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Country Report Israel

Country Report

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Economic growth in Israel is expected to slow in 2013 but pick up in 2014 as gas output increases. The new government has an opportunity to push through reforms. Tensions with Syria and Iran will continue in the forecast period.

Strengths and weaknesses

Strengths

Strong institutions

Israel has strong institutions and a well-developed education system, which have led to high human development indicators and a high GDP per capita.

Diverse and advanced economy  

Israel has a modern and advanced economy and the business environment promotes innovation. It has an open economy and the agricultural, industrial and services sectors are all well-developed.

Weaknesses

Heightened geopolitical risks

Tensions with Iran over its nuclear proliferation program and with Syria over alleged armaments to Hezollah  are expected to remain high.

Conflict with Palestine to continue

Negotiations about the territorial dispute over the West Bank and Gaza Strip between the UN, Israel, and Palestine (Hamaz and Fatah) are ongoing and unlikely to be resolved soon.

Key developments

1. Economic growth slowdown expected to reverse

After two years of robust expansion, economic growth slowed to 3.2% in 2012, the lowest growth since 2009. Growth in 4Q12 was affected by a conflict with Hamas, which according to the Bank of Israel knocked 0.15% off GDP.  Also, energy supply disruptions from Egypt is necessitating expensive imports, hurting the performance of energy-intensive industries. External demand has been affected by the euro zone peripheral crisis and sluggish US growth in 2012; these regions are Israel’s largest export markets. In 2013, we expect this slowdown to continue and GDP growth is estimated at only 2.3%. This slowdown is reflected in part in an easing of investment on gas projects and residential construction. Tax hikes will hit private consumption, which was also affect-ted by rising housing costs. But we expect the trend of slowing growth to reverse in 2014, as it will by then be pushed by gas production as exploitation from the offshore Tamar field which came online at the end of March 2013. The economy will benefit over 2014 from both the ramping-up of production and the reduction of fuel imports, which is expected to add 0.8% to GDP growth. 

Figure 1: Growth expected to rebound
Figure 1: Growth expected to reboundSource: EIU
Figure 2: High human development
Figure 2: High human developmentSource: See factsheet

2. Prime Minister Netanyahu loses power in new government

Mr. Netanyahu's party, Likud-Beiteinu, fared poorly in the January 2013 elections, winning only 31 seats (out of 120) in the Knesset (parliament), far short of the 61 needed for a parliamentary majority. As Yesh Atid and Jewish Home formed a negotiating alliance that Mr Netanyahu was unable to break, he was forced to form a coalition with them both. It is the first coalition in a decade without ultra-orthodox parties. It has the opportunity to undertake economic reforms that could tackle the contentious social and economic issues that are holding back the economy. The coalition also appears more committed to fiscal discipline than the previous administration. There appears to be consensus between the leaders of the main coalition partners on the key areas of economic reform. However, this may not be shared by all in Likud. Divisions could also arise as the leaders of Yesh Atid and Bayit Yehudi have starkly different views over talks with the Palestinians. In addition, the new parties face high expectations from the electorate that cannot easily be satisfied and Israel has a history of parties based around personalities that rise and then fall rapidly. It is unusual for a government in Israel to last a full term, but it is too early to tell how this government will fare.

3. Tensions with Iran will continue

The tensions over Iran’s nuclear proliferation program have become more pronounced this year. Israel has drawn a so-called “red line”, which Iran’s nuclear program should not cross. In February, Mr. Netanyahu stated that “the international community needs to increase sanctions and make clear that if Iran continues with its program, there will be military sanctions”. During a visit to Israel in April, US defense secretary Chuck Hagel, stressed the extent to which the US and Israel see eye-to-eye on the issue. However, Hagel also said that there might be some differences over estimates for Iran’s nuclear development timeline and he mentioned that Israel has the right as a sovereign nation to unilaterally attack Iran. This could be a hint that the US dovish views have hardened, but also an excuse for the US to rapidly finalize their USD 10bn arms sale to Israel, the reason for Mr. Hagel’s visit. Even so, we do not expect tensions to escalate to a unilateral attack by Israel, especially as it lacks the arms to decimate Iran’s nuclear facilities in a single strike and since talks between Israel, the US, Iran and the UN Security Council are ongoing. However, the longer the situation goes unresolved, the greater the risks will become.   

4. Tensions with Syria and Hezbollah increased, but unlikely to escalate

Tensions with Syria have increased after several attacks on Syrian soil by Israel this year.. The Israeli government has issued repeated and increasingly detailed warnings to the Syrian regime about transferring what it regards as "game-changing" arms to Hezbollah that would alter the balance of power between Israel and the militant group. The Israeli defense establishment is particularly concerned about the fact that, if SA-17 anti-aircraft missiles fall into the hands of Hezbollah, it could limit Israel's freedom of movement in Lebanese skies and damage its intelligence-gathering capabilities. There is a risk that this could precipitate a wider conflict with Hezbollah. Since Israel fought a month-long war with the Shi’a group in 2006, the border with Lebanon has remained quiet apart from this year’s attacks. At the moment, however, Hezbollah's statement portraying the raid as a purely Syrian affair suggests that the group is not looking for a pretext to go to war. Also, retaliation by the Syrian regime seems unlikely, given its domestic preoccupations and lack of military capacity to fight Israel. The peace talks between Israel and Palestine concerning the territorial dispute over the Gaza Strip and West Bank remain stalled. We expect no progress in the peace talks, especially after Israel deepened grievances of Palestine by announcing a further push of the settlement construction in the disputed areas, just after Palestine won non-member observer status at the UN in November 2012. 

Economic indicators of Israel
Economic indicators of IsraelSource: EIU, CIA World Factbook, UN, Heritage Foundation, Transparency International, Reporters Without Borders, World Bank.

Background information

While Israel has long claimed to be the only democratic state in the region, it has been under international scrutiny for the de facto changing of the borders established in 1967 with the Palestine territories, thus in effect occupying the West Bank and Gaza Strip. Israel has a mulit-cultural society, since not only a large part of the population is of Palestinian background, the dominating Jewish population is a heterogeneous melting pot of mainstream ‘Jews from everywhere’. This led to a highly fractious political landscape, in which several parties form a coalition but with very little common ground and stubborn personalities. The conflictuous nature of domestic politics means coalitions seldom last a full term. Also, as the discussions revolve around the Palestinian or other geopolitical conflicts, meaningful socio-economic reforms are hardly implemented. Israel has a technologically advanced market economy with substantial, though diminishing, government participation. Due to limited natural resources (apart from new finds of huge gas reserves and some potash), Israel has intensively developed its agricultural and industrial sectors over the past 20 years. The economy is open and flexible and Israel is significantly oriented towards advanced economies. Israel imports substantial quantities of grain, but is largely self-sufficient in other agricultural products. Israel spends a higher proportion of its GDP on private research and development than any other country in the world. The high-tech nature of the economy is to a large extent driven by military security needs, but has significant spill-over effects to civilian industrial applications.

Economic indicators of Israel
Economic indicators of IsraelSource: EIU
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