Israel's financial stability improved in 2003. Domestic and external financial markets were less uncertain and volatile than in 2002, the structure of domestic liabilities in forex improved, and the underlying domestic and global conditions for financial stability were better. Developments in financial stability were affected mainly by the decrease in Israel's country risk, abetted by the redirection of global capital flows from developed markets to developing markets-among which Israel is included-and by an improvement in the credibility of economic policy and the state of the domestic economy.

The effects of events in 2002-foremost the substantial capital outflow by households and the increase in risk and uncertainty in view of the economic downturn and geopolitical developments-were hardly in evidence by the beginning of 2003. The trend in Israel's International Investment Position in 2003 pointed to greater exposure to exchange-rate changes but the composition of assets and liabilities changed in a way that expressed greater financial stability. On the liabilities side, there were several positive developments; the shares of the nonbanking private sector in total liabilities, of capital instruments, and of direct investment increased. On the assets side, although vulnerability to market risks increased (asset prices declined and the NIS appreciated), the nontradable proportion of total assets declined.

The ratios of short-term external debt to short-term assets and liquid assets of the Bank of Israel (foreign reserves) were low, indicating that the liquidity of the domestic economy improved. Net external debt continued to decrease and Israel was a net lender to the rest of the world for the second year.
The process of development in the NIS-forex market spent itself in 2003, as indicated chiefly in the deceleration of growth in trading volumes. However, the share of nonresidents in trading remained higher than in the past. This aside, trading margins widened and exchange-rate volatility was lower at the end of 2003 than before December 2001. It is not clear whether this marks a level of long-term stability in the NIS-forex market or a passing phenomenon.

Outstanding gross external debt was $ 71 billion at the end of December 2003-$ 3.4 billion (5 percent) higher than the 2002 level. The gross debt/GDP ratio declined (in dollar terms) from 65 percent in 2002 to 63 percent in 2003 due to appreciation of the NIS during 2003.

The structure of external debt and external debt assets is very important in assessing the financial strength of an economy. Israel's share of tradable debt in gross external debt climbed to a record level of 30 percent in 2003 as against 28 percent in 2002. The tradable proportion of total government external debt also established a record at 56 percent. An increase in tradable debt means that financial stability has worsened, since under such conditions foreign creditors may offer their debts for sale in the market in one stroke, thereby raising the price of debt issues to the government and other debtors. However, Israel's large surplus of short-term assets-$ 29 billion at the end of 2003, up $ 4 billion (18 percent) from the end of 2002-reflects its ability to pay back short-term debt.
At the end of 2003, the exchange-rate exposures of different sectors headed in different directions relative to December 2002. The depreciation exposure of the business sector decreased considerably; the vulnerability of households, due to their appreciation exposure, remained relatively high.

Developments in 2003 underscore the powerful effect of global developments on Israel's financial stability and, accordingly, the need to monitor continually the state of the economy vis-a-vis  the rest of the world. However, economic policy also had a vast influence on the relative standing of Israel's economy.

External Financial Stability - PDF file