In January 2005, Standard & Poor's Ratings Services raised its outlook for Israel from negative to stable and affirmed Israel’s 'A-/A-1' foreign currency and 'A+/A-1' local currency ratings.

According to S & P credit analyst David Cooling: "The revision of the outlook reflects the narrowing of the budget deficit in 2004, prospects for medium-term fiscal consolidation underpinned by the U.S. loan guarantee program, renewed economic growth, and a significant improvement in the balance of payments. At the same time, geopolitical risks have also stabilized, following a reduction in the level of violence, and the prospect of a new Palestinian leadership to reinvigorate the stalled peace process."

In February 2005, Fitch Ratings revised the outlook on Israel's long-term local currency rating from negative to stable. It also affirmed the long-term local currency rating at 'A', the long-term foreign currency rating at 'A-', outlook stable, and the short-term foreign currency rating at 'F1'.

"The improved local currency rating outlook reflects a decline in Israel's public debt ratio in 2004 and better medium-term debt dynamics," said Richard Fox, Senior Director in Fitch's Sovereign team. "Demonstrable spending control and a political commitment to spending restraint and deficit limitation lead Fitch to conclude that the debt ratio has at least stabilised and will probably trend down in the medium-term, albeit gradually. This marks a significant, if not decisive, turning point in Israel's public debt dynamics."

Israel's economy in brief

Once a traditional economy based mainly on agriculture, light industry and labor-intensive production, Israel has matured into a knowledge-based economy with internationally competitive telecommunications, IT, electronics, and life sciences industries.  As a result of its small size and limited natural resources, Israeli industry is export-driven and capitalizes on a highly skilled, educated and innovative workforce.

In addition, Israel serves as a trade bridge to three continents with Free Trade Agreements with the US, the European Union, Canada, Mexico, EFTA nations, and many Eastern bloc countries. These factors, as well as a highly developed infrastructure and investor-friendly business environment, are attracting foreign investors. 

Foreign investment increased dramatically in the 1990s with the growth of the high-tech industry. In 1992, total foreign investment in Israel was $537 million; in 2004, that figure was $5.3 billion. Israel also became a magnet for venture capital to invest in Israeli start-up companies. 

International high-tech firms have been eager to set up shop in Israel, attracted by the country’s skilled workforce, R&D capabilities and government-sponsored incentive programs. US companies continue to establish offices and subsidiaries in Israel and to expand existing facilities. 

Summary of the Israeli economy in 2004

GDP increased by 4.2 percent in 2004 (following an increase of 1.3% in 2003 and a decrease of 0.7% in 2002) and business-sector product by 6 percent, against the backdrop of economic recovery worldwide and a certain easing of the security situation in the region. This growth was accompanied by a rise in employment, mainly in the business sector, reflecting a moderate downward trend in unemployment, from a peak of 10.9 percent in the third quarter of 2003 to 10.2 percent in the third quarter of 2004, alongside a rise in the participation rate in the labor force and a rise in labor productivity.

Source: Ministry of Finance

The population of Israel increased by 1.7% in 2004, so that the per capita GDP rose by 2.4%, following a decline of 0.5% in 2003. The per capita GDP in 2004 amounted to NIS 77,200 ($17,200) in current prices.

Source: Ministry of Finance

Domestic Economy (in $ U.S.)	2002	2003	2004
Gross Domestic Product (GDP):	$104.2 billion	$110.4 billion	$117.2  billion
GDP Growth Rate:	-0.7%	+1.3%	+4.2%
Total Foreign Investment:	$3.4 billion	$5.5 billion	$5.3 billion (first 11 months)
Exports of Goods and Services:	$38.6 billion	$42.4 billion	$50.1 billion

(Source: Central Bureau of Statistics, Bank of Israel, Ministry of Finance, Ministry of Industry and Trade)

Foreign Trade

Exports of goods and services increased by 14.0% in 2004, following an increase of 6.2% in 2003 and a decline of 2.4% in 2002. Exports of manufacturing industries (excluding diamonds) increased by 16.2% in 2004, following a 4.6% increase in 2003. This increase reflects an expansion of exports in most manufacturing industries. Agricultural exports increased by 18.3%, following an increase of 5.8% last year. Exports of tourism services rose sharply by 30.0%, following a mdoest increase of 4.0% in 2003 and a marked decline in 2002. In addition, exports of diamonds increased by 5.1%.

Throughout 2004 industrial exports across all levels of technology increased at double-digit rates. The high-tech sectors benefited from a significant increase in global demand for technology, and from the rapid pace of growth recorded in 2004 in the US economy, as well as in additional countries. As a result, high-tech exports from Israel increased approximately 22% during the year. Similar growth rates were recorded as well among medium-technology sectors (chemicals, machinery, and equipment).

Exports of traditional low-tech goods increased rapidly as well. Many industrial sectors in which Israel is not thought to have a comparative advantage showed impressive rates of export growth during 2004. For example, exports of rubber and plastic goods amounted to approximately US$1.5 billion in 2004, representing an increase of about 17% compared to 2003, and 39% compared to 2002. Another notable sector was metals, where exports amounted to approximately US$1.4 billion in 2004, compared to US$1.0 billion in 2003. Other traditional industries such as textiles and clothing, wood and furniture, and mining and quarrying all succeeded in significantly increasing their exports in 2004.

Imports of goods and services, in constant prices, increased by 12.5% in 2004, compared with a 1.8% decline in 2003 and a 2.1% decline in 2002. Imports of goods and services, excluding defence imports, ships, aircraft, and diamonds, increased by 13.4% in 2004 compared with a decline of 1.6% in 2003 and 6.4% in 2002.

The deficit in the account of goods and services (excluding defence imports) amounted to US$81 million in 2004, compared with a surplus of US$132 million in 2003.

Expenditure

In 2004 private consumption expenditure increased by 5.3%, following an increase of 1.3% in 2003. This increase reflects a rise in current consumption expenditure (total consumption minus durable goods) and in the expenditure for consumption of durable goods.

Government consumption expenditure declined this year by 2.3%, following a decline of 2.0% in 2003. This development reflects a decline of 4.6% in security consumption, and 1.3% in civilian consumption.

Per capita private consumption expenditure rose by 3.5% this year, following a decline of 0.5% in 2003 and 0.9% in 2002.

Current consumption expenditure (total consumption minus durable goods) increased by 2.5% per capita this year, following a decline of 0.4% in 2003. The rise in current per capita consumption expenditures mainly reflects increases in expenditures for services (5.2%), clothing and footwear (4.3%), and other disposable manufacturing products such as medications, toiletries, cleaning materials, etc. (4.7%). In addition, household expenditures for electricity and fuel increased. Housing expenditures remained almost unchanged.

In additional, there was a substantial increase in per capita expenditure for purchase of durable goods (14.3%), following a steady decline in 2002 and 2003 (10.4% and 1.6%, respectively). A detailed breakdown of the expenditures reveals a sharp per-capita increase of 24.2% in  purchases of private motor vehicles, and a per capita increase of 12.9% in purchases of household appliances such as  refrigerators, air conditioners, washing machines, etc., as well as an increase of 3.5% in purchases of furniture.

Capital formation

Gross domestic capital formation which is the sum of gross fixed capital formation and investment in inventories, including inventories of start-up companies, increased by 11.2% this year, compared with a decline of 10.7% in 2003.

The increase in gross fixed capital formation reflects an increase in inventories, following the decline in 2003. In 2004, the stock of raw materials, work in progress, and finished products in current prices increased by 1.2% of the GDP, following a decline of 0.7% in 2003. The change in stocks includes the value of products in the process of development at start-up companies.

Fixed capital formation (in construction, machinery and equipment, and transport equipment) declined in 2004 by 1.8%, following a decline of 4.9% in 2003 and 7.0% in 2002.

Gross domestic capital formation which is the sum of gross fixed capital formation and investment in inventories, including inventories of start-up companies, increased by 11.2% this year, compared with a decline of 10.7% in 2003.

The increase in gross fixed capital formation reflects an increase in inventories, following the decline in 2003. In 2004, the stock of raw materials, work in progress, and finished products in current prices increased by 1.2% of the GDP, following a decline of 0.7% in 2003. The change in stocks includes the value of products in the process of development at start-up companies.

Fixed capital formation in various industries of the economy (non-residential construction, machinery, equipment, and motor vehicles excluding ships and aircraft) remained almost unchanged in 2004, following a decline of 5.1% in 2003 and 9.3% in 2002.

Work productivity: The net product per work hour in the business sector increased by 4.5% in 2004, following an increase of 1.1% in 2003.

The Consumer Price Index (CPI) rose by 1.2 percent in 2004, within the target range of price stability, i.e., a rise of between 1 percent and 3 percent, set by the government for 2003 onwards. In the last six years, since 1999, annual inflation in Israel has averaged 1.4 percent, within the price-stability target range. This was achieved despite the fact that inflation during this period was more volatile than in other countries in which price stability prevails. As price stability was becoming more firmly based, the financial markets, including the foreign currency market, continued to be stable.

The government budget ended 2004 with a deficit of approximately NIS 20.4 billion, in line with the original budget plans (NIS 20.6 billion). The target deficit for 2004, which is defined as a percentage of GDP, was 4.0% of GDP, and in practice the deficit came in at approximately 3.9% of GDP. Achieving the target deficit rate was made possible by the sharp increase in state revenues from taxes, at a real rate of approximately 5.8%. This is despite the cut in tax rates, which had an impact on state revenues of approximately NIS 4.5 billion (net).