In 2003 Israel was favorably affected by global economic developments that caused its current-account activity to increase. These effects overcame the contractionary impact of domestic economic and security developments since late 2000. The combined result was a significant improvement in the balance-of-payments deficit, which finished 2003 at the lowest level in a decade (Table 1.1). The financial account also expanded this year, after a two-year downtrend, and foreign direct investment (FDI) increased markedly. Thus, 2003 was a turnaround year after two years of doldrums.

Most of the favorable change in the current account traces to the global economic expansion that began in 2002, after a severe downturn in 2001 (Figure 1.1). The expansion was manifested in faster growth of goods and services exports than of imports and, in the last few months of the year, in an uptrend in high-tech exports as well.

Two domestic factors affected the capital account: the belated and slow recovery of real domestic activity, which began only in the second half of the year, and the security unrest that began in late 2000. The belated recovery dampened the annualized growth rate of imports of capital goods and consumer durables and had a downward effect on the capital-account deficit. The ongoing security situation is the factor of greatest influence on tourism revenues, which increased only slightly in 2003, whereas global developments in tourism have hardly any effect on Israel’s inbound tourism at the present time.

In the factor-inputs account, the downtrend in nonresident and resident activity in 2001 and 2002 stopped in 2003. The increase in FDI, reflecting the global economic recovery, led to an increase in dividend payments to shareholders abroad. The decline in global interest rates reduced net interest income due to the structure of domestic assets and liabilities; most public-sector assets are short-term and earn floating interest, whereas public-sector liabilities are long-term and at fixed interest.

In the financial account, the downtrend in nonresident and resident activity in 2001–2002 was braked in 2003. Financial-account activity increased slightly in 2003, although not to the level observed in the ‘bubble’ years of 1999–2000. Net capital inflows in the financial account (excluding net reserve assets), which were considerable during the global boom years-largely due to Israel’s high-tech orientation-ceased in 2001, changed into the country’s first net capital outflow in 2002, and remained such in 2003, although on a smaller scale than in 2002 (Figure 1.2).

The nonbanking private sector, a net importer of capital during the boom years-except for 2002, when domestic factors led to a capital outflow-again became an importer of capital in 2003, albeit at a scanty $ 0.8 billion, mainly due to global effects. The banking sector, in contrast, was a significant exporter of capital in 2003-at $ 2.7 billion-due to domestic factors: payback of forex credit by residents and continued gradual reduction of secondary liquidity ratios on forex deposits. Concurrently, the public sector was an importer of capital due to the issue of bonds backed by US government guarantees, and its behavior in this regard offset some of the capital outflow created by the banking sector.