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Monday, April 3, 2006
Annual Report of the Bank of Israel for 2005 issued

Annual Report of the Bank of Israel for 2005 issued
(Communicated by the Bank of Israel)
Jerusalem, 2 April 2006

In 2005, Israel's economic recovery continued and became even more firmly
based. GDP grew rapidly by 5.2 percent, led again by the business sector
which expanded by 6.6 percent. The integration of the Israeli economy into
the global economy continued apace.

Macroeconomic policies in 2005 achieved its three numerical objectives: The
rate of inflation at 2.4 percent was within the price-stability range, and
both the budget deficit at 1.9 percent of GDP and the increase in public
expenditure at about 0.3 percent were below their ceilings. Correspondingly
the public-debt/GDP ratio declined significantly, although it remains very
high in international terms.

The main goal of economic policy for the next few years should be to create
the necessary conditions for sustainable growth, which will raise the
overall economic well-being of Israelis, and make it possible to tackle
social problems, in particular that of poverty. To do this, economic policy
will need to maintain fiscal discipline, price stability and financial
stability, while promoting reforms that will improve infrastructures and
intensify competition in the economy. Alongside all these, a continuous
policy focused on reducing poverty is required.

In 2005, Israel's economic recovery continued, and became even more firmly
based. GDP grew by 5.2 percent, led again by the business sector, which grew
by 6.6 percent. Improvements in the macroeconomic environment and in the
state of the economy were reflected in many ways. These included the decline
in unemployment from 9.8 percent at the end of 2004 to 8.8 percent at the
end of 2005, accompanied by increases in the rates of both employment and
labor force participation; the increase in the surplus in the current
account of the balance of payments; and positive developments in the capital
markets. The above points are taken from the Annual Report of the Bank of
Israel for 2005, which was presented today to the President, the Vice Prime
Minister and the Knesset Finance Committee.

The Report also states that Israel's economic growth was bolstered by the
continuation of strong global growth and the sustained improvement in the
security situation, as well as the steady implementation of a supportive
economic strategy. The macroeconomic policy mix combined fiscal discipline,
reflected in tight control of expenditure, a considerable reduction in the
deficit, and tax cuts, together with an accommodative monetary policy. These
made it possible to take advantage of the favorable underlying conditions,
and were a key factor in the positive reactions of the financial markets.

The integration of the Israeli economy into the global economy continued
apace in 2005: Imports currently constitute more than 40 percent of GDP, and
exports more than 35 percent; Israelis' investments abroad, direct and
portfolio, reached $10.1 billion; nonresidents' investments in Israel
totaled $10.8 billion; and nonresidents' participation in the NIS/forex
market rose to 49 percent. Integration into the global economy is vital for
Israel's continued economic growth.

Macroeconomic policy in 2005 achieved its three numerical objectives: The
rate of inflation, at 2.4 percent, was within the price-stability range; and
both the budget deficit at 1.9 percent of GDP and the increase in public
expenditure at about 0.3 percent were below their ceilings. Correspondingly
the public-debt/GDP ratio declined significantly, although it remains very
high in international terms.

In the capital markets, where important reforms have been under way for some
years, progress was made on two fronts: A significant start was made on the
implementation of the recommendations of the Bachar Committee to reduce
banks' holdings in provident and mutual funds, aimed at increasing
competition in the capital markets and reducing conflicts of interest; and
the process of equating tax rates on income earned on securities in Israel
and abroad was completed, thus ending the tax discrimination that had
favored Israelis' investment in securities in Israel over such investment
abroad.

The incidence of poverty in Israel has risen in the last few years, whether
measured in relative terms or in terms of basic needs. This reflects both
the long recession, and the cuts in welfare benefits from 2002. The latter
were intended to raise the rate of participation in the labor market, which
is an important means of reducing poverty in the long run.

The main goal of economic policy for the next few years should be to sustain
and strengthen the continuing growth of the economy. Sustained strong growth
will make it possible to raise the overall economic well-being of Israelis,
and to tackle social problems, in particular that of poverty. To sustain
growth, economic policy will need to maintain fiscal discipline, while
striving to keep government spending and the budget deficit as a share of
GDP on a downward path. In addition, macroeconomic policy should maintain
price stability and financial stability, while promoting structural reforms
aimed at improving infrastructure and intensifying competition.

Alongside all these, a continuous policy focused on reducing poverty is
required. It is important that resources be allocated to education to ensure
that, in the long term, the weaker sections of the population receive a
level of education that will enable them to participate in the labor market.
Several steps are required to reduce poverty in the medium term; These
should focus on the sections of the population with a particularly high
incidence of poverty - low-wage employees, the elderly, the ultra-orthodox
and the Arab sector. At the same time some welfare benefits will need to be
adjusted for those unable to participate in the labor force.

Legislation should be completed of a new central bank law, which will deal
with the independence of the central bank, clearly define its purposes, and
determine new frameworks for decision-making and transparency. The main
objective of the Bank will be defined as maintaining price stability in the
long run in accordance with the target set by the government, while
supporting other government targets such as growth and employment, without
undermining long-term price stability, and while supporting the stability of
the financial system.

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