Recent Developments and Outlook

Ministry of Finance

January 2011

State of IsraelMinistry of Finance

Recent Economic Developments

3

GDP GrowthQuarter-on-Quarter at Annual Rate, 2004Q1-2010Q3

3.1%

5.9%

3.2%

5.6%

4.3%

7.2%7.7%

-1.7%

6.3%5.8%

5.1%

6.7%

3.3%

0.7%

-2.7%

1.2%

3.6%

4.5%4.9%

4.4%

6.2%

4.6%

-1.6%

6.2%

8.0%

6.9%6.8%

-5%

0%

5%

10%

2004 2005 2006 2007 2008 2009 2010

Rapid recovery since the second half of 2009.

4

GDP GrowthAnnual Percentage Change , 1995-2012

4.0%3.8%3.6%

0.8%

4.2%

5.3%5.7%

4.9%5.1%

1.5%

-0.6%-0.1%

9.1%

3.3%4.1%

3.3%

5.6%

6.5%

-2%

0%

2%

4%

6%

8%

10%

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

*

2011

*

2012

*

*Budget estimates.

5

1.2%

1.6%

3.7%

4.5%

4.9%4.9%

1.7%

4.1%4.4%

1.6%

2.0%

3.2%

0%

2%

4%

6%

Israel United Kingdom USA Euro Area

2010 Q1 2010 Q2 2010 Q3

GDP Growth in Israel, USA, UK and the Euro Area The 1st, 2nd, 3rd Quarters of 2010 at annual rate

Source: EuroStat, BEA, CBS.

6

The Global Economic Crises had a Moderate Impact on Israel:

A strong starting position:

Israel experienced 5 years of high GDP growth led by the private sector

Low levels of unemployment in an historical perspective and steady improvement in the participation rate in the last few years

Maintaining fiscal discipline

A continues surplus in the current account

A bubble did not develop in the real estate market

The Israeli capital market did not offer complex financial instruments

A stable banking system

A timely and targeted reaction by policy makers

7

-12.9%

-12.3%

-9.9%

-9.8%

-8.6%

-6.5%

-5.0%

-4.8%

-3.7%

0.7%

3.6%

7.0%

-15% -10% -5% 0% 5% 10%

Japanese Yen

Australian Dollar

Thai Baht

Swiss Franc

Singpore Dollar

New Israeli Shekel

Canadian Dollar

Brazilian Real

South Korean Won

Russian Rubel

British Pound

Euro

Exchange rates US$ vs. Others Currencies, 31/12/2010 vs. 31/12/2009

8

Balance of Payments - The Current AccountUS$ Billions & As Percent of GDP, 2000-2010

-0.8%-0.8%

3.1%

5.1%

2.9%0.8%

3.9% 3.7%

2.3%

1.2%

-1.0%

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010*

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

Percent of GDP

\

*2010 first 3 quarters annualized.

The current account surplus contributed to the appreciation of the shekel.

9

Exports and Imports of GoodsUS$ billions per month, excl. diamonds, ships & airplanes

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

2006 2007 2008 2009 2010

Exports

Imports

Exports recovery began in the second half of 2009, although in recent months exports of goods had slowed.

10

Composition of Industrial Exports1995-2010

0

5

10

15

20

25

30

35

40

45

1995 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

US

$ b

illi

ons

Traditional Industries

Advanced Industries

35%

65%

23%24%

76%77%

28%

73%

25%

27%

75%73%

27%

72% 75%

25%

25%

75% 78%

22%

27%

73%78%

22%

11

Destination of ExportsExcluding diamonds, aircraft & ships, US$ billions

0

2

4

6

8

10

12

14

16

18

20

European Union USA Other Countries

2008 2009 2010

Diversification of export destinations continued during the years 2009-2010

12

The Unemployment and Participation Rates

8.9% 8.7%

9.3%

10.3%10.8%

10.3%

9.0%

7.7%

6.9%6.4% 6.6%

7.6%

8.4%

7.3%

6.1%

7.3%

4%

6%

8%

10%

12%

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2009

Q3

2009

Q4

2010

Q1

2010

Q2

2010

Q3

52%

53%

54%

55%

56%

57%

58%

59%

60%

Participation rate(right axis)

Since the second half of 2009 there has been a significant decrease in the unemployment rate.

13

Real Wages 1999-2010, 2004 prices, CPI-adjusted

7,2467,340

6,794

6,783

6,997

6,8226,8236,802

7,152

6,971

6,6136,524

6,8436,947

7,4927,392

7,2687,160

7,236

7,747

7,503

7,038 7,056

7,440

6000

6500

7000

7500

8000

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010*

Public Services

Business Sector

*Jan – October average, seasonally adjusted.

In the last decade there has been very little change in real wages.

14

2,000

4,000

6,000

8,000

10,000

12,000

14,000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

2,000

4,000

6,000

8,000

10,000

12,000

Housing Starts, Housing units per quarter (Left axis)

Fixed Investment in Residential Consruction, SA, (Right axis)

Housing Starts and Fixed Investment in Residential Construction2000-2010q3

The increase in building permits led to a rise in housing starts. This is expected to expand supply in the residential market.

Units Per Q Mil NIS

17

-1%

2.0%

3.0%

-3%

-2%

-1%

1%

2%

3%

4%

5%

6%

Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 01/11

Real interest rate

BOI interest rate

Inflationexpectations

BOI Interest Rate, Short-Term Real Interest Rate and Inflation Expectations, 2005-2010

Although the BOI rate is rising, real interest rate remains negative

18

Official Reserves (Held by the Bank of Israel)1999-2010

5

10

15

20

25

30

35

40

45

50

55

60

65

70

75

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

0

2

4

6

8

10

12

14

Billions of US Dollars

In Months of Imports (Right Axis)

19

Market Indexes, January 2006=100, Monthly Average

40

50

60

70

80

90

100

110

120

130

140

150

160

170

180

Jan-0

6

Jul-0

6

Jan-0

7

Jul-0

7

Jan-0

8

Jul-0

8

Jan-0

9

Jul-0

9

Jan-1

0

Jul-1

0

Tel Aviv 100

Nasdaq

EEM

Source: TASE, Bloomberg

Israeli stock and corporate bonds markets exhibit positive correlation with global counterparts.

20

Risks to the Global Economic RecoverySince mid-2009 there are clear indications that the global crisis is

subsiding. But global downside risks remain a concern:

Deterioration of Global Fiscal Positions. Premature Exit from Accommodative Fiscal and Monetary

Policies. Potential of Asset Price Bubbles Abroad. Remaining Stress in the Financial Sector. Imbalances in the Global Economy. Potential for Protectionist Policy. Long Term Effects in the Labor Market.

Israel, as a small and open economy, is largely affected bydevelopments in the global economy.

Policy Issues

22

3.7%

0.6%

4.1%

3.5%

5.2%

3.5%

1.8%

1.0%

0.0%

2.1%

5.2%

2.0%

2.9%

6.0%

5.5%

3.0%

2.0%

1.0%

1.5%

0%

1%

2%

3%

4%

5%

6%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011** 2012** 2013 2014

Est.Budget DeficitTarget

• The budget deficit in 2010 was 3.7 % GDP (compared to budget ceiling of 5.5%).

•According to two-year budget, the deficit is projected to be close to the ceiling in 2011-2012.

Central Government's Budget Deficit as Percent of GDP, 2000-2014

Source: CBS, MOF*EST.** PROJ

23

Fiscal Rule – Expenditure Side

1. Adoption of the New Fiscal Rule into the 2011-2012

Budget

– Spending growth cap calculated as follows:

– An increase in expenditure depends on a decrease in the Debt/GDP

ratio.

– When the Debt/GDP ratio declines to 60%, expenditures can be

raised by the average real GDP growth of the last 10 years.

Debt/GDP Target)Maastricht Criteria(

-----------------------Current Debt/ GDP

Average GDP growth in the last 10 years* =* 3.5%= 2.6%

60% ---------

80%

24

Fiscal Rule - Deficit Ceiling Reduction of Deficit/ GDP ratio according to a deficit ceiling law.

YearDeficit Ceiling

20105.5% Target, 3.7% Actual

20113.0%

20122.0%

20131.5%

2014 and on1.0%

The government must implement the more effective of the two rules.

25

6.2

8.8

5.5

6

6.5

7

7.5

8

8.5

9

9.5

10

10.5

Jan-07

Apr-07

Jul-07

Oct-07

Jan-08

Apr-08

Jul-08

Oct-08

Jan-09

Apr-09

Jul-09

Oct-09

Jan-10

Apr-10

Jul-10

Oct-10

Income taxesConsumption Taxes

Income and Consumption Taxes

)Billion of Nis, December 2010 prices, Seasonally adjusted(

Taxation revenue in 2010 was 195.4 BN NIS, 12.3

BN NIS higher than planned.

26

General Government Expenditure as Percent of GDP, 1995-2010

51.8%

49.2%

47.2%

49.6%50.8%

47.3%

43.6% 43.1%44.6%

52.1%

43.0%43.0%44.7%

45.3%

50.1%51.6%

50.3%

35%

40%

45%

50%

55%

60%

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 OECDAVERAGE

2010*

* Weighted average; Source: OECD

The government cut expenditure in order to divert resources to the private sector.

27

General Government Expenditure,

as Percent of GDP, 2009

5956 56 56 54

52 52 52 52 51 51 51 50 50 49 48 4846 46 46 45 45 45 45 45 44 43 42 42 42 41

33 32 32

25

30

35

40

45

50

55

60

65

Denm

ark

Sweden

France

Finlan

d

Belgiu

m Ita

ly

Austria

Nether

lands

Icela

nd

United K

ingdom

Portuga

l

Euro are

a

Gre

ece

Sloven

ia

Hungar

y

Irela

nd

Ger

man

y

Czech

Rep

ublic

Norway

Spain

Estonia

OECD A

vera

ge*

New Z

eala

nd

OECD T

otal

Poland

Canad

a

Isra

el

Luxembourg

Japan

United S

tate

s

Slovak

Rep

ublic

Switzer

land

Kor

ea

Australi

a

* Weighted average; Source: OECD

28

5755 54 53 53

51 51 50 50 49 49 48 48 4846 46

45 45 44 44 43 43 42 4241 39

37 36

3330 30

25

30

35

40

45

50

55

60

65

Denm

ark

Sweden

Finlan

d

France

Belgiu

m

Icela

nd

Austria

Italy

Nether

lands

Portu

gal

United K

ingd

om

Slove

nia

Hunga

ry

Irela

nd

Gre

ece

Ger

man

ySpai

n

Czech

Rep

ublic

Norway

New Z

eala

nd

Estonia

Poland

Canad

a

OECD A

vera

ge

Japan

Slova

k Rep

ublic

United S

tates

Isra

el

Switzer

land

Austral

ia

Kor

ea

*General government expenditure excluding military expenditure.Source: Sipri Yearbook 2010, OECD.

General Government Civil Expenditure*, Percent of GDP, 2009

29

Public and Government Debt, as percent of GDP, 1995-2010

102.2100.1 99.4

100.8

84.4

88.8

96.699.0

97.4

93.5

84.4

77.8 77.179.3

77.7

100.7

70

75

80

85

90

95

100

105

110

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

*

Public Debt

Government Debt

*MOF Estimate.

Strong fiscal discipline and high growth rates in 2003-2008 led to a reduction in the Debt/GDP ratio.

30

0

20

40

60

80

100

120

140

160

180

200 20102007

Increase in Public Debt between 2007 & 2010, as Percentage of GDP

Maastricht: 60% Debt

Source: OECD, Israel 2010 - MOF estimates

The rise in the Israeli public debt is relatively moderate. The current public debt-GDP ratio is close to OECD

average.

31

Public Debt, as percent of GDP, 2010-2025

40%

45%

50%

55%

60%

65%

70%

75%

80%

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025

3.3% Growth rate

Debt GDP ratio is expected to decline

steadily to 60% around 2020.

Key Economic Policies

• Internal Growth Engines

• Insuring the Future of Advanced Sectors

• Human Capital - Maintaining the High Level of Education

• Improving Infrastructure

• Active Labor Market Policies

• Improving the Public Sector's Efficiency

• Responsible Fiscal Policy

• Bi-annual Budget

• Fiscal Rule