% consisted of
administrative or managerial workers.
           A significant factor affecting the economy in the 1990s has been the large number of immigrants
arriving mainly from the former Soviet Union (under the Law of Returns, any Jewish immigrant may
become a citizen of Israel). These large inflows of immigrants have led to substantial benefits for thedomestic economy.  Between 1990 and 1995, over 700,000 immigrants were absorbed into the economy,increasing the population by around 13% in that period.  Many immigrants were scientists, physicians andacademics – two thirds of immigrants from the former Soviet Union have been employed as professionals,scientists, engineers, and technical staff - thereby addi ng to the country's human capital.  The decision not to
absorb immigrants through public sector employment has contributed to additional flexibility in the labour
market.  After peaking at 11.2% at the end of 1992, Israel's unemployment rate decreased substantiallyfrom 1994 through 1996, as the creation of jobs outpaced the growth of the civilian work force.Subsequently the unemployment rate has increased (8.7% in February 1999), as the economy is currentlyexperiencing a slowdown.
           Labour unions have historically played a significant role in the economy.  By the end of 1997 morethan 40  of total employees were members of unions related to the General Federation of Labour (Histadrut),
of which 45% were in the private sector.  No longer linked to the nation's health care system, and having
divested itself of a number of assets, the Histadrut plan s to concentrate its function as a trade union and as a
provider of social services related to employment.  While the Histadrut has opposed the privatization ofessential industries and those considered of strategi c importance, it has accepted privatization of others on
the conditions that workers' rights are protected and labour agreements secured for a period of time.
           Structural reforms to the wage bargaining process since the late 1980s have contributed to
"de-linking" private and public sector wage evolution and enhanced wage flexibility in the private sector.
Collective bargaining negotiations in the public sector take place between the Histadrut and the Ministry of
Finance, representing the Government.  In the private sector, negotiations at the national level between the
Histadrut and the Employers' Association are supplemented by local negotiations.  National levelnegotiations have become more limited in scope and now define only the common framework and rules bywhich each firm subsequently negotiates its wage contract.  The national level negotiations primarily focuson the cost-of-living adjustment (COLA), overtime compensation, and conflict resolution.  The COLA,which has been reduced and now only partly compensates for inflation (85% of price rises, although with a
lag) is negotiated in the private sector and then becomes binding for the public sector.  As a result of the
smaller share of the wage bill negotiated at the national level, companies have been equipped with enhancedflexibility in wage bargaining at the local level.  Despite the fact that the labour market has become moreflexible in the last few years, rigidities still exist (such as the minimum wage, which is linked to the averagewage in the economy) which limit the sensitivities of wages to the level of unemployment.
Source :  Ministry of Finance, Prospectus  [online].  Available at:  www.mof.gov.il;  Bank of Israel  (1998b),
Annual Report 1997 , Jerusalem, March;  IMF (1997), Israel: Selected Issues and Statistical
Appendix, Staff Country Report No. 97/2, Washington D.C., February;  and Barclays (1998),
Israel: Country Report , London, July.WT/TPR/S/58 Trade Policy Review
Page 4
Table I.2
Selected economic indicators, 1985-98
1985-93a1994 1995 1996 1997 1998
National accounts (constant prices)
Real GDP, market prices (percentage change) 4.6 6.9 7.2 4.7 2.7 2.0
    Private consumption 6.5 9.5 7.2 5.0 4.1 3.3
    General government consumption 1.8 -0.2 0.3 5.7 1.9 2.3
    Gross domestic capital formation 7.8 8.4 12.6 6.7 -6.1 -7.6
    Exports, goods and services 5.8 12.8 8.2 6.8 7.6 6.0
    Imports, goods and services 8.9 10.9 7.2 8.1 2.8 2.1
Prices and interest rates (Per cent)
Consumer price inflation (end-period) 34.9 14.5 8.1 10.6 7.0 8.6
Treasury bill rate (annual rate) 14.8 13.0 15.4 15.6 14.1 12.3
Discount-window loan 13.6b13.4 15.5 16.1 14.3 12.3
Non-directed credit (new shekel) 67.0 17.4 20.2 20.7 18.7 16.2
Real effective exchange rate (1990=100)c116.6 90.0 81.8 77.7 77.2 80.7
Savings and investment (Per cent of NI)d
Gross national saving 19.0 18.1 17.2 16.6 16.4 ..
      Public sector 0.6 1.0 -0.7 -1.7 -0.5 ..
(Per cent of GDP)
Gross fixed investment 17.7 23.1 23.8 24.8 23.6 22.4
Public finance
Central government balance before foreign grantse -9.4 -6.2 -6.6 -8.4 -5.8 ..
Central government balance after foreign grantse -1.1 -2.6 -4.6 -4.1 -2.5 ..
   Revenues from customs duties 0.5 0.3 0.3 0.4 0.4 ..
Outstanding debt of the Central Governmente 169.6 126.7 120.8 118.8 116.2 ..
Monetary sector (end period) (Percentage change)
Narrow money (M1) 83.2 20.6 8.4 14.9 14.3 12.1
M2f88.2 34.2 31.1 27.0 26.3 19.3
External sector (Per cent of GDP, unless otherwise specified)
Trade balance -7.3 -7.5 -8.7 -7.5 -5.2 -3.3
Current account balanceg-0.5 -4.6 -6.0 -5.6 -3.5 -0.9
Financial account balance -0.2 2.1 2.8 1.8 -0.4 -1.4
      Foreign direct investment, net 0.6 0.6 1.5 1.5 1.8 1.9
      Portfolio investment, net 1.2 2.4 3.2 3.5 6.6 7.2
Total external debt (end-period) 77.2 56.3 51.5 49.7 52.1 56.0
      Short-term external debt (STED) 30.6 20.6 19.9 17.9 19.1 20.8
      STED/In't reserves, per cent 245.5 221.5 207.8 148.0 92.6 89.6
Debt-service ratioh24.2 14.8 13.5 13.6 13.1 10.2
In't reserves, US$ billionsi5.3 6.9 8.3 11.6 20.3 22.7
In't reserves, months of merch. importsi3.2 2.6 2.6 3.3 5.7 6.4
Merchandise trade (imports plus exports) 55.4 53.9 53.1 52.0 51.1 50.2
(Twelve-month growth rate, end period, per cent)
Merchandise export growthj10.1 16.6 12.0 10.2 6.6 1.4
Merchandise import growthj10.4 10.8 17.9 5.9 -2.1 -5.9
Memorandum item:
    Nominal GDP (billion US$) 46.8 74.1 86.9 95.2 98.8 97.9
.. Not available.
a Annual average.
b 1989-93 only.c Decrease equals appreciation.
d Total national income = GDP + net unilateral transfers from abroad.
e Not including net lending.f M2 = M1 + interest-bearing local-currency deposits and other deposits + treasury bills.
g Current account excluding capital transfers (new definition).
h Debt service as a share of exports plus transfers.i Total reserves, excluding gold.
j Current U.S. dollars.
Source : Data provided by the Israeli authorities.Israel WT/TPR/S/58
Page 5
6. To address the situation, the Government tightened its fiscal stance in 1997 (Chart I.1).  The
public sector deficit was reduced in 1997, so that fiscal policy acted to dampen excess demand.
However, the composition of the State's expenditure - heavily influenced by "fixed" expenditures such
as interest payments, civil service wages and defence - may not augur well for future rapid
expenditure cuts.  During this period, tight monetary policy continued to focus on attaining the
inflation target, with average real interest rates therefore at relatively high levels (5% in 1997 and6% in 1998).
0246810
1992 93 94 95 96 1997Central govern ment deficit 
(before foreign grants)
Central government deficit 
(after foreign grants)
General government balancePer cent of GDP
Source :  Israeli Central Bureau of Statistics;  and IMF (1998),   IMF Staff Country Report No. 98/28, Washington D.C., April.Chart I.1
Fiscal position, 1992-98
020406080100
1992 93 94 95 96 97 1998aaPer cent of Central Government ex penditure
Interest payments
Wages and salaries
(excludin g defence )Subsidies and transfers
Defence (including wages)
Other expenditure
a              Budget. 
7. Inflation has been curbed.  Apart from the latter half of 1998, when inflation rose in the wake
of the sharp currency depreciation, inflation has gradually slowed, to 2-3% in 1999 compared to
14.5% in 1994 and 8.6% in 1998.6  Besides disciplined monetary action, other factors influencing the
decline in inflation include recent fiscal restraint,  the fall in import prices, and a general fall in
consumer demand.
8. As a relatively small economy, Israel relies heavily on foreign trade.  Merchandise trade
(exports and imports) is equivalent to about half of  GDP.  Israel has traditionally registered large
deficits on its trade balance;  during the 1990s, rapid economic growth accelerated imports, causing
the deficit to exceed US$7.5 billion (or 8.7% of GDP) in 1995 (Table AI.1).  Nominal import levelshave since fallen, mainly as a result both of a slowdown in demand and a decrease in import prices,
while exports have continued to grow albeit at a falling pace.  The sharp improvement in the trade
balance registered in 1997 continued in 1998, with the trade deficit falling to about 3.3% of GDP.
9. In the period 1994-96, strong domestic demand led a steady widening in Israel's current
account deficit, to the equivalent of almost 6% of  GDP in 1995.  The tightening of the fiscal deficit
in 1997 and the economic slowdown, together with impr oved terms of trade, have contributed to a
                                                     
6 At the inception of the Russian financial crisis, the currency depreciated significantly (4.1% in
nominal terms) in August and a more steep depreciation (9.7%) occurred in October.WT/TPR/S/58 Trade Policy Review
Page 6
narrowing of the current account deficit to US$0.8 billion in 1998, or the equivalent of 0.9% of GDP
(Table AI.1).
10. Despite Israel's history of large current account deficits, its external debt to GDP ratio has
remained relatively stable since 1994 (at slightly more than 50% of GDP);  concern could, however,
be noted with respect to Israel's sizeable short-te rm debt, particularly in relation to international
reserves (excluding gold), even though this ratio has come down considerably in recent years(Table I.2).
7  The debt to GDP ratio has been manageab le because of large unilateral inflows.  In
recent years, external funds in the form of grants, contributions and unrequited transfers have totalled
around US$7 billion.  Of the total, around 40% are private transfers and 60% comprise economic aid
(about US$1.8 billion) and military aid (about US$1.2 billion) from the United States and
contributions made via the Jewish Agency and ot her public institutions.  Roughly half of the
Government's external debt is to the United States.8  Moreover, net foreign investment has contributed
substantially to the financing of the current account deficits.  In particular, this was the case in 1998
and was related in part to the acceleration of the privatization programme.  Foreign currency reserves
have steadily increased since 1994, as a result of high domestic interest rates and the resultant inflow
of short-term capital.  Total reserves (excluding gold) amounted to US$22.7 billion in December 1998compared with US$6.9 billion in December 1994.  The increase in reserves has coincided with a
steady real appreciation of the domestic currency, a pattern that was reversed between August and
October 1998 when the currency sharply depreciated.
(3) I
SRAEL 'S ECONOMIC REFORMS
11. During the review period, Israel has undertaken a number of important economic reforms;
implementation was concentrated in the second half of the period.  The Government has implemented
a programme of deregulation of money and capital markets, lifting controls on foreign exchange
flows, has continued with trade liberalization (Cha pter III), and the sale of state assets gained
momentum in 1997 (notably telecommunications and banking) (Chapter III(4)(i)(b)).  Competition
policy has also been strengthened (Chapter III(4)(i)(a)), while segments of the telecommunications
and financial services sectors have been opened up to competition (Chapter IV(4)).  The Governmenthas adopted a plan to open up to competition the en ergy, and transport sectors.  Structural reform to
the wage bargaining process in tandem with a reduction in the cost-of-living adjustment has enhanced
the functioning of the labour market (Box I.1).  Is rael has also reformed its pension and health care
system, while several minor reforms to the tax system  have been implemented.  The remainder of this
section summarizes important reforms, including monetary, fiscal, exchange rate and foreignexchange controls reforms, that are not addressed elsewhere in the report.
(i) Monetary area
12. During the period under review, monetary policy has been aimed at achieving an inflation
target set by the Government, while at the same tim e letting the domestic currency fluctuate within a
diagonal exchange rate band.  Initially, inflation targets were defined for one year, but in 1996 the
Government decided to bring down inflation on a l ong-term basis, to reach a level similar to the
OECD countries by the year 2001.  Monetary policy has been focused on meeting the inflation target
                                                     
7 This ratio, which was around 90% in 1998 down from more than 200% in 1995, is considered by
some analysts as being crucial in determining the likelihood of an attack on a country's currency and thecountry's chances of repelling the attack.
8 The high reliance on the United States as a creditor is largely reflected by a system of U.S. guarantees
on Israeli bonds.  Between 1992 and early 1998, Israel had access to a total of US$10 billion in loan guarantees,
under which Israel could borrow up to US$2 billion per year.  Since 1993, Israel has relied heavily on this
mechanism for external borrowing (EIU, 1998a).Israel WT/TPR/S/58
Page 7
set by the Government, while the policy instrument is the interest rate on Bank of Israel (the central
bank) lending to or deposits from the banks, which is the benchmark for money market interest rates.9
13. A committee (the Levin Committee) was established at the end of 1997 to review the Bank of
Israel Law.  The committee submitted its report to the Government in December 1998, but it has not
yet been discussed by the Government.  The main recommendations of the report include:  (i) making
price stability the main target of the Bank of Israel;  (ii) price stability and the quantitative inflationtargets to meet it, to be set by the Government (after consulting with the Bank of Israel);  (iii) the
Bank of Israel would pursue other Government economic policy objectives, such as growth and
employment, only if the Bank of Israel believes that the objective of price stability will not be
harmed;  (iv) establishing a Monetary Committee, chaired by the Governor of the Bank of Israel, to
set the monetary policy aimed at achieving and maintaining price stability;  (v) allowing the Bank ofIsrael to independently choose and operate its monetary instruments to maintain price stability;  and
(vi) establishing a Board of Directors, chaired by the Governor, which is responsible for the current
budget of the Bank of Israel.
(ii) Fiscal and related area
14. The fiscal policy framework in Israel wa s changed by the Deficit Reduction Law of 1996,
which requires an annual decrease in the targeted domestic budget deficit (excluding credit guarantees
granted by the Government).  Thus, starting in 1996, the fiscal position has improved and the
difference between the actual budget deficit and the target has narrowed.  By law, the Government is
required to reduce its state  budget deficit to GDP ratio to 2% in 1999 and 1.5% in 2001.
15. In 1997, the Government introduced several measures to improve budget monitoring and
control.  The deficit target was changed from th e domestic deficit to the overall deficit, thereby
broadening the coverage of the Government's fiscal position.  Moreover, the 1997 Budget wasadjusted at the beginning of the year to better reflect the actual revenue base from the previous year.
16. Reforms related to the health care and pension systems should ease fiscal pressure over the
medium term.  Israel reformed its pension system in 1995 to put new participants in defined
contribution plans.  However, these new plans still receive an interest subsidy from the Government.
Israel's health system is based on four public health funds, covering about 95% of the population.  TheNational Health Insurance Law of 1994, which came into effect in January 1995, defines the services
to which all Israeli citizens are entitled and the health  tax rates they have to pay.  The law encourages
competition among health funds by removing obstacles to movement between funds, and a system of
complementary insurance has emerged to cover treatments not included in the national insurance
scheme.
                                                     
9 The principal instruments of monetary controls used  by the Bank of Israel are monetary loans to the
banks, deposits posted by commercial banks at the Bank of Israel, and a discount-window facility.  Monetaryloans are colletarized loans to the banks that are allocated to the banking system by periodic auctions of
overnight funds and of deposits of various maturities at the Bank of Israel.  The rate of interest determined
therein is the principal determinant of short-term interest rates in Israel.  Since 1997, the Bank of Israel has alsoused the interest rate on the bank's term deposits at the Bank of Israel for the purpose of achieving the targetlevel of inflation.  These interest rates are closely correlated.  Finally, through the discount window, Israelibanks can obtain limited overnight loans to fill temporary funding needs.  Although the Bank of Israel does notissue its own securities, it also implements monetary po licy by selling un-indexed fixed-rate treasury bills of up
to one year maturity;  such issuance has increasingly b een utilized in recent years (Ministry of Finance, 1998;
and Bank of Israel, 1998c).WT/TPR/S/58 Trade Policy Review
Page 8
(iii) Exchange rate and foreign exchange controls
17. One of the cornerstones of Israel's reforms has been the liberalization of the exchange system.
In September 1993, Israel accepted the obligations of Article VII of the IMF's Articles of Agreement,
removing all remaining constraints on current account transactions.  Within the framework of
liberalization policy, at the end of the 1980s the Bank of Israel also started a process of gradually
removing restrictions on capital flows and rendering the exchange rate regime more flexible.10  The
currency became almost fully convertible after most of the remaining foreign exchange restrictions
were removed in May 1998.  Foreign investment can now move freely into and out of the country,
Israelis can invest abroad, Israeli banks can lend domestic currency to foreign parties and Israelis can
take loans from foreign sources.  There are still some limitations on capital flows of institutional
investors:  provident funds can invest only part of their resources in foreign markets (up to 5%) andpension funds and insurance companies are not allowed any foreign investments.  There are also a few
limitations on some derivatives transactions with non-residents.
(4) T
RADE AND FOREIGN INVESTMENT PERFORMANCE
(i) Trade patterns
18. Israel has for several decades registered large deficits on its trade balance.  During the 1990s
rapid economic growth accelerated imports, causing the trade deficit to rise to 8.7% of GDP in 1995.
However, import levels have since fallen as a result of slowing growth in private consumption as well
as improved terms of trade driven by declining import prices (a substantial drop in world prices for oil
and non-oil commodities, such as food and industrial raw materials).  In 1998, merchandise imports
(expressed in current US dollars) contracted by almost 6%.  Alongside, exports have increased, but at
a diminishing rate.  In 1998, merchandise exports increased by 1% compared with 10% in 1996, a
trend that continued in the first quarter of 1999.  According to the Bank of Israel, this movementappears to be explained by the global slowdown in economic activity
11;  however, the exchange rate
may also have been a contributory factor. Nevertheless, the resulting sharp contraction of the trade
deficit (to 3.3% of GDP in 1998) may be a short-lived phenomenon as renewed growth, as well as a
rise in world prices for oil, is likely to increase the import bill in the near future.
(a) Commodity pattern of merchandise trade
19. The overall commodity composition of Israel's merchandise trade has changed little since the
previous Trade Policy Review conducted in 1994.  Exports are dominated by manufactures,
accounting for 92% of total merchandise exports in 1997 (Table I.3).  Diamonds account for almost
one third of merchandise exports, and machinery and transport equipment (notably office machines
and telecommunications equipment) account for another third.  While the share of diamonds in totalmerchandise exports has remained relatively stable during the 1990s, machinery and transport
equipment (including telecommunications equipment) accounted for much of the rapid increase in
total merchandise exports since the previous Review.  The latter development may reflect government
efforts to encourage research and development to pr omote industrial exports.  Israel has also been
targeting high-technology niches in international markets, such as medical scanning equipment,through trade missions, marketing, and seminars.  The share of agriculture in total merchandise
exports has continued to decline over this period.
                                                     
10 Israel has accepted the obligations of Article VIII, Sections 2, 3, and 4 of the IMF.
11 Bank of Israel (1999c).Israel WT/TPR/S/58
Page 9
Table I.3
Exports by groups of products, 1980-97
(US$ billion and per cent)
Commodity 1980 1990 1991 1992 1993 1994 1995 1996 1997
Total (US$ billion) 5.5 12.0 11.9 13.1 14.8 16.9 19.0 20.5 22.5
(Per cent of total)
Total primary products 17.9 13.3 12.4 10.6 9.3 8.8 8.5 8.7 7.7
Agriculture 15.7 11.0 10.2 8.6 7.5 7.0 7.1 6.9 6.0
   Food 11.7 8.5 7.6 6.5 5.7 5.1 5.3 5.1 4.2
Mining 2.2 2.3 2.1 2.0 1.8 1.8 1.4 1.8 1.7
   Ores and other minerals 1.0 0.9 1.0 0.8 0.8 0.8 0.7 0.7 0.7
   Non-ferrous metals 1.2 0.7 0.6 0.5 0.4 0.5 0.7 0.6 0.6
      Fuels 0.0 0.7 0.6 0.6 0.6 0.5 0.0 0.5 0.5
Manufactures 81.9 86.6 87.5 89.3 90.6 91.1 89.1 91.1 92.1
   Iron and steel 0.7 0.3 0.3 0.2 0.2 0.2 0.2 0.3 0.3
   Chemicals 15.3 13.7 14.0 13.4 14.0 13.7 13.8 12.9 13.6
   Other semi-manufactures 39.8 33.2 32.4 32.3 31.2 33.0 34.1 34.5 34.0
         Diamonds, non- industrial, unset 29.2 29.1 28.0 27.9 27.3 28.9 29.7 30.2 29.9
   Machinery and transport equipment 13.0 24.5 24.0 27.6 31.3 30.9 27.2 29.5 30.5
      Power generating machines 0.4 0.7 0.7 0.5 0.4 0.4 0.6 0.6 0.7
      Other non-electrical machinery 3.4 6.8 6.1 9.6 12.1 11.7 6.9 6.5 5.4
      Office machines & telecom equip. 2.8 10.2 10.3 11.2 12.7 12.6 12.4 14.9 16.6
      Other electrical machines 2.0 3.5 3.4 3.5 3.4 3.6 4.3 4.8 5.0
      Automotive products 0.6 0.3 0.3 0.3 0.2 0.3 0.2 0.2 0.2
      Other transport equipment 3.8 3.0 3.2 2.5 2.5 2.3 2.7 2.4 2.6
   Textiles 3.4 2.2 2.6 2.5 2.2 2.0 2.1 1.9 2.0
   Clothing 4.7 4.0 4.3 4.5 3.9 3.7 3.5 3.2 2.7
   Other consumer goods 5.1 8.6 9.9 8.6 7.9 7.6 8.3 8.8 9.0
        Real jewellery, gold, silver 1.4 2.1 2.7 3.0 2.8 2.4 2.4 2.3 1.8
        Measuring, controlling instrument 0.1 2.6 3.0 1.0 0.8 0.8 0.9 1.3 1.6
        Medical instruments n.e.s 0.3 0.5 0.7 0.8 0.6 0.6 0.7 0.9 1.1
Other 0.2 0.1 0.2 0.2 0.2 0.1 2.4 0.2 0.2
n.e.s Not elsewhere specified.
Source : UNSD, Comtrade database (SITC Rev.1).
20. Manufacturing accounts for about four fifths of merchandise imports, of which machinery and
transport equipment and other semi-manufactures (notably diamonds) are the most important items
(Table I.4).  Fuel is also an important import item, accounting for 8% of merchandise imports in 1997,
while food accounted for another 7%.  The structure of imports by function has remained broadly the
same during the 1990s.  Intermediate goods (including diamonds and fuel) dominate merchandiseimports, accounting for close to 70%, while investment goods account for 17% (1997).
12
(b) Geographic pattern of merchandise trade
21. The Arab boycott continues to be an important obstacle to Israeli trade, however, in recent
years to a lesser extent.  According to the aut horities, the "primary" (direct), "secondary" and
"tertiary" boycotts have had significant effects on trade performance, though the peace process hasproduced some notable changes.
13  In addition, an increasing number of foreign companies have
recognized the value of the Israeli economy and established contacts in Israel.  Since trade with most
of its immediate neighbors has been precluded by the political situation, Israel has concentrated on
trade with more distant markets.
                                                     
12 Central Bureau of Statistics (various issues), Monthly Bulletin of Statistics , Jerusalem.
13 The secondary boycott applies to foreign companies dealing with Israel.  Foreign companies trading
(or investing) with Israel are put on a "black list" and are excluded from doing business with Arab countries.
The tertiary boycott prohibits foreign firms from establishing partnerships or joint ventures with blacklisted
foreign companies.WT/TPR/S/58 Trade Policy Review
Page 10
Table I.4
Imports by group of products, 1980-97
(US$ billion and per cent)
Commodity 1980 1990 1991 1992 1993 1994 1995 1996 1997
Total (US$ billion) 8.0 15.2 16.8 18.7 20.3 23.6 28.2 29.8 28.9
(Per cent of total)
Total primary products 43.2 21.8 19.5 18.9 17.8 16.5 16.4 16.3 18.5
Agriculture 13.2 10.3 9.5 9.0 8.4 8.5 8.2 8.2 8.4
   Food 10.7 7.9 7.4 7.2 6.8 6.9 6.6 6.9 7.1
   Agricultural raw material 2.5 2.4 2.0 1.8 1.6 1.6 1.6 1.3 1.3
Mining 30.0 11.5 10.0 9.9 9.3 8.0 8.3 8.1 10.1
   Non-ferrous metals 2.5 2.0 1.9 1.7 1.6 1.6 1.9 1.6 1.8
   Fuels 26.4 8.8 7.6 7.8 7.4 6.0 6.0 6.1 7.9
      Crude petroleum, etc. 22.4 7.1 6.2 7.1 6.6 5.3 4.8 5.0 5.2
Manufactures 56.5 76.9 79.2 79.6 80.9 82.2 82.0 82.3 81.1
   Iron and steel 3.7 3.2 3.5 3.0 2.9 2.6 3.3 2.5 2.7
   Chemicals 6.3 9.9 9.2 9.5 9.2 8.8 9.1 8.9 9.3
   Other semi-manufactures 20.3 26.9 24.5 24.1 24.4 24.6 24.2 24.2 24.7
      Diamonds non-industrial, unset 15.0 20.1 16.2 16.5 17.4 17.5 16.5 17.0 17.5
   Machinery and transport equipment 21.0 26.9 31.9 32.3 33.3 35.1 34.3 35.3 32.9
    Power generating machines 0.6 1.0 1.2 1.0 1.0 0.7 0.8 0.8 1.5
      Other non-electrical machinery 6.3 6.8 8.4 8.2 8.4 8.6 8.2 7.8 6.8
      Office machines & telecom equip. 4.0 6.1 6.7 6.7 7.4 8.0 8.9 10.1 9.7
         Communication equipment 1.7 1.7 1.9 2.0 2.4 2.7 3.4 3.9 3.5
      Other electrical machines 3.7 4.9 5.3 5.4 5.7 6.1 5.7 6.4 5.8
      Automotive products 4.5 5.9 7.7 9.0 8.6 9.2 8.3 8.0 7.0
         Pass. motor vehicles, excl. buses 1.2 3.3 4.1 5.6 4.9 5.3 5.1 4.7 4.3
         Lorries and trucks 0.8 1.1 1.9 1.8 2.1 2.3 1.7 1.8 1.4
      Other transport equipment 1.9 2.3 2.6 2.0 2.1 2.6 2.4 2.2 2.2
   Textiles 2.1 3.1 3.2 3.4 3.4 3.1 2.9 2.5 2.7
   Clothing 0.2 0.4 0.4 0.6 0.9 0.9 1.0 1.1 1.2
   Other consumer goods 3.0 6.5 6.5 6.7 7.0 7.1 7.3 7.7 7.7
Other 0.2 1.3 1.3 1.5 1.3 1.3 1.5 1.4 0.4
Source : UNSD, Comtrade database (SITC Rev.1).
22. The bulk of Israel's trade is conducted within the framework of free-trade agreements;
in 1998, close to three quarters of Israel's trade (excluding diamonds) was covered by such
agreements.  The European Union - with which Isr ael signed a free-trade agreement in 1975 - is the
principle source of imports (51% of merchandise imports in 1997) as well as the principal market for
exports (30%) (Tables I.5 and I.6).  Israel signed a free-trade agreement in 1985 with the UnitedStates, its second largest trading partner (19% of imports and 32% of exports).  In this regard, it is
interesting to note that Israel is the only countr y that maintains free-trade agreements with both the
EU and the United States.  Trade with other countries with which Israel has recently signed
preferential agreements (Canada, Czech Republic, Hungary, Jordan, Poland, Slovak Republic,
Slovenia and Turkey) is beginning to pick up, albeit from low levels.  Trade with East Asia is alsogaining importance.
(c) Intra-industry trade
23. Intra-industry trade, which refers to the importing and exporting of goods in the same product
category, has continued to increase since 1994 (Chart I.2).  It accounts for some 58% of Israel's total
merchandise trade, up from 41% in 1985, and 55% in  1994.  In 1997, Israel's intra-industry trade with
the EU comprised 43% of the trade between these countries, while its intra-industry trade with the
United States comprised 39%.  The share of bilateral intra-industry trade with East Asia is lower,
albeit growing.Israel WT/TPR/S/58
Page 11
Table I.5
Exports by destination, 1980-97
(US$ billion and per cent)
1980 1990 1991 1992 1993 1994 1995 1996 1997
Total (US$ billion) 5.5 12.0 11.9 13.1 14.8 16.9 19.0 20.5 22.5
(Per cent of total)
America 21.6 32.3 33.5 33.6 34.5 34.8 33.7 34.3 36.2
   USA 17.5 28.8 30.2 30.5 31.2 31.1 30.1 30.6 32.1
   Canada 0.8 0.8 0.8 0.7 0.7 0.6 0.6 0.6 0.7
Europe 52.2 41.0 41.9 40.3 37.2 35.4 39.1 38.7 37.1
   EU15 44.0 36.6 37.2 35.6 30.6 29.3 32.3 32.1 30.1
      United Kingdom 8.4 7.0 6.7 7.7 5.5 5.0 6.1 6.7 6.2
      Belgium-Luxembourg 4.3 5.7 5.8 5.0 5.4 5.4 5.4 5.5 5.0
      Netherlands 4.5 4.5 4.5 4.2 3.7 3.7 4.2 4.3 4.4
      Germany 10.2 5.9 6.7 5.8 5.3 5.0 5.5 5.1 4.3
   EFTA 6.0 2.7 2.5 2.0 2.0 2.2 2.0 1.7 2.0
   East Europe 0.8 0.6 0.9 1.6 3.5 2.9 3.6 3.6 3.4
   Other Europe 1.5 1.1 1.2 1.1 1.1 1.0 1.2 1.3 1.6
      Turkey 0.7 0.7 0.9 0.9 0.9 0.8 1.0 1.0 1.1
Asia 11.7 16.4 14.9 15.9 16.9 18.8 20.2 20.3 18.9
   Middle East 0.5 0.3 0.2 0.2 0.2 0.2 0.3 0.4 0.6
   East Asia 11.1 15.3 14.0 14.6 15.0 16.4 18.0 18.1 16.6
      Hong Kong, China 4.5 4.4 4.6 5.1 4.9 5.0 5.1 5.2 5.3
      Japan 4.2 7.2 6.1 5.3 5.2 5.8 6.9 5.9 4.6
      Korea, Rep. of 0.2 0.4 0.6 0.7 0.9 0.9 1.6 1.8 1.8
   South Asia 0.1 0.8 0.7 1.0 1.6 2.2 1.8 1.8 1.8
Africa 3.5 1.4 1.6 1.7 1.8 1.7 1.9 1.9 2.1
Other 11.0 8.8 8.1 8.5 9.6 9.3 5.2 5.0 5.6
Source : UNSD, Comtrade database (SITC Rev.1).
Table I.6
Imports by country of purchase, 1980-97
(US$ billion and per cent)
1980 1990 1991 1992 1993 1994 1995 1996 1997
Total (US$ billion) 8.0 15.2 16.8 18.7 20.3 23.6 28.2 29.8 28.9
(Per cent of total)
America 22.1 19.9 21.6 19.1 19.5 19.8 20.4 21.6 21.0
   USA 19.3 17.9 19.5 17.3 17.9 18.0 18.6 20.0 18.8
   Canada 1.0 0.9 0.8 0.6 0.5 0.7 0.8 0.6 1.0
Europe 49.6 61.6 59.9 60.9 60.6 62.4 61.3 59.8 59.5
   EU15 39.0 51.5 49.9 52.4 51.6 53.6 51.8 51.2 51.0
      Belgium-Luxembourg 5.0 13.3 11.2 12.8 12.3 12.9 12.2 12.2 12.5
      Germany 9.9 11.8 12.0 12.0 10.5 10.5 9.7 9.4 9.4
      United Kingdom 8.6 8.5 8.0 7.8 8.5 8.5 8.0 8.5 8.2
      Italy 4.4 6.1 6.5 7.0 7.4 7.8 7.8 7.6 6.9
      Netherlands 2.8 3.5 3.4 3.3 3.4 3.3 3.4 3.2 3.8
   EFTA 8.5 8.9 8.3 7.1 7.2 6.4 6.1 5.7 5.5
   East Europe 1.6 0.8 1.1 0.9 1.2 1.4 1.9 1.5 1.5
   Other Europe 0.4 0.3 0.6 0.5 0.6 1.0 1.5 1.4 1.4
      Turkey 0.1 0.2 0.5 0.4 0.5 0.7 0.9 0.8 1.2
Asia 2.5 7.0 8.2 9.6 10.2 9.8 10.2 10.4 11.0
   Middle East 0.0 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.2
   East Asia 2.3 6.4 7.7 9.0 9.4 9.0 9.4 9.4 9.8
      Japan 1.5 3.6 4.4 5.3 5.1 4.1 3.3 3.7 3.6
      Hong Kong, China 0.3 0.8 0.9 1.0 1.2 1.2 1.3 1.4 1.5
   South Asia 0.2 0.5 0.4 0.4 0.7 0.7 0.7 0.8 1.0
Africa 2.1 1.8 1.8 1.8 1.6 1.4 1.5 1.3 1.3
Other 23.7 9.6 8.4 8.7 8.2 6.6 6.7 6.9 7.2
Source : UNSD, Comtrade database (SITC Rev.1).WT/TPR/S/58 Trade Policy Review
Page 12
010203040506070
1994 1997 1994 1997 1994 1997 1994 1997Per cent
Source :     WTO Secretariat.Chart I.2
Intensity of Israel's intra-industry tr ade with selected regions, 1994 and 1997
World
EU15United States
East Asia
(d) Trade in services
24. Israel runs a deficit in services, amounting to almost US$1 billion in 1998, equivalent to 1.0%
of GDP (Table AI.1).  All of the largest services components on both payments and receipts - travel,
and freight and transportation - are in deficit.  While tourism in Israel generated US$2.7 billion
in 1998, Israelis travelling abroad spent US$3.6 billion.  In the same year, freight and transportation
receipts were US$2.1 billion, and payments amounted to almost the double.
(ii) Foreign direct investment and portfolio investment14
25. While foreign investment is a small share of total investment, Israel relies heavily on private
investment to finance its current account deficit.  As noted by the Bank of Israel, the ability to finance
Israel's current account deficit without increasing the debt burden depends on the persistence of the
inflow of foreign (in particular the less volatile direct) investment, which in turn depends on the
implementation of a sound economic policy.15
26. Net private investment by foreign residents in Israeli assets has steadily increased since 1994
from US$3 billion (equivalent to 4.0% of GDP) to r each a peak of US$4.6 billion in 1997 (Table I.7),
thereafter dropping to US$3.4 billion in 1998.  Over  the same period, the flow of investments by
foreign residents into Israel has multiplied seve ral times to US$8.3 billion in 1998.  Between 1995
and 1998, about 37% of total foreign investment in Israel was in the form of direct investment.  The
effects of recent foreign currency liberalization may have contributed to increased foreign directinvestment.  The long-term evolution of foreign direct investment is mainly the result of a relatively
                                                     
14 The definition of portfolio and direct investment varies from country to country.  In Israel, direct
investment is defined as negotiable shares and negotiabl e convertible securities amounting to more than 10% of
the company's equity, non negotiable securities, share hold ers' loans, and real estate.  Portfolio investment is
defined as financial assets which are negotiable securities.
15 Bank of Israel (1998b).Israel WT/TPR/S/58
Page 13
free investment regime together with Israel's long standing policy of encouraging inward foreign direct
investment (Chapter II(4)).
Table I.7
Foreign investment, 1990-98a
(US$ billion)
1990 1991 1992 1993 1994 1995 1996 1997 1998
Foreign investment in Israel and Israeli investment abroad:
1. Net investment of foreign residents 0.1 0.1 0.0 0.3 0.5 1.6 1.2 2.0 1.7
Investment by foreign residents 0.3 0.4 0.8 5.3 1.8 3.4 3.4 6.8 8.3
- Quoted securitiesb0.0 0.1 0.4 4.8 1.0 1.8 1.8 4.4 5.7
- Direct 0.3 0.3 0.4 0.4 0.8 1.6 1.6 2.4 2.6
- State of Israel bondsc0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Repatriation of investment by foreign residents 0.2 0.3 0.7 5.0 1.3 1.8 2.2 4.9 6.6
2. Net investment abroad by Israelis 0.2 0.6 1.3 0.6 0.3 0.5 0.5 0.7 0.8
Investment abroad by Israelis 0.4 1.4 2.6 3.2 1.4 1.5 3.0 2.4 2.7
- Securities 0.2 1.0 2.2 2.4 0.7 0.8 2.0 1.4 1.2
- Direct 0.2 0.4 0.5 0.7 0.7 0.7 1.0 1.0 1.5
Repatriation of investment by Israelis 0.2 0.7 1.3 2.6 1.1 0.9 2.5 1.6 1.9
3. Net private foreign investment (1-2) -0.1 -0.5 -1.3 -0.2 0.2 1.0 0.7 1.2 0.9
4. Foreign securities held by banks 0.4 -0.1 0.3 0.8 0.6 -0.1 -0.1 0.0 0.3
5. Total net foreign investment (3-4) -0.5 -0.4 -1.6 -1.0 -0.4 1.1 0.8 1.3 0.6
Net foreign investment in Israeli assets traded abroad:
Quoted securities 0.0 0.0 0.2 0.3 0.4 0.6 1.1 1.3 0.3
State of Israeli bonds -0.1 0.2 -0.1 1.8 2.1 0.5 1.5 1.1 1.0
Directd0.0 0.0 0.0 0.0 0.0 0.1 0.5 0.2 0.3
6. Total -0.1 0.2 0.1 2.1 2.5 1.2 3.1 2.6 1.7
Net private investment by foreign residents in Israeli assets (1 + 6)
0.0 0.3 0.1 2.4 3.0 2.8 4.3 4.6 3.4
a Figures may not add due to rounding errors.
b Securities traded in Tel Aviv Stock Exchange (TASE).c Bonds redeemed for reinvestment.
d Mergers and acquisitions of traded assets.
Source : Data supplied by the Bank of Israel (Controller of Foreign Exchange).
27. Foreign direct investment is typically concentrated in a few projects.  Thus, data on gross
foreign direct investment by sector - excluding investment transactions below US$0.1 million and
direct investment in real estate and equity-holders ' loans - fluctuate substantially from year to year.
For example, in 1997 two investments (in Bank Hapoalim and the purchase of the shares in the
Migdal Insurance Company in Generali) accounted for 40% of gross direct investments (excluding
real estate).16  While the financial services sector accounted for 49% of net direct investment in 1997,
the sector accounted for only 4% of the inflows during the previous year (Table I.8).  In 1998,electricity and electronics, followed by software and communications were the major recipients of
foreign investment.
28. By the end of 1998, the Israeli private sector ha d holdings of about US$5 billion in direct
investments abroad.  Financial investments abroad, which had increased in 1991-92 in response to
foreign currency liberalization, dropped during 1994 and 1995 in reaction to the yield differentialsbetween Israel and overseas, but  picked up again (Table I.7).
                                                     
16 Bank of Israel (1998b), p. 151.WT/TPR/S/58 Trade Policy Review
Page 14
Table I.8
Distribution of non-residents' gross direct investment in Israel by industry, 1996-98
(Per cent of total, and US$ million)
1996 1997 1998
Total manufacturing 30 14 56
Electricity and electronics 10 7 38
Chemicals 83 1 0
Foodstuffs 730
Other manufacturing 4 1 7
Commerce -1 2 6
Construction and real estate 0 1 2
Total services 60 78 31
Software and communications 52 20 15
Financial services 44 9 5
Other services 49 1 2
Other 11 4 5
Memo :  Total 1,012 1,341 1,597
Note: Data only include investment transactions over US$100,000 in 1996-97 and over US$50,000 in 1998, and exclude direct
investment in real estate and equity-holders' loans.
Source : Data supplied by the Bank of Israel (Controller of Foreign Exchange ).
(5) OUTLOOK
29. The Israeli economy is currently expanding below its potential.  While GDP is projected to
grow at 2% in 1999, it increased by an annual average of 6% during the first half of the 1990s.  Theslowdown in growth is attributed to several factors,  including the ebbing of the stimulative effects of
the immigration waves, tight monetary and fiscal po licy, and external factors such as the slowdown in
world growth.
30. However, Israel's high human capital stock, the recent invigoration of the privatization
programme, the liberalization of current account transactions, and the enhancement of marketexposure to competition are factors that should c ontribute to Israel's future growth path.  The
continued tightening of the fiscal position, taking place according to a preannounced schedule, in
combination with an appropriate mix of monetary policy, will also enhance the growth prospects in
the medium and long term.  The improved fiscal deficit should alleviate some pressure on the current
account, which, in turn, may mitigate potential pressures for protectionism.  Unless reversed, therecent real depreciation and increasing export profitability should also boost Israel's export
performance, exports traditionally being the largest component of GDP growth.