Recent Developments and Outlook

1. Ministry of Finance January 2011 State of Israel Ministry of Finance Recent Developments and Outlook

2. Recent Economic Developments

3. GDP GrowthQuarter-on-Quarter at Annual Rate, 2004Q1-2010Q3 Rapid recovery since the second half of 2009.

4. GDP GrowthAnnual Percentage Change, 1995-2012 *Budget estimates.

5. GDP Growth in Israel, USA, UK and the Euro AreaThe 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. Exchange ratesUS$ vs. Others Currencies, 31/12/2010 vs. 31/12/2009

8. Balance of Payments - The Current AccountUS$ Billions & As Percent of GDP, 2000-2010 • The current account surplus contributed to the • appreciation of the shekel. * 2010 first 3 quarters annualized.

9. Exports and Imports of GoodsUS$ billions per month, excl. diamonds, ships & airplanes • Exports recovery began in the second half of 2009, although in recent months exports of goods had slowed.

10. Composition of Industrial Exports1995-2010 25% 22% 22% 25% 25% 27% 27% 23% 24% 28% 27% 78% 78% 75% 77% 75% 75% 76% 73% 73% 35% 72% 73% 65%

11. Destination of ExportsExcluding diamonds, aircraft & ships, US$ billions Diversification of export destinations continued during the years 2009-2010

12. The Unemployment and Participation Rates Since the second half of 2009 there has been a significant decrease in the unemployment rate. Participation rate (right axis)

13. Real Wages1999-2010, 2004 prices, CPI-adjusted In the last decade there has been very little change in real wages. *Jan – October average, seasonally adjusted.

14. Housing Starts and Fixed Investment in Residential Construction2000-2010q3 Units Per Q The increase in building permits led to a rise in housing starts. This is expected to expand supply in the residential market. Mil NIS

15. BOI Interest Rate, Short-Term Real Interest Rate and Inflation Expectations, 2005-2010 Although the BOI rate is rising, real interest rate remains negative

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

17. Market Indexes,January 2006=100, Monthly Average Israeli stock and corporate bonds markets exhibit positive correlation with global counterparts. Source: TASE, Bloomberg

18. Risks to the Global Economic Recovery Since 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.

19. Policy Issues

20. Central Government's Budget Deficitas Percent of GDP, 2000-2014 • 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. Source: CBS, MOF *EST. ** PROJ

21. Fiscal Rule – Expenditure Side • 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 60% --------- 80% = = * * 3.5% 2.6%

22. Fiscal Rule - Deficit Ceiling • Reduction of Deficit/ GDP ratio according to a deficit ceiling law. The government must implement the more effective of the two rules.

23. 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.

24. General Government Expenditureas Percent of GDP, 1995-2010 The government cut expenditure in order to divert resources to the private sector. * Weighted average; Source: OECD

25. General Government Expenditure,as Percent of GDP, 2009 * Weighted average; Source: OECD

26. General Government Civil Expenditure*,Percent of GDP, 2009 *General government expenditure excluding military expenditure. Source: Sipri Yearbook 2010, OECD.

27. Public and Government Debt, as percent of GDP, 1995-2010 Strong fiscal discipline and high growth rates in 2003-2008 led to a reduction in the Debt/GDP ratio. *MOF Estimate.

28. Increase in Public Debt between 2007 & 2010, as Percentage of GDP The rise in the Israeli public debt is relatively moderate.The current public debt-GDP ratio is close to OECD average. Maastricht: 60% Debt Source: OECD, Israel 2010 - MOF estimates

29. Public Debt, as percent of GDP, 2010-2025 Debt GDP ratio is expected to decline steadily to 60% around 2020.

30. 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