STATE OF ISRAEL

[GRAPHIC MISSING]

This description of the State of Israel is dated as of June 6, 2008 and appears as Exhibit D to the State of Israel’s Annual Report on Form 18-K to the U.S. Securities and Exchange Commission for the fiscal year ended December 31, 2007.

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STATE OF ISRAEL


	Page
Map of Israel		D-1
Summary Information		D-3
State of Israel		D-5
The Economy		D-14
Balance of Payments and Foreign Trade		D-35
The Financial System		D-45
Public Finance		D-54
Public Debt		D-62
Debt Record		D-68
Tables and Supplementary Information		D-69

LIST OF TABLES


	Page
Table No. 1 NIS/U.S. Dollar Exchange Rates		D-2
Table No. 2 Selected Economic Indicators		D-4
Table No. 3 Distribution of Knesset Seats by Party		D-8
Table No. 4 Main Economic Indicators		D-15
Table No. 5 Resources and Use of Resources		D-15
Table No. 6 Composition and Growth of Business Sector Product		D-16
Table No. 7 Manufacturing by Category		D-17
Table No. 8 Industrial Production Index		D-17
Table No. 9 Imports and Production of Crude Oil, Coal and Natural Gas		D-21
Table No. 10 Tourist Arrivals by Area of Origin and Receipts		D-22
Table No. 11 Selected Price Indices		D-23
Table No. 12 Structure of Employment in Israel		D-25
Table No. 13 Principal Labor Market Indicators		D-26
Table No. 14 Selected State-Owned Companies		D-28
Table No. 15 Balance of Payments		D-35
Table No. 16 Exports of Goods by Major Groups		D-38
Table No. 17 Imports of Goods by Major Groups		D-39
Table No. 18 Exports of Goods by Region		D-40
Table No. 19 Imports of Goods by Region		D-40
Table No. 20 Merchandise Trade Indices		D-41
Table No. 21 External Assets and Liabilities (Debt Instruments)		D-42
Table No. 22 Foreign Currency Reserves at the Bank of Israel		D-42
Table No. 23 Average Exchange Rates		D-44
Table No. 24 Selected Interest Rates		D-48
Table No. 25 Monetary Indicators		D-48
Table No. 26 Assets, Liabilities and Equity Capital of the Five Major Banking Groups		D-52
Table No. 27 The Budget Deficit and Its Financing		D-55
Table No. 28 Government Taxes		D-57
Table No. 29 Government of Israel Statement of Net Expenditures		D-57
Table No. 30 Net Public Debt		D-62
Table No. 31 Ratio of Net Public Debt to GDP		D-62
Table No. 32 Annual Local Currency Government Debt Issuances		D-63

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	Page
Table No. 33 Outstanding Public Sector External Debt		D-65
Table No. 34 Forward Amortization of Public Sector External Debt — Principal Payments		D-66
Table No. 35 Forward Amortization of Public Sector External Debt — Interest Payments		D-67
Table No. 36 Government Guarantees by Category		D-68

Tables and Supplementary Information:


Foreign Currency Debt of the Government of Israel			D-69
Loans from the Government of the United States of America			D-69
Bonds Issued Under the U.S. Loan Guarantee Program			D-69
Housing Loans Guaranteed by the U.S. Government			D-69
Loans from the Government of Germany			D-70
Loans from Government Trusts Backed by the U.S. Government			D-70
Loans from Various Financial Institutions in the United States Guaranteed by the U.S. Government			D-70
Loans from Israeli and Non-Israeli Banks			D-71
International Capital Markets Issues			D-71
State of Israel Notes (Issued through the Israel Bonds)			D-71
State of Israel Bonds (Issued through the Israel Bonds)			D-72
Balances of the Government’s Foreign Currency Debt by Currency			D-74
Government Guarantees of Foreign Currency Indebtedness			D-75
Tradable Local Currency Direct Debt of the Government of Israel			D-75
Floating Rate Loans			D-75
Fixed Rate Loans			D-75
CPI Index-linked Loans			D-75
Dollar-linked/Floating Rate Loans			D-76
Non-Tradable Local Currency Direct Debt of the Government of Israel			D-76
CPI-linked Loans			D-76
Various Loans of the Government of Israel			D-77
Balance of the Government’s Floating Rate Debt by Currency			D-77

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* These areas are subject to agreements between Israel and the Palestinian Authority. The Palestinian Authority has gradually taken responsibility for administering certain self-rule areas, including the Gaza Strip and parts of the West Bank (Judea and Samaria).

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Except as otherwise specified, all amounts in this report are expressed in New Israeli Shekels (“NIS”) or in U.S. dollars (“$”, “US$”, “dollars” or “USD”). Any amounts stated in dollars in this report as of a stated date or for a stated period that were converted from NIS into dollars, were either converted at the representative foreign exchange rate for dollars on such date, or at the average of the representative foreign exchange rates for dollars for each day during such period, as published by the Bank of Israel. The Bank of Israel calculates the representative foreign exchange rate for dollars for any day as the average of the NIS/$ buying and selling rates prevailing in the market on such date. The representative NIS/$ exchange rates as of the following dates and for the following periods were:

Table No. 1

NIS/U.S. Dollar Exchange Rates


	Year
	2003		2004		2005		2006		2007
December 31		4.379		4.308		4.603		4.225		3.846
Yearly Average		4.548		4.482		4.488		4.456		4.108

Source: Bank of Israel.

On June 5, 2008, the Bank of Israel representative foreign exchange rate for US$ was NIS3.376 per US$1. In October 2000, all restrictions on foreign currency derivative transactions with nonresidents were abolished. For a further discussion of the convertibility of the NIS, see “Balance of Payments and Foreign Trade — Foreign Exchange Controls and International Reserves” below.

The fiscal year of the Government of Israel (the “Government”) ends December 31. The twelve-month period which ended on December 31, 2007 is referred to in this Prospectus as “2007”, and other years are referred to in a similar manner.

Totals in certain tables in this report may differ from the sum of the individual items in such tables due to rounding. Unless otherwise specified, amounts in NIS or USD are given in current prices without adjustment for inflation.

Figures in this report are as of December 31, 2007, except as otherwise indicated.

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SUMMARY INFORMATION

The following summary is qualified in its entirety by, and should be read in conjunction with, the more detailed information appearing elsewhere in this document.

Economic Developments in 2007: The economic recovery that began in 2003 and gained strength in 2004, 2005 and 2006, continued in 2007. The Gross Domestic Product (“GDP”) growth rate was 5.3% and the business sector GDP growth rate reached 6.1%. The economic improvement was reflected in a rapid growth of all components of GDP, including private consumption (6.8% increase), investment in fixed assets (13.1% increase), exports and imports (increases of 8.4% and 12.3%, respectively). Among the factors that contributed to the rapid growth in 2007 were: positive global economic trends throughout the first half of the year; the ongoing responsible fiscal policy that contributed to reductions of the tax burden and of the public debt; the increase in local demand, and in particular, an increase of 8.9% in revenues of commercial and services sectors; the increase in real wages and employment; the continued tax cuts; and the increase in the value of the public’s asset portfolio. Both the number of Israeli employees and the labor participation rate rose in 2007. The unemployment rate decreased from annual averages of 9.0% in 2005 and 8.4% in 2006 to 7.3% in 2007. External sustainability indicators, a particularly high surplus in current account balance of $5.0 billion in 2007, ample foreign currency reserves ($29.0 billion as of December 31, 2007) and negative net external debt (negative 25.2% of GDP as of December 31, 2007), reflect a high degree of external stability both by international standards and relative to the domestic situation in the mid-1990s. In 2007, the NIS strengthened against the main foreign currencies.

Fiscal and Monetary Policy: The improvement in the economic conditions in 2007 was supported by the ongoing firm fiscal policy, which addressed the need for increases in the budget accompanied by a relatively non-contractionary monetary policy. The budget deficit declined to close to zero in 2007 compared with a budget deficit of 1.0% in 2006. Israel’s gross public debt as a percentage of GDP declined to 78.8% in 2007, down from 84.7% in 2006 and 93.9% in 2005. The low deficit may be attributed to the fact that government revenues and GDP growth exceeded budget forecasts, while government expenditures were slightly lower then planned.

Balance of Payments and Foreign Trade: As a result of a more rapid expansion of exports as compared with the expansion of imports, Israel’s current account transformed into a smallsurplus in 2003and peaked with a surplus of $8.5 billion in 2006. In 2007, current account surplus was $5 billion. The 2006 expansion in exports continued in 2007 and measured 8.4% in real NIS terms (17.3% rise in exports of goods (excluding diamonds, ships and aircrafts)). Total exports (excluding diamonds) constituted 45% of GDP. Israel is a party to free trade agreements with its major trading partners, and it is one of the few nations that is a party to free trade agreements with both the United States and the European Union (“EU”).

Inflation: Since 1985, inflation has been reduced and stabilized. In 2007, the average consumer price index (“CPI”) inflation rate was 0.5%.

Privatization: In recent years, the Government has made significant progress in the privatization of state-owned enterprises and the reduction of State subsidies. From 1986 through April 2008, 95 Government Companies (as defined below (see “The Economy — Role of the State in the Economy”)) have been transferred to private hands, and the Government’s proceeds from privatization were approximately $14.2 billion. In 2007, proceeds from privatization totaled $1.4 billion.

Capital Markets: In 2007, share prices on the Tel-Aviv Stock Exchange (“TASE”) continued to rise. During 2007, the Tel Aviv 100 Index, which is comprised of the 100 largest companies by market capitalization, increased in USD terms by 35%, compared with an increase of 22.3% in 2006. As of December 31, 2007, the total market value of all listed securities (stocks and bonds) was NIS1,557 billion, compared with NIS1,188 billion in 2006 and NIS1,017 billion in 2005. The average daily trading for equity securities increased to NIS2,075 million during 2007, compared with NIS1,453 million in 2006 and NIS1,001 million in 2005.

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Table No. 2

Selected Economic Indicators
(In Billions of NIS Unless Noted)


	Year
	2003			2004			2005			2006			2007
Main Indicators
GDP (at constant 2005 prices)		NIS531.7			NIS559.4			NIS588.9			NIS619.7			NIS652.2
Percentage change, real GDP		2.3	%		5.2	%		5.3	%		5.2	%		5.3	%
GDP per capita (at constant 2005 prices) (in NIS)		79,484			82,146			84,983			87,848			90,881
Percentage change, GDP per capita		0.41	%		3.35	%		3.45	%		3.37	%		3.45	%
Inflation (change in CPI – annual average)		0.7	%		-0.4	%		1.3	%		2.1	%		0.5	%
Industrial production		-0.40	%		7.1	%		4.7	%		8.3	%		4.8	%
Business sector product (at constant 2005 prices)		375.7			402.6			428.9			456.8			484.7
GDP (at current prices)		527.0			554.1			588.9			633.1			664.7
Permanent average population (thousands)		6,690			6,809			6,930			7,054			7,177
Unemployment rate		10.7	%		10.4	%		9.0	%		8.4	%		7.3	%
Foreign direct investment (net inflows, in billions of dollars)		3.9			2.0			4.8			14.3			10.3
Trade Data
Exports (f.o.b.) of goods and services (NIS, at constant 2005 prices)		209.1			247.1			258.3			273.6			296.6
Imports (f.o.b.) of goods and services (NIS, at constant 2005 prices)		222.6			249.6			258.4			266.9			299.9
Public Debt⁽¹⁾
Total Gross Public Debt (at end-of-year current prices)		522.7			541			552.8			535.9			524
Total Gross Public Debt as percentage of GDP		99.2	%		97.6	%		93.9	%		84.7	%		78.8	%
External Debt⁽²⁾
External Debt Liabilities (in millions of dollars)		71,966			76,759			76,509			85,136			86,994
Net External Debt (in millions of dollars)		-6,609			-10,149			-20,344			-32,258			-40,837

(1)

Government debt (excluding local authorities debt).

(2)

Source: Bank of Israel.

Sources: Central Bureau of Statistics, Bank of Israel, Ministry of Finance.

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STATE OF ISRAEL

Introduction

The State of Israel (the “State” or “Israel”) is a highly developed, industrialized democracy. Since 1990, Israel has seen improvements in most economic indicators. GDP increased on average by 3.9% annually from 1996 through 2007. A number of negative factors converged during 2001 and 2002, including the ongoing security unrest in Israel, which negatively affected tourism; the global technology slump, which slowed investments in high-tech companies; and the global economic slowdown, which negatively affected Israeli exports. As a result, GDP decreased by 0.6% in 2001 and by 0.9% in 2002. An economic recovery began in 2003 and accelerated during 2004, 2005 and 2006. In 2007, GDP continued to grow and increased by 5.3%, following an increase of 5.2% and 5.3% in 2006 and 2005, respectively. This growth rate was the result of several factors: increased macroeconomic stability, which resulted from firm fiscal policy aimed at reducing the fiscal deficit and public debt burden; growth of global economic activity during the second half of the year, particularly, global trade; increased activity in high-tech sectors; and relatively low real interest rates.

The Israeli economy is trade-oriented. Following two years of recession during which a decrease in exports was measured, exports recovered in 2003 and continued to grow in 2004, 2005, 2006 and 2007. By 2007, exports of services and goods (excluding diamonds) constituted 37.4% of GDP (45.4% of GDP including diamonds). In 2007, exports rose by 8.4% in real terms. The increase in exports in both high-tech and traditional industries during 2003 – 2007 was a result of a variety of factors, including: the depreciation of the Israeli currency in real effective terms; the global economic recovery through the first half of 2007; the expansion of global trade and the increase in demand for high-tech products; and the corporate efficiency measures. Exports of services grew by 7.3% in 2007, a significant portion of which is attributed to tourism and transportation. Exports of goods (in US$ terms, excluding diamonds, ships and aircrafts) to the European Union in 2007 rose by 21.4%, to the United States by 4.5% and to the rest of the world by 24.5%.

Since 1990, Israel has made substantial progress in opening its economy, and major trade barriers and tariffs have been removed. Israel has entered into free trade agreements with its major trading partners, and Israel is one of the few nations that is a party to free trade agreements with both the United States and the European Union. Israel has also signed free trade agreements with the European Free Trade Association (“EFTA”) countries, as well as with Canada, Turkey and Mexico.

As of 2007, Israel succeeded in reducing Israel’s tax burden, narrowing the Government’s fiscal deficit, and attaining levels of inflation similar to those in other industrialized countries while enhancing economic growth.

Since 1999, the annual average inflation rate has been close to 2%. The annual average inflation rate was 0.7% in 2003, negative 0.4% in 2004, 1.3% in 2005, 2.1% in 2006 and 0.5% in 2007.

The total budget deficit (excluding net lending and the realized profits of the Bank of Israel) averaged 3.1% of GDP per year between 1995 and 2000. The total budget deficit increased to 4.2% of GDP in 2001, 3.6% of GDP in 2002 and 5.4% of GDP in 2003, mainly as a result of a decline in GDP and in tax revenue. In 2004 total budget deficit was reduced to 3.7% of GDP. The 2005 and 2006 total budget deficits were 1.9% and 0.9% of GDP, respectively, mainly reflecting higher than expected government revenues. Total budget deficit in 2007 was close to zero.

The implementation of a decisive fiscal policy starting in mid-2003, backed by the loan guarantees provided by the U.S. government, contributed significantly to macroeconomic stability by raising fiscal credibility and lowering economic uncertainty.

The current account deficit of the balance of payments that existed between 1995 and 2002 transitioned into a small surplus in 2003 and has been growing ever since 2004, primarily due to the growing expansion of exports, as compared with the expansion of imports during that period. The current account surplus reached 5.6% of the GDP in 2006 and 3.2% of GDP in 2007. Another factor that contributed to the growing surplus is the significant expansion of financial investments of Israeli residents abroad, which produced higher interest and dividend income, partially because of higher interest rates abroad. These surpluses reflect a high degree of external stability both by international standards and relative to the situation that existed in Israel in the mid-1990s.

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The unemployment rate dropped in recent years. The average unemployment rate decreased from 10.4% in 2004 to 9.0% 2005, and in 2006 it dropped to 8.4%, further declining to 7.3% in 2007. Both the number of Israeli employees and the labor participation rate rose in recent years. The rate of participation in the civilian labor market (as a percentage of the population aged 15 and above) rose to 56.3% in 2007, compared with 55.6% in 2006, 55.2% in 2005 and 54.9% in 2004.

Israel’s productive and highly educated population remains a principal strength of the economy. Based on 2006 statistics, approximately 41.8% of the Israeli population over the age of 15 has had 13 or more years of schooling. In addition, from 1990 through 2006, approximately 1.2 million immigrants arrived, increasing Israel’s population by more than 25%. The new immigrants are generally highly educated and include a high percentage of scientific, academic, managerial, technical and other professional workers. Although this wave of immigration initially placed strains on the economy by raising the budget and trade deficits and contributing to a relatively high level of unemployment, these immigrants have been successfully integrated into the economy. Today, the employment rate of immigrants who came to Israel in the first half of the 1990s is similar to that of native-born Israelis.

Over the past three decades, Israel has made progress in reducing the hostilities that have existed with Arab countries in the region since the establishment of the State in 1948. Nevertheless, the unrest in the areas administered by the Palestinian Authority, which began in September 2000 and intensified during 2001 and 2002, has been a major setback in the peace process. Since 2003, there has been an improvement in the security situation, as it relates to the Israeli-Palestinian conflict, which is reflected by the relative decline in the number of terrorist attacks and security incidents. The first peace agreement between Israel and its neighbors was the 1979 Camp David peace accord with Egypt. In September 1993, Israel and the Palestinian Liberation Organization (“PLO”) signed a Declaration of Principles, a turning point in Israeli-Arab relations. Israel signed a peace treaty with Jordan in 1994. Further agreements have also been signed between Israel and the PLO. In 2005, Israel implemented the Disengagement Plan, in which it dismantled all Israeli communities in the Gaza Strip, four Israeli towns in the northern West Bank and all of its military installations in those areas. In July and August 2006, Israel was engaged in a war against the Lebanese terror organization Hezbollah in Lebanon (the “Second Lebanon War”). See “ — International Relations” below. Since the disengagement from Gaza, Palestinian terrorist organizations have been firing increasing number of rockets into Israel. During the month of May 2007, Palestinians launched from Gaza 300 Qassam rockets at Sderot and the western Negev. Hamas claimed responsibility for the attack. In May 2008, Israel and Syria revealed that they have started indirect peace talks, under the auspices of Turkey.

Geography

Israel lies on the western edge of Asia bordering the Mediterranean Sea. It is bounded on the north by Lebanon and Syria, on the east by Jordan, on the west by the Mediterranean Sea and Egypt, and on the south by Egypt and the Gulf of Eilat. Israel has a total land area (excluding the Gaza Strip and the West Bank) of approximately 21,500 square kilometers or 8,305 square miles, approximately the size of the state of New Jersey. Jerusalem is the capital of Israel.

Population

Israel’s population, including Israeli citizens residing in the West Bank, but not including foreign nationals residing in Israel for employment purposes, was estimated to be 7.24 million as of December 31, 2007, up from 7.11 million as of December 31, 2006. During the period from 1990 through 2007, Israel’s population grew by 50%, largely as a result of immigration. In 2006, approximately 10% of the population was 65 years of age or older, 30% was between the ages of 35 and 65, 31% was between the ages of 15 and 34, and 28% was under the age of 15. Approximately 92% of the population lives in urban areas. Twenty percent of the population lives in Israel’s three largest cities: Jerusalem (population 719,900), Tel-Aviv (population 378,900) and Haifa (population 268,300).

The Israeli population is composed of a variety of ethnic and religious groups. At the end of 2005, 76% of the total Israeli population was Jewish, 16% was Muslim, 2% was Christian, 2% was Druze and 4% were not classified by religion. Israel’s Declaration of Independence and various decisions by Israel’s Supreme Court guarantee freedom of worship for all Israeli citizens. Hebrew and Arabic are the official languages of Israel and English is commonly used.

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Immigration

Israel has experienced a continuous flow of immigrants, in part due to Israel’s Law of Return which provides that any Jewish immigrant is entitled to become a citizen of Israel. Since 1990, and primarily between 1990 and 2003, the flow of immigrants has increased dramatically. The substantial influx of immigrants during these years totaling 1.1 million increased Israel’s population by more than 23% over this period. Over the same period, total population growth was 42.5%. Approximately 83% of all immigrants to Israel since 1990 have come from the former Soviet Union. Many of these immigrants are highly educated. Of the immigrants who arrived since 1990 who were over 15 years of age, 58% had over 13 years of schooling. Of the immigrants who arrived between 1990 and 2003, approximately 62% held scientific, academic, managerial, technical or other skilled jobs. This influx of highly skilled workers has contributed to the growth of the Israeli economy since 1990.

Form of Government and Political Parties

The State of Israel was established in 1948. Israel is a parliamentary democracy, with governmental powers divided among separate legislative, executive and judicial branches. Israel has no formal written constitution. Rather, a number of basic laws govern the fundamental functions of the State, including the electoral system, the government, the legislature and the judiciary, and guarantee the protection of property, life, body and dignity, as well as the right to privacy and freedom of occupation. These laws are given special status by Israeli courts relative to other laws and, in some cases, cannot be amended except by an absolute majority vote of the Knesset, Israel’s parliament. All citizens of Israel, regardless of race, religion, gender or ethnic background, are guaranteed full democratic rights. Freedom of worship, speech, assembly, press and political affiliation are embodied in the country’s laws, judicial decisions and Declaration of Independence.

The President is the head of state and is elected by the Knesset for a single seven-year term. The President has no veto powers and the duties of the office are mainly ceremonial. The President selects one of the Knesset members to form the government, after consulting with different parties’ representatives. This Knesset member becomes Prime Minister. The current President, Shimon Peres, was elected on June 13, 2007. The Prime Minister is the head of Israel’s Government and appoints a cabinet to assist in governing the country.

The legislative power of the State resides in the Knesset, a unicameral parliament that consists of 120 members elected by universal suffrage under a system of proportional representation. The entire country constitutes a single electoral constituency. Each party receiving more than 2.0% of the total votes cast is assigned membership in the Knesset in proportion to its percentage of the total national vote. Knesset elections are held every four years, unless the Knesset votes for elections to take place earlier or if the Knesset fails to pass the annual budget by the end of March.

If a 61-vote majority of the Knesset subsequently passes a vote of no confidence in the government and proposes an alternate candidate, the government will dissolve and the President will select the alternate candidate to form a new government. If the alternate candidate fails to form a new government, new elections will be held. The Prime Minister, with the approval of the President, also has the authority to dissolve the Knesset. However, a majority of Knesset members may require the President to appoint another Knesset member to form a new government. If this Knesset member fails to form a new government, new elections will be held.

Currently, Israel has two major political parties, Kadima and Avoda (Labor)-Meimad. Since the establishment of the State of Israel in 1948, the Government has been a coalition government led by Avoda or Likud and supported by a majority of the members of the Knesset.

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The following table presents the distribution of current Knesset seats by party as of June 2008:

Table No. 3

Distribution of Knesset Seats by Party


	Number of Seats
Kadima		29
Avoda (Labor) – Meimad		19
Likud		12
Shas		12
Israel Beitenu		11
Ihud Leumi – Mafdal		9
Gil		4
Torah and Shabbat Judaism		6
Meretz		5
United Arab List – Arab Renewal		4
Zedek Lazaken		3
Hadash		3
National Democratic Assembly		3
Total		120

Following the March 2006 elections, the former President Moshe Katsav selected Ehud Olmert to form a government. Prime Minister Olmert formed a new coalition government, consisting of the Kadima party, the Avoda-Meimad party, the Shas party and Gil party. In July 2007 Roni Bar-On was appointed Minister of Finance.

The judicial power in Israel is exercised by the Supreme Court, District Courts and Magistrate Courts, as well as municipal courts, labor courts, administrative tribunals and religious courts. The six District Courts (located in Jerusalem, Tel-Aviv, Haifa, Beer-Sheva, Nazareth and Petach Tikva) hear all cases not within the exclusive jurisdiction of the Magistrate Courts or the specialized courts and also hear appeals from the Magistrate Courts. The Supreme Court has ultimate appellate jurisdiction over all decisions rendered by District Courts. The Supreme Court also exercises original jurisdiction by sitting as the High Court of Justice in matters outside the jurisdiction of any other court or tribunal and where it is necessary to grant relief in the interest of justice. In its capacity as the High Court of Justice, the Supreme Court hears petitions in matters of constitutional and administrative law and reviews acts of the executive branch and the Knesset. In addition, the High Court of Justice may order religious courts and labor courts to adjudicate any particular matter, or to set aside any proceeding held or decision given. Judges are appointed by the President upon election by the Judges’ Election Committee, the majority of whose members represent the legal profession. Some marital and family matters, and certain other matters related to personal status, are handled by religious courts. Most religions have their own religious courts.

National Institutions

Israel has four so-called National Institutions: The Jewish Agency for Israel, the World Zionist Organization, Keren Hayesod and the Jewish National Fund. The National Institutions, which predate the formation of the State, perform a variety of non-governmental charitable functions. Each of the National Institutions is independent of the Government and finances its activities through private and public sources, including donations from abroad. In 2007, the National Institutions were responsible for net unilateral transfers into Israel of $400 million.

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International Relations

Over the past three decades, Israel has made progress in reducing the hostilities that have existed between Israel and the region’s Arab countries since the establishment of the State of Israel in 1948. As a result of the historic visit to Israel by the President of Egypt in 1977 and the intensive negotiations held by the two countries, Egypt and Israel signed a peace treaty on March 26, 1979, which was the first between Israel and one of its neighboring countries. The Madrid Conference in 1991 marked the start of a broader peace process in the Middle East.

On October 26, 1994, Israel and Jordan signed a peace treaty. After resolving issues relating to borders and water, Israel and Jordan entered into negotiations to promote economic cooperation and plan regional economic development initiatives. In addition, the agreement with Jordan, and subsequent progress in Israel’s negotiations with the Palestinians, enabled Israel to begin to establish economic and political relations with other countries in the region, in both North Africa and the Gulf states. In October 1999, Israel and Mauritania established full diplomatic relations. Mauritania is the third Arab country after Egypt and Jordan with whom Israel has exchanged ambassadors. Israeli authorities continue their efforts to promote peaceful relations and increase economic opportunities, with a particular focus on the goal of enhancing regional development.

In September 1993, the mutual recognition and the signing of a Declaration of Principles between Israel and the Palestinian Liberation Organization was a turning point in Israeli-Arab relations. A number of interim agreements were concluded and the Palestinian Authority (the “PA”) was established. As part of the 1994 Gaza Strip and Jericho Agreement signed in Cairo, and the 1995 Interim Agreement on the West Bank and the Gaza Strip signed in Washington, D.C., Israel withdrew from Jericho and much of the Gaza Strip, as well as from six additional West Bank towns. The PA has gradually taken responsibility for administering the Gaza Strip and those areas of the West Bank designated as self-rule areas. Several rounds of negotiations were held between Israel and the PLO in 2000, aimed at achieving a permanent agreement and an end to the conflict. Unfortunately, those negotiations did not result in an agreement. Since September 2000, relations between Israel and the PA have deteriorated due to violence conducted by Palestinian terror organizations against Israeli targets and citizens in violation of all bilateral agreements signed since 1993, as well as the election in January 2006 of the Hamas terrorist organization to head the Palestinian Authority. This has also resulted in significant damage to economic relations, primarily in the area of bilateral trade.

A performance-based, multi-phase plan to end the Israeli-Palestinian conflict, known as the Road Map, was released by the United States, the United Nations, the European Union and Russia in April 2003. The first phase of the Road Map requires the immediate cessation of violence by the Palestinians, the implementation of comprehensive political reforms by Palestinians, the withdrawal from Palestinian areas controlled by the Israeli Defense Forces since September 28, 2000, and action by Israel in relation to settlements, in particular the dismantling of settlement outposts erected since March 2001. The second phase of the Road Map, which would begin upon satisfactory performance of the first phase, contemplates the creation of a temporary Palestinian state with provisional borders and an elected government. The third and final phase of the Road Map would include the negotiation of a final agreement to end the Israeli-Palestinian conflict and fulfill the vision of two states, Israel and Palestine, living side by side in peace and security. While the Road Map was accepted by both the Israeli and the Palestinian sides, implementation of the Road Map faces a number of serious obstacles, including opposition by certain groups, ongoing Palestinian terrorist activity and, more recently, the refusal of the Hamas-led Palestinian Authority to accept the conditions for legitimacy set out by the international community: namely, the renunciation of terrorism and violence, the recognition of the right of Israel to exist and acceptance of previous agreements and obligations, including the Road Map.

In view of the obstacles facing implementation of the Road Map, the Government of Israel approved, on June 6 2004, the Disengagement Plan, stating that it was Israel’s intention to evacuate all civilians and withdraw all military forces from the Gaza Strip and parts of the northern West Bank. In October 2004, the Knesset approved the implementation of the Disengagement Plan. The Knesset also approved the Disengagement Implementation Law in February 2005, allowing the Government to compensate the residents relocated from the Gaza Strip and northern West Bank.

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Implementation of the disengagement from Gaza was completed in August 2005 and included the formal dismantling of Israel’s military government in the Gaza Strip and withdrawal of all Israeli troops from the ‘Philadelphi Route’ along the border between the Gaza Strip and Egypt. The withdrawal brought an end to Israeli presence and authority over the area, which began after the Six-Day War in June 1967. Disengagement from parts of the northern West Bank was completed in September 2005. In a joint statement on September 20, 2005, representatives of the United States, Russia, the European Union and the UN welcomed the successful implementation of the disengagement plan and the “moment of opportunity that it brings to renew efforts on the Roadmap.”

Although disengagement from Gaza was designed to create the opportunity for peace, in the year following disengagement (January 2006), the terrorist organization Hamas emerged victorious from elections in the Palestinian Authority. In light of the establishment of the Hamas-led government, Israel adopted a dual strategy towards the Palestinians, maintaining pressure against Hamas and the extremists while not closing the door to dialogue with the moderates among the Palestinians towards a negotiated two-state solution to the Israeli-Palestinian conflict. The international Quartet reiterated its commitment to a Palestinian government committed to nonviolence, recognition of Israel, and acceptance of previous agreements and obligations, including the Roadmap.

Since the disengagement from Gaza, Palestinian terrorist organizations have been firing locally-manufactured rockets into Israel at increasing numbers. While rockets were fired even before the disengagement at Israeli settlements in the Gaza Strip, since 2006, rockets have mostly landed in the western part of the Negev. In 2006, 861 rockets were fired at population centers in the Negev, primarily in Sderot, compared with 222 in 2005 and 268 in 2004. During the month of May 2007, Palestinians launched from Gaza 300 Qassam rockets at Sderot and the western Negev. Hamas claimed responsibility for the attack.

Over 830 rockets and 840 mortars fired from Gaza have struck southern Israel between January and April 2008, and in February, in an unprecedented attach, 23 hits of Grad missiles were identified, hitting as far as Ashkelon and Netivot. On May 14, 2008, a Grad missile struck a shopping mall in Askelon, wounding 90 people.

The Hamas takeover of the Gaza Strip in June 2007 and the subsequent formation of the new moderate Fatah-led Palestinian government under President Mahmoud Abbas and Prime Minister Salam Fayyad opened the door to a resumption of talks between Israel and the Palestinians, towards the achievement of the goal of two homelands for two peoples, one Jewish and the other Palestinian.

An international conference was convened on November 27, 2007 in Annapolis, Maryland to relaunch the negotiating process. Negotiating teams from both sides began direct talks shortly thereafter in Jerusalem on December 12, 2007. The International Donors’ Conference for the Palestinian State which convened in Paris on December 17, 2007, committed to support the government of President Mahmoud Abbas and Prime Minister Salam Fayyad and their vision of a future Palestinian state both politically and economically, underpinning the political process launched in Annapolis. Delegations from 87 countries and international organizations pledged a total of $7.4 billion to support Palestinian institution-building and economic recovery over the next three years.

Although Israel has entered into various agreements with Arab countries and the PLO, and various declarations have been signed in connection with the efforts to resolve some of the economic and political problems in the Middle East, no prediction can be made as to whether, and under what terms, a complete resolution of these problems will be achieved. To date, Israel has not entered into a peace treaty with either Lebanon or Syria. On May 23, 2000, in accordance with a Government decision, Israeli military forces unilaterally withdrew from South Lebanon in compliance with United Nations Security Council Resolution 425, as confirmed by the Security Council and Secretary General of the United Nations. In July 2006, an attack of the Lebanse terror organization Hezbollah on Israeli military patrol within the Israeli border led to the Second Lebanon War, which included heavy fighting during July and August 2006. The war ended with UN Resolution 1701, which called the government of Lebanon to take full control of Lebanon and prohibited the presence of paramilitary forces, including Hezbollah, south of the Litani river.

Since 1948, the members of the Arab League have maintained a trade boycott of Israel. The primary tier of the boycott prohibits the importation of Israeli-origin goods and services by member states. The secondary

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tier of the boycott prohibits individuals in Arab League states from engaging in business with foreign firms that contribute to Israel’s military or economic development, and the tertiary tier of the boycott prohibits business dealings with firms that do business with blacklisted entities. In September 1994, the Gulf Cooperation Council (which includes Qatar, Oman, Bahrain, the United Arab Emirates, Saudi Arabia and Kuwait) suspended their secondary and tertiary trade boycott tiers of Israel, signifying a major shift in Israel’s relations with several Arab nations in the region. These Gulf states, as well as four other Arab League members (Algeria, Djibuti, Mauritania and Somalia) no longer enforce the secondary and tertiary boycotts of Israel.

Prior to the recent security unrest, Israel and its Arab neighbors had taken several initiatives to encourage the development of economic relations among the countries of the region. The formation of additional regional economic organizations was proposed to enhance cooperation between Israel and other countries of the region. Among these, the most important are the Middle East Development Bank (MEDB), the Middle Eastern-Mediterranean Tourist and Travel Association (MEMTTA) and the Regional Business Council (RBC).

Israel maintains a close economic, diplomatic and military relationship with the United States. Israel receives economic and military assistance from the United States in amounts that have averaged approximately $3 billion per year since 1987. In 1991, the United States provided Israel with an additional one-time special grant of $650 million due to expenses incurred by Israel as a result of the Gulf War. In 1992, the United States approved up to $10 billion of loan guarantees during U.S. fiscal years 1993 through 1998 to help Israel absorb the recent influx of immigrants. In April 2003, the United States approved up to $9 billion in loan guarantees for the State of Israel to be issued during U.S. government fiscal years 2003 through 2005, with an option to extend the program by an additional year. In 2005, the United States confirmed Israel’s request to extend the program for two more years. The amount of guarantees that shall be issued to Israel under the loan guarantee program may be reduced by an amount equal to the amount extended or estimated to have been extended by Israel for activities that the President of the United States determines are inconsistent with the objectives and understandings reached between the United States and Israel regarding the implementation of the loan guarantee program. For United States fiscal year 2003, the amount of this reduction was $289.5 million. For United States fiscal year 2006, a reduction of $795.8 million was made. The proceeds of the guaranteed loans may be used to refinance existing debt (see “Public Debt — External Public Debt” below). In May 2003, as part of the aid package, the United States formally granted Israel $1 billion in military aid.

The Government of Israel and the United States have agreed to reduce foreign assistance to Israel. This reduction involves a phase-out of U.S. Economic Support Fund (“ESF”) assistance to Israel through incremental annual reductions in the level of such annual assistance over a ten-year period that began in fiscal year 1999. Over the same time period, the United States will increase annually the level of its Foreign Military Financing (“FMF”) assistance to Israel in amounts equal to half the amount of the annual reduction in ESF assistance. From U.S. fiscal year 1999 through 2008, each year the level of ESF assistance has been reduced by $120 million and the level of FMF assistance has been increased by $60 million. The level of ESF assistance for U.S. fiscal year 2007 was $120 million. ESF assistance is expected to cease in 2008. In August 2007, the United States and Israel signed a Memorandum of Understanding which outlined defense aid to be provided to Israel in the amount of $30 billion over the next ten years, starting in 2009.

Israel currently maintains diplomatic relations with more than 160 countries. Israel has established or re-established commercial, trade and diplomatic relations with several republics of the former Soviet Union, nations of Eastern Europe, and other countries that had been aligned politically with the former Soviet Union. Furthermore, the developments toward peace in the region in the last decade have facilitated the growth of commercial, trade and diplomatic relations with several Asian countries, including Japan, South Korea, China and India.

Membership in International Organizations and International Economic Agreements

Israel is a member of a number of international organizations, including the UN, the World Bank Group (including the International Finance Corporation), the International Monetary Fund (“IMF”), the European Bank for Reconstruction and Development, and the Inter-American Development Bank.

Israel has been a signatory to the General Agreement on Tariffs and Trade (“GATT”) of 1947 since 1962 and it is a founding member of the World Trade Organization (“WTO”). In addition, Israel actively participates

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in plurilateral initiatives conducted under the framework of the WTO, such as the Government Procurement Agreement and the Information Technology Agreement.

In March 1996, the Council of Ministers of the Organization for Economic Co-operation and Development (“OECD”) approved Israel’s request to participate in the organization’s activities, and Israel has accordingly joined certain OECD committees as an observer. Since February 2000, Israel has been in a dialogue with OECD leadership in order to promote Israel’s admission to the organization as a full member. In May 2007, OECD countries invited Israel to begin discussions on its accession to the organization. Israel has an extensive network of free trade agreements with most of its trading partners: United States, European Union, EFTA, Turkey, Canada, Mexico and Jordan. Approximately 75% of Israel’s foreign trade is conducted under its bilateral free trade agreements, which provide duty free access and other preferential treatment schemes. On December 18, 2007, Israel signed a free trade agreement with the MERCOSUR trade block (Brazil, Argentine, Uruguay and Paraguay), and has become the first country outside Latin America to have signed a free trade agreement with this trade block.

In 1975, Israel signed a free trade agreement with the European Economic Community (EEC) that provided for the gradual reduction and ultimate elimination of tariffs on manufactured goods and certain agricultural products. In July 1995, Israel signed an Association Agreement with the European Union, which came into force in June 2000. The 1995 agreement, which replaced the 1975 agreement, addresses issues relating to services, competition, government procurement, and cooperation in many areas including research and development. It also expands the liberalization in agricultural products. At the end of 2004, Israel and the European Union approved an Action Plan (within the European Neighborhood Policy) to address several issues including but not limited to services, dispute settlement for trade matters and standardization. Since 1996, Israel has participated in the EU Framework Programs for Research and Development, which allow Israeli firms and academic institutions to participate in European Union research and development projects. Israel is the only country outside Europe to enjoy this special status, a status granted to Israel largely in recognition of its role as a key technological player in the global arena. Under the Fifth Research and Development Program, more than 500 Israeli projects have been implemented, with a total value of more than EUR150 million. In November 2002, Israel was admitted to the EU’s Sixth Research and Development Program and gained access to EUR17 billion in research and development tenders from European Union countries. Israel is a full associated member of the Seventh Framework Program for Science and Technology since it was launched on December 22, 2006. This program, which is the biggest in the world involving the academia as well as business and industry sectors, has provided Israel with access to EUR50 billion in research and development tenders from the European Union. In addition, in 2004 Israel joined the EU GALILEO program for the development of a space navigation system.

In 1985, Israel and the United States entered into a free trade agreement that resulted in the elimination of all tariffs on all industrial products effective January 1, 1995. The free trade agreement with the United States also resulted in the elimination of certain non-tariff barriers to trade between the two countries.

In recent years, Israel, with the assistance of the United States, has developed new regional trade agreements that stimulate economic cooperation between Israel and its neighbors in the Middle East. Israel signed a Qualified Industrial Zones (“QIZ”) agreement with Jordan in 1997 and a separate QIZ agreement with Egypt in December 2004. The above mentioned agreements allow Egypt and Jordan to export products to the United States free of export duties if the products contain inputs from Israel (8% of input from Israel in the Israeli-Jordanian QIZ agreement, 10.5% of input from Israel in the Israeli-Egyptian QIZ agreement). The purpose of this trade initiative has been to support prosperity and stability in the Middle East by encouraging regional economic integration.

In order to promote its international economic cooperation, and, in particular, to promote Israeli investments in emerging markets, Israel has signed 32 bilateral investment treaties. The treaties provide investors from countries that are party to the treaties with basic security and protection rights when investing in another party’s country. Some of those rights include repatriation of investments and returns, a prohibition on expropriation or nationalization other than for public purposes, prompt, adequate and effective compensation, and no less favorable treatment as compared to investors from countries that are not party to the treaties.

Israel is also a party to 44 conventions for the avoidance of double taxation that cover most aspects of income tax and capital gains tax. Three more tax treaties were signed but have not yet been ratified. Most of

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Israel’s tax treaties are based on the OECD Model Tax Convention on Income and on Capital. Some of the treaties also include provisions from the UN Model Double Taxation Convention between Developed and Developing Countries. The conventions provide investors from countries that are parties to the conventions with greater certainty when investing in another party’s country and contribute to economic cooperation between the countries that are parties to the conventions.

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THE ECONOMY

Overview

Israel’s economy is industrialized and diversified. GDP per capita in 2007 was $22,560. From 1996 through 2007, real GDP growth averaged 3.9% per year (1.6% per capita). Since 2004, growth rate was accelerated and averaged 5.2% annually. The recovery during the years 2003 through 2007 was related to: the improvement in the global economy, as manifested by the expansion of global trade and demand for high-tech products; the adoption of a firm fiscal policy; a relatively calm security situation (apart from the Second Lebanon War); and a less restrictive monetary policy. The year 2007 was characterized by a rapid growth of all components of the GDP, with private consumption, investments and external trade growing at a rate that is faster than that of the overall GDP. In 2007, exports of goods and services increased by 8.4%, private consumption increased by 6.8% and investments (in fixed assets and changes in inventory) increased by 13.1%.

The composition of Israel’s trade reflects the industrialized nature of its economy. In 2007, exports consisted primarily of manufactured goods, in particular high-tech goods, while raw materials and investment goods comprised 80% of imported goods. Exports have always played a significant role in Israel’s economic growth. During the period from 1995 to 2007, exports of industrialized goods (excluding diamonds) grew by an annual average of 8.1% (in USD terms). In 2003, with the upturn in the business cycle, exports began to recover, growing by 8.1%. The recovery in exports gained momentum in 2004, as exports rose sharply, by 18.2%. The expansion in exports continued in 2005 and 2006 as well, albeit at a lower rate than in 2004 (4.3% and 5.9% in real terms, respectively). In 2007, exports grew by 8.4%. Hi-tech and traditional industries both contributed to the expansion in exports of goods; the exports of services also rose, in particular the sharp increase in tourism, recovering from a slump that began in late 2000. The growth in exports during the years 2003 – 2007 was a result of the global economic recovery, the expansion of global trade and increased demand for high-tech products, the depreciation of the NIS in real effective terms during the period from 2002 through 2004, the decrease in real wages during 2002 and 2003, improved efficiency of business enterprises in Israel, and lower interest rates. Exports of services grew by 7.3% in 2007, with a significant growth in tourism and transportation, representing a fast recovery from the effects of the Second Lebanon war in 2006. After a year with no change in agricultural product exports, such exports increased by 30.7% in 2007.

Historically, the Government has had substantial involvement in nearly all sectors of the Israeli economy. In the past 20 years, however, a central aim of the Government’s economic policy has been to reduce its role in the economy and to promote private sector growth. In order to advance these goals, the Government has pursued a policy of privatizing state-owned enterprises, including banks (see “ — Role of the State in the Economy” below). The Government has also pursued stability-oriented monetary and fiscal policies. These policies build upon the economic stabilization program established by the Government in 1985.

The 1985 economic stabilization program was a comprehensive plan designed mainly to reduce Israel’s high inflation rates and chronic deficits in the balance of trade that resulted from high levels of defense expenditures, other Government spending and rising oil prices.

Since 1985, Israel has made significant progress in stabilizing inflation through effective implementation of monetary policy by the Bank of Israel, fiscal restraint and trade liberalization by the Government. In 1986, the Government succeeded in reducing inflation to 19.6%. During the period of 1987 through 1991, inflation stabilized to an annual average rate of 17.8%. During the period of 1992 through 1999, the annual average inflation rate decreased to an average of 9.5%. The average rate of inflation dropped to a mere 1.1% in each of 2000 and 2001, but rose in 2002 to an average of 5.7%, mainly as the result of the currency depreciation during the first half of 2002. Since then, inflation has dropped back again, to an average annual rate of 0.7%, negative 0.4% and 1.3% in 2003, 2004 and 2005, respectively. In 2006, the average annual inflation rate was 2.1%. In 2007 inflation declined further to 0.5%. The Government’s inflation target for 2008 and onwards is 1% to 3%.

Gross Domestic Product

GDP is defined as gross national product (“GNP”) minus income of Israeli residents from investments abroad, earnings of Israeli residents working abroad, and other income from work and leases abroad, less corresponding payments made abroad (after deduction of payments to foreign companies with respect to production facilities located in Israel).

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GDP growth averaged 4.9% annually between 1996 and 2000. From October 2000 until the beginning of 2003, the GDP growth rate declined mainly due to: the global economic slowdown, which dampened demand for high-tech products on which a significant percentage of the Israeli economy relies; the decline of the NASDAQ index, which is correlated to investments in Israeli start-up companies and in the high-tech industry in general; and the adverse effects of Palestinian terrorism on tourism, construction, agriculture and exports to the Palestinian Authority areas. Growth was negative 0.6% and negative 0.9% in the years 2001 and 2002, respectively. The recovery process began in 2003 and gained momentum in 2004, 2005 and 2006 with GDP growth rate increasing to 5.20%, 5.29% and 5.21% in each of these years. The fast GDP growth continued in 2007 with a 5.26% increase. Contributing factors to the rate of GDP growth include: the improvement in the global economy, as manifested by the expansion of global trade and demand for high-tech products; the adoption of a firm fiscal policy; a relatively calm security situation (apart from the Second Lebanon War); and relatively low real interest rates. In 2007, economic improvement was reflected in rapid growth of all components of GDP.

Table No. 4

Main Economic Indicators
(In Billions of NIS Unless Noted)


	Year
	2003			2004			2005			2006			2007
Growth (Percent Change)
Real gross domestic product		2.30	%		5.20	%		5.29	%		5.21	%		5.26	%
GDP per capita		0.41	%		3.35	%		3.45	%		3.37	%		3.45	%
Inflation (change in CPI – annual average)		0.70	%		-0.40	%		1.30	%		2.10	%		0.52	%
Industrial production		-0.40	%		7.10	%		4.70	%		8.34	%		4.77	%
Constant 2005 Prices
GDP		531.7			559.4			588.9			619.7			652.2
Business sector product		375.7			402.6			428.9			456.8			484.7
Current Prices
GDP		527.0			554.1			588.9			633.1			664.7
Business sector product		368.7			390.5			429.0			465.6			491.8
Permanent Average Population (thousands)		6,690			6,809			6,930			7,054			7,177

Source: Central Bureau of Statistics.

Table No. 5

Resources and Use of Resources
(In Billions of NIS at Constant 2005 Prices)


	Year
	2003		2004		2005		2006		2007
Resources
GDP		531.7		559.4		588.9		619.7		652.2
Imports of goods and services		223.9		250.2		258.4		267.0		299.9
Total		755.6		809.6		847.4		886.6		952.1
Use of Resources
Private consumption		293.8		310.3		322.3		336.8		359.8
Public consumption		154.3		150.3		154.9		158.4		162.5
Gross Domestic Capital Formation		98.8		101.2		111.9		117.8		133.2
Exports of goods and services		209.7		247.7		258.3		273.6		296.6
Total		532.6		559.4		589.0		619.7		652.3

Source: Central Bureau of Statistics.

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Savings and Investments

In 2007, gross national savings as a percentage of national income (which is defined as GNP plus income from abroad transferred to individuals and the Government) decreased slightly to 22.4% compared with 23.4% in 2006, 21.6% in 2005 and 19.7% in 2004. Gross domestic investment, the sum of investments in fixed assets and the change in inventories, totaled 19.5%, up from 18.1% in 2006. In 2007, total gross domestic investment increased by 13.1% in real terms following increases of 5.3% and 10.5% in 2006 and 2005, respectively.

Investment in machinery, equipment and transport vehicles increased by 22.4% in 2007 following an increase of 10.4% in 2006. Investment in residential construction in 2007 increased by 2.9%, following an increase of 6% in 2006. The residential construction sector has contracted since 1998 as a result of the decrease in demand following the slowdown in the wave of immigration and in response to the recession during the years 2001-2002.

Business Sector Product

Business sector product in Israel equals GDP less general government services, services of private non-profit institutions and housing services (representing the imputed value of the use of owner-occupied residential property). Business sector product grew at an average annual rate of 6.8% in real terms from 1990 through 2000, but decreased by 1.9% and by 2.8% in 2001 and in 2002, respectively. Since 2003, business sector product began to grow again, increasing by 2.2%, 6.8%, 6.7% and 6.4% in 2003, 2004, 2005 and 2006, respectively. In 2007 the business sector product grew by 6.1%.

Table No. 6

Composition and Growth of Business Sector Product


	Annual Growth (Real Terms)															Percentage of Total 2007
	2003			2004			2005			2006			2007			Percentage of Total 2007
Total business sector		2.20	%		6.80	%		6.70	%		6.40	%		6.10	%		100.00	%
Trade and services		-0.4			6.3			7			7.1			6.8			56.4
Manufacturing⁽¹⁾		5.8			6.8			4.5			10.5			4.4			20.5
Transport and communications		2.7			7.6			5.1			3.6			6.5			10.9
Construction		-3.7			-6.4			1.2			2.2			5.5			6.7
Agriculture		-7.5			19.4			4.2			0.6			4.6			2.7
Water and electricity		4.1			0.3			6.5			4.1			6.6			2.9

(1)

Excluding diamonds.

Source: Bank of Israel.

Trade and Services. The trade and services sector consists of retail and wholesale sales, professional services, banking, hotels and other services. The trade and services sector increased by 6.9% in real terms in 2005, by 8.3% in 2006 and by 6.8% in 2007.

Manufacturing. Manufacturing (excluding diamonds) increased by 4.5% in real terms in 2005, by 10.5% in 2006 and by 4.4% in 2007.

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Table No. 7

Manufacturing by Category


	Annual Real Percentage Change
	2003		2004		2005		2006		2007
Total (excluding diamonds)		-0.3		6.6		3.6		9.9		4.6
Food, beverages and tobacco		-2.3		1.3		0.4		1.9		2.8
Mining		-2.9		-3.2		2.1		-0.4		-1.3
Textiles and clothing		-8.7		-2.8		0.8		4.5		-1.6
Leather and leather products		3.6		-8.2		0.2		6.8		6.7
Wood and wood products		-0.9		7.5		1.0		4.0		8.0
Paper and paper products		-3.4		0.1		4.5		1.5		4.2
Publishing and printing		-2.8		5.0		2.2		4.5		-0.1
Chemical products and refined petroleum		5.6		12.6		4.6		29.1		-1.5
Rubber and plastic products		6.1		5.8		9.4		4.7		9.6
Non-metallic mineral products		-5.3		-8.4		4.6		3.9		8.4
Basic metal		-11.1		7.8		2.3		-0.3		6.0
Metal products		-1.2		6.3		4.5		12.0		2.2
Machinery and equipment		-3.7		-7.0		-1.1		5.9		10.5
Electric motors		1.1		-3.0		0.0		5.9		7.3
Electric and electronic equipment		4.1		7.2		4.4		11.5		7.4
Communication equipment		-8.4		21.7		7.3		23.2		13.6
Transport equipment		3.1		16.6		4.2		3.2		13.0
Jewelry and goldsmiths		-7.0		-3.1		4.5		-12.2		-8.0
Other		11.2		-0.6		5.3		-0.5		17.0

Source: Bank of Israel.

Table No. 8

Industrial Production Index
(Base: Year 2004)


	Year
	2003			2004			2005			2006			2007
Index Level⁽¹⁾		93.3			100			104.7			113.4			118.8
Annual Real Percentage Change		-0.4	%		7.1	%		4.7	%		8.3	%		4.8	%

(1)

Excludes diamonds.

Source: Central Bureau of Statistics.

Transportation. Buses are the major form of public transportation. Bus routes exist in all cities in Israel and connect Israel’s major cities smaller towns and rural areas. Israel also has a network of over 17,000 kilometers of roads, including highways that link Tel-Aviv with Haifa, Jerusalem and Dimona. Government-owned railways run from Nahariya on the northern coastline to Dimona in the south, linking some of Israel’s major cities and the southern part of the country.

Since 1993, the Government has identified infrastructure improvement as one of its top priorities. In September 2003, the Government founded the Israel National Roads Company LTD (“INRC”), a Government Company (as defined below (see “ — Role of the State in the Economy”)) responsible for the inter-urban road system, traffic management and control, planning, development and maintenance of the roads and their safety. The budget for INRC projects in 2007 was approximately NIS2.7 billion. In recent years, the Government has

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approved a number of major road construction projects, including the “Cross-Israel Highway” — Israel’s North-South toll highway. The 86-kilometer central sections of this highway were opened to traffic in January 2004, at the end of 2007 a 19-kilometer section was opened, and two additional sections of this highway, totaling 32 kilometers, are currently under construction. A 17-kilometer section in the north of the State is scheduled to open in 2009, and a 16-kilometer section in the south of the State is scheduled to open in the second half of 2008. Other projects include the Carmel Tunnel (to be completed in 2011), a fast toll lane at the east entrance to Tel-Aviv (to be completed in 2010) and Highway 431 which will serve the south-eastern suburban part of Tel-Aviv (to be completed in the second half of 2008) and, unlike existing highways, is implemented as a private-financial-initiative.

The Government considers the development of an advanced railway system a top priority. In 2000, the Government issued a tender to establish a light rail build-operate-transfer (“B.O.T.”) project in Jerusalem. In 2003, the Government issued a tender to set up a light rail BOT project in metropolitan Tel-Aviv. The first Tel-Aviv line is expected to commence operations in 2014. The first Jerusalem line is expected to commence operation in 2010. In 2004, the Government decided to invest $4.5 billion over five years in a rail development program. As part of this development plan (i) the old line between Jerusalem and Tel-Aviv (via Beit-Shemesh) was rehabilitated and opened to the public in April 2005, (ii) a direct and upgraded line between Jerusalem and Tel-Aviv is scheduled to commence operations in 2014, (iii) the line between Tel-Aviv and Ben-Gurion International Airport was opened to the public in March 2005, and its extension through Modi’in was opened in 2007, and (iv) several new and improved lines, such as Tel-Aviv-Rishon Le-Zion, Haifa-Beit She’an, Kfar Saba-Rananna-Tel-Aviv, and Ashkelon-Beer-Sheva, are scheduled to commence operations in 2010 and 2012.

Israel has three major seaports: Haifa and Ashdod, on the Mediterranean coast, and Eilat, by the Red Sea. In 2007, 22 million tons of freight were unloaded and 17.7 million tons were loaded at Israeli ports. In July 2004, the Knesset decided on a structural reform of the seaports in order to enhance competition and improve efficiency of the ports, thereby strengthening Israel’s foreign trade. As mandated by legislation, the Israel Ports Authority ceased operations on February 16, 2005 and was replaced by four Government-owned companies. Israel Ports Development and Assets Company Ltd. serves as landlord of the ports’ real estate in Haifa, Ashdod and Eilat and is responsible for developing and leasing those properties. Ashdod Port Company Ltd., Haifa Port Company Ltd. and Eilat Port Company Ltd., the three port-operating companies, received a mandate to operate port facilities that have been leased to them (in Ashdod and Haifa, for terms of 49 years; in Eilat, for a term of four years). Among the major projects are the development of the “Hayovel” terminal in Ashdod which commenced operations in May 2005, and the “Hacarmel” terminal in Haifa, which is scheduled to commence operations in 2009. The Israel Ports Development and Assets Company Ltd. is investing approximately NIS3.9 billion in these two projects.

Israel has three international airports. The Airports Authority is responsible for maintaining, developing and operating the airports and their security in accordance with the directives of the Minister of Transportation. Israel’s main airport is Ben Gurion Airport in Lod, which is located approximately 40 kilometers from Jerusalem and 20 kilometers from Tel-Aviv. Ben Gurion Airport served approximately 10.1 million passengers in 2007, compared with 8.8 million passengers in 2006 and 8.5 million in 2005, with flights to and from most major cities in Europe, Asia and North America. A new terminal opened at Ben Gurion Airport in November 2004 in order to increase the capacity for annual passenger arrivals and departures to approximately 16 million passengers. The financing for this expansion was derived exclusively from Airports Authority revenues and private project financing.

Communications. The telecommunications market presently contributes approximately 7% of the Gross National Income, and in 2007, the average ratio of household communications expenditures out of total household consumption expenditure was 5.5% ($150 per month). Israel’s communications market is characterized by fundamental technological and regulatory structural changes, large investments, and rapid development. The market is currently comprised of four domestic cellular operators, four international telephony service providers, one cable television provider, one satellite television provider and two fixed domestic telephony operators with universal service obligation.

While Bezeq, the Israel Telecommunications Corp. Ltd. (“Bezeq”), remains the main fixed telephony service operator, the cable companies have acquired more than 250,000 voice telephony subscribers, mainly in the

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households segment. In September 2004, the domestic fixed telephony market was opened to competition after the Ministry of Communications promulgated regulations allowing new entrants to provide services without the attendant obligations to provide services over large areas. Under these new regulations, four new operators were licensed to provide domestic fixed telephony services.

After being limited to three competing operators before, international telecommunications services have been opened to complete competition since the end of 2004. As of December 2007, Israel has four companies offering international telephony services. In 2006 the total number of Incoming & Outgoing minutes used in international services was 2.7 billion minutes. Israel has four cellular telephone network operators which provide digital technology, countrywide coverage and modern, third generation services. As of 2007 there were approximately 8.4 million cellular subscriptions, more than one cellular phone, on average, per capita. Total cellular market revenues in 2006 were approximately $3.36 billion.

Three major Internet service providers and about seventy smaller ones serve more than three million users, including more than 65% of households and more than 80% of businesses. Fixed broadband service in Israel (by either Cable Modem or ADSL) is used in 99% of households that have Internet service. The cable company and Bezeq are obligated to provide universal deployment of broadband Internet access service.

The Israeli Public Broadcasting Authority had an official monopoly on television broadcasts through 1993. As of 2001, there were three national public TV channels broadcasting in Israel and one national commercial channel. In 2002, a second commercial channel started to operate via cable and satellite and a fourth public Arabic-speaking satellite-delivered channel was launched. In addition, a Russian-speaking channel and an Israeli music channel, which are commercial special-interest TV channels, began broadcasting in 2003. A fifth public TV channel, with broadcasting related to the Knesset, started operating via cable and satellite in 2004.

The cable television market has a single cable television operator (the result of a merger of three regional operators) and a single direct broadcast satellite (“DBS”) operator that began operations in 2000. About 48% of all households subscribe to cable television, and 29% of households subscribe to the DBS service.

Construction. In 2007, investment in residential construction increased by 2.9%, compared to a 6% increase in 2006 and following a low level of activity in residential building that began in 1998. Prices of housing, which comprises about a fifth of CPI, decreased by 2.2% in 2007, following an increase of 1.2% in 2006.

Agriculture. In 2007, agricultural exports totaled $1.35 billion, representing 2.9% of total merchandise exports. Agricultural revenue in 2007 was NIS13.6 billion: livestock (44.3%) and crops (55.7%). In 2007, 2.3% of all Israeli employees were working in agriculture, compared to 1.7% in 2006. Investments in agriculture amounted to 1.7% of fixed investments in 2007.

The Government has implemented structural reforms in order to increase agricultural competition and productivity. In 1994, the Government launched a reform to eliminate production quotas for poultry, cattle and crops. In 1998, a reform in the dairy sector was launched, aimed at enhancing competition and efficiency and reducing pollution levels emanating from dairy farms. The effects of this reform may be noticed in the diminishing number of dairy farms and the rising number of cows per farm. The reforms in the poultry, cattle, crops and dairy sectors facilitated a sizeable shift from manufacturing, marketing and financing of agricultural products through large co-operatives, which were heavily subsidized by the Government, to a system in which decisions regarding such matters are made by individual production units, which receive fewer subsidies from the Government.

Water and Electricity. The scarcity of fresh water is a serious problem for the entire Middle East region. Since 2000, the Government significantly increased investment in the water and electricity sectors. Israel is conducting discussions with Jordan and the PA with respect to the allocation of water resources. The primary sources of fresh water in Israel are the Sea of Galilee, the eastern mountain region aquifer (a portion of which is located under the West Bank) and the coastline region aquifer along Israel’s western border. Water from these sources is distributed throughout Israel by pipeline, including distributions to the arid areas in the south.

Approximately 70% of Israel’s fresh water is distributed through Mekorot Water Co. Ltd., a state-owned enterprise (see “ — Role of the State in the Economy” below). The remaining 30% of Israel’s fresh water is supplied by private water associations established by agricultural users and certain municipalities. During 2006,

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Mekorot Water Co. spent NIS804 million on capital investments related to water distribution, an increase from NIS672 million spent during 2005 and NIS577 million spent during 2004.

Approximately 57% of Israel’s total water use and 40% of Israel’s fresh water use is attributable to agriculture. As almost all of Israel’s existing fresh water resources are already being consumed, Israel is investing resources to develop additional water sources, mainly from treated wastewater and desalinated seawater. Currently, desalination plants are being built by both local and foreign private sector companies through build-operate-own (“B.O.O.”) and B.O.T. projects. When all the plants are operational, the Government expects to purchase approximately 505 million cubic meters of desalinated seawater per year from the plants at an estimated cost of NIS1.4 billion per year. During 2007, the Government plans to purchase a total of approximately 135 million cubic meters of desalinated seawater from the desalination plant in Ashkelon, which commenced operations in August 2005, and the desalination plant in Palmachim, which commenced operations in May 2007. In addition, further development of agriculture involves intensifying the yield from land that is already irrigated and the reuse of treated wastewater. During 2007, the reuse of treated wastewater was approximately 75% (350 million cubic meters), and the Government plans to further increase its efforts of making more use of treated wastewater. As a result, in recent years there has been a reduction in the size of certain agricultural crops, such as cotton, that require large amounts of water. To address the relative shortage of water, Israeli companies have developed a number of sophisticated irrigation systems, including micro-drip systems, that permit efficient irrigation.

Israel has also increased its investment in purification and improvement of wells and sewage treatment plants. The 2008 Government budget includes provisions for both grants and loans to stimulate capital investment in these programs. The Government has also taken steps to facilitate the establishment of regional companies to assume responsibility from Israel’s municipalities for the treatment of water and sewage. The purpose of these steps is to promote professional and efficient management of water and sewerage systems and to direct the revenues from these services to investments in water and sewerage infrastructures. In July 2001, the Knesset passed a law regulating the commercial relationship between the regional companies, the municipalities and consumers. As of 2007, nine regional companies are already in operation.

Almost all electric power in Israel is provided by the Israel Electric Corporation Ltd. (“IEC”), a Government Company (as defined below) that generates virtually all its own power (see “ — Role of the State in the Economy” below). In 1996, IEC’s exclusive concession from the Government expired, and the Electricity Industry Act was enacted. The purpose of the Act is to regulate activity in the electricity industry for the benefit of the public by achieving reliability, availability, quality, efficiency and cost minimization within a competitive market. The Act provides for a ten-year transition period during which IEC has a license to transmit, distribute, supply and market electricity. Under the Act, the owner of a license for transmission or distribution functions will be required to purchase electricity from other generators of electricity, and to enable other licensed generators to use the same transmission and distribution channels to supply electricity to their own customers. IEC currently holds licenses to produce electricity at each of its 67 generation units. The generation and transmission licenses have been extended several times and are valid until mid 2008, and the licenses for distribution and supply have been extended until mid 2009, when the licenses are expected to be revised and extended. A public utility commission has been established to supervise electric utility services, which includes regulating the prices of electricity. In recent years, the Government has begun to open up the electricity industry to competition by setting rules for the entry of private electricity producers into co-generation of electricity and publishing a tender for generation. This plan was reflected in changes in the Electricity Industry Act in 2003 and in 2007, which formulated rules for the licensing of additional electrical distribution companies. The Government’s goal is to achieve a decentralized industry divided into the following segments: generation, where the Government expects to be competitive; transmission, where the Government expects a natural monopoly to take hold; and distribution, where the Government expects regional monopolies to take hold.

Energy

Israel’s main sources of energy are oil and coal. Israel is almost totally dependent on imported fuel for its energy requirements, since domestic production of crude petroleum is negligible and Israel has no domestic production of coal. Most of Israel’s foreign oil is purchased in the open market. Pursuant to the Oil Supply

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Arrangement, the United States has agreed to supply Israel with oil in the event of a failure of Israel’s oil supply. In 2000, a substantial amount of natural gas was discovered near Israel’s Mediterranean shore. The discovery of the natural gas could reduce Israel’s dependence on imported oil.

Israel has succeeded in significantly reducing its dependence on oil for the production of electricity by switching to coal-fired power stations located along Israel’s coastline, and by expanding a coal facility in Ashkelon. All of the coal used in Israel is imported. Israel purchases the majority of its coal from South Africa, the United States, Colombia and Australia. Smaller amounts of coal are purchased from other countries, including China. The shift to coal has not had a significant environmental impact in Israel, because most of the coal used is low-sulfur coal.

In 1997, the Government decided to establish a natural gas infrastructure in Israel. In August 2003, the Government founded Israel Natural Gas Lines Ltd. (“INGL”), a Government-owned company that was established to supervise, control and operate the natural gas transportation system. In March 2004, the first natural gas power station in Israel was inaugurated in Ashdod. Currently, this power station has the ability to produce approximately 10% of Israel’s total energy capacity.

In April 2004, INGL, IEC and the State signed an agreement for the financing, construction and operation of a natural gas transportation system that would be state-owned. Under the agreement, IEC will build the 100 kilometer underwater gas pipeline route, and INGL will construct the continental route. The underwater pipeline construction is expected to be completed in 2007. INGL has completed building the continental segment between Ashdod and Ashkelon. In 2005, the Government decided to build two more continental segments: one between Kiryat-Gat and Sdom, which is expected to open by 2009, and the other, between Haifa and Alon-Tavor, which will open during 2009.

Table No. 9

Imports and Production of Crude Oil, Coal and Natural Gas
(In Thousands of Tons Oil Equivalent)


	Year
	2003		2004		2005		2006
Imports
Crude oil		10,723		9,497		10,421		10,246
Coal		7,486		7,789		7,718		7,726
Production
Crude oil		3.1		1.9		1.6		1.5
Natural gas		7.1		1,088		1,497		2,061

Sources: Central Bureau of Statistics, Ministry of Infrastructure.

Tourism

Tourism plays an important role in the Israeli economy. Israel’s tourist centers include: Jerusalem, various significant religious sites, the Eilat area, the Dead Sea and its region and the Mediterranean coast. Income derived from foreign tourism (excluding expenditures of foreign workers in Israel) in 2006 and 2007 amounted to $1.9 billion (1.4% of GDP) and $2.4 billion (1.5% of GDP), respectively. However, these figures are still low compared with $3.1 billion in 2000 (2.6% of GDP), which had been a record year.

The unrest that began in late September 2000 resulted in an immediate drop in the number of tourists entering Israel by air. Between 2000 and 2001, the total number of tourists entering by air decreased by 45.8%. In 2002, the number of tourists further decreased by 26.6%, followed by an additional reduction in tourism in the first quarter of 2003 due to the war in Iraq. Since the second half of 2003, tourism has recovered in light of the increasingly improving security situation, the favorable effects of the end of major combat activities in Iraq and the global economic recovery. In the first half of 2006 tourist arrivals continued to grow rapidly, following the fast increase of 2005 (26.4% over 2004), but the Second Lebanon War led to a sharp decline in tourism which affected the year’s total. The number of tourists arriving in 2006 was 1.8 million, a decrease of 4.1% relative to 2005. In 2007, tourist arrivals returned to the positive trend of pre-2006 war.

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Table No. 10

Tourist Arrivals by Area of Origin and Receipts
(Arrivals in Thousands and Receipts in Millions of Dollars)


	Year
	2003		2004		2005		2006		2007
Total arrivals		1,063.4		1,505.5		1,902.8		1,825.9		2,267.9
Asia		86.9		117.8		146.7		141.4		175.4
Africa		32.4		43.4		45.8		62.6		72.5
Europe		572.7		828.7		1,074.2		984.1		1,301.6
North America
United States		271.9		379.1		457.5		494.0		541.6
Other		75.7		107.4		145.0		65.2		77.7
Oceania		11.5		17.2		22.5		20.9		24.7
Other		12.1		12.1		11.0		8.1		74.4
Total travel services	$	2,059.9	$	2,430.0	$	2,797.0	$	2,777.0	$	3,250.0
of which: Expenditures of foreign workers in Israel	$	996.5	$	954.0	$	891.0	$	909.0	$	894.0

Source: Central Bureau of Statistics.

Research and Development

The Government encourages investment in industrial research and development through support and incentive programs created under the Law for the Encouragement of Industrial Research and Development. The objectives of the Government’s support for industrial research and development are to: foster the development of technology-related industries; create employment opportunities for Israel’s scientific and technological labor force; and improve Israel’s balance of payments by increasing exports of high-technology products and reducing reliance on imports of such products. In 2006, approximately 4.5% of GDP was invested in civilian research and development. Government support of civilian research and development, including general university funds financed by the Government, totaled NIS4 billion in the 2006 budget, NIS4.2 billion in the 2005 budget and NIS4.2 billion in the 2004 budget.

Israel participates in 29 different international and bi-national industrial research and development joint ventures, of which three are with the United States, three with the European Union, two each with Canada and India and one each with Australia, Germany, China, France, Belgium, Italy, Ireland, Turkey, Hong Kong, United Kingdom, Greece, Taiwan, Singapore, Spain, Portugal, South Korea, Sweden, Finland and the Netherlands. The 2007 annual budget includes, in addition to allocations for other, bi-national projects, NIS268 millionfor the European Framework Programme, compared to NIS299 million in 2006.

Wages and Prices

In the early and mid-1980s, Israel’s economy experienced high rates of inflation In response, in 1985 the Government implemented the Economic Stabilization Program, which succeeded in reducing the rate of inflation.

Since 2003, the rate of inflation was low, at one percent on average during the years 2003-2007. In 2007, CPI rose by 0.5%. These low rates were influenced by the reduction in the Government deficit, appreciation of the NIS and reduction in taxes on consumption.

Both the Ministry of Finance and the Bank of Israel have stated that reaching and maintaining price stability is one of their main priorities. Since the end of 1991, the Government has announced annual inflation targets as part of its effort to further reduce inflation (see “Public Finance — The Budget Process and Deficit Reduction” below). For 2008, the Bank of Israel has set the inflation target range at between 1% and 3%.

Since November 1993, the Bank of Israel has adjusted its key interest rate on lending to banks on a monthly basis. Beginning in June 2003, the Bank of Israel lowered the key interest rate at an accelerated rate, reaching

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5.2% by the end of 2003. In 2004, the key interest rate was lowered to 3.9% and by September 2005, the interest rate reached 3.5%. Subsequently, the Bank of Israel increased the interest rate gradually up to 4.5% in December 2005, and to 5.0% in April 2006. A cautionary reaction to the deterioration in security led the Bank of Israel to increase the rate to 5.5% in August 2006. Since November 2006 the interest rate has been gradually decreased and was set at 3.5% in June 2007. In August 2007, the Bank of Israel began gradually to increase the interest rates, and in February 2008, the interest rate reached 4.25%. Since then, however, following global trends and in response to the NIS appreciation, the Bank of Israel began to reduce interest rates again. As of May 2008, the key interest rate is 3.25%.

Real interest rates, derived from the Bank of Israel’s key interest rate, have fallen from more than 6% in mid-2003 to less then 1% in May 2008. The public’s inflation expectations are calculated as the difference between nominal yields (on unindexed Government bonds) and real yields to maturity (on CPI-indexed Government bonds). During 2007, the public’s inflation expectations for one year ahead, as derived from the capital market, were around 1.4%.

Table No. 11

Selected Price Indices
(Percentage Change, Annual Average)


Period	CPI		CPI (Excluding Housing, Fruits and Vegetables)		Wholesale Price of Manufacturing Output
2003		0.7		2.4		4.3
2004		-0.4		0.5		5.4
2005		1.3		1.7		6.2
2006		2.1		2.2		5.7
2007		0.5		0.9		3.5

Source: Central Bureau of Statistics.

The wage system in Israel is subject to comprehensive indexation under nationwide cost-of-living agreements. These agreements are negotiated by Israel’s nationwide labor union and representatives of the major employers’ organizations in the private sector. After the agreements are negotiated, the Minister of Labor validates the agreements for all workers in the public and private sectors. The 2002 agreement provides employees a cost-of-living increase at an agreed-upon percentage tied to changes in the CPI. Furthermore, wages in certain industries are subject to labor agreements that guarantee additional periodic wage increases, as well as equality of treatment with respect to wage increases with workers in other specified industries. In the past decade, wage linkage between sectors weakened as a result of a decrease in the scope of unionization and an increase in the use of individual employment contracts. In 2003, the Ministry of Finance reached an agreement with the labor unions on cutbacks in public sector employment and a temporary wage reduction prior to the Knesset’s adoption of the comprehensive economic plan in May 2003. The temporary wage reduction under this agreement expired in July 2005. On April 17, 2008, the Ministry of Finance reached an agreement with labor unions regarding future wage conditions. The agreement provides for a 5% wage increase over the course of 2008 – 2010.

Real wage per employee post (nominal wage deflated by the CPI) in the business sector significantly decreased in 2002 by 6.6%. In the public services sector, real wages decreased by 4.9%, as a result of a decrease in demand for labor and a rise in prices. In 2003, the real wage per employee post declined by 3.0% (2.5% in the business sector and 4.2% in the public services sector). In the public services sector, the nominal wage per person employed declined in 2003 by 3.5%, mainly due to public sector wage reductions that were part of the comprehensive economic plan adopted in May 2003.

In 2004, the real (CPI-adjusted) wage per employee rose by 2.5%. The increase was 1.5% in the business sector and 4.6% in the public service sector. This increase was the result of a general economic recovery and a one-time change in timing of wage supplements in the public services sector. In 2005, real wages rose by 1.0% (1.5% in the business sector and 0.0% in the public services sector). In 2006, real wages rose by 1.3% (1.7%

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in the business sector and 0.4% in the public services sector). In 2007 there was a real wage increase of 1.8%, led by a 1.6% increase in private sector wages and a 2.3% increase in public sector wages.

Employment and Labor

One of Israel’s most important resources is its experienced and highly educated work force. In 2006, approximately 41.8% of the Israeli population over age 15 had 13 or more years of schooling. With this highly-educated population, Israel has developed an export-oriented, technology-based industrialized economy. In 2005, 30% of the Israeli work force consisted of scientific, academic, professional, technical and related workers, while 22% consisted of administrative or managerial workers. These percentages compare favorably with the percentages of such workers found internationally. The employment qualifications of recent immigrants have been consistent with the high quality of the Israeli work force, with two-thirds of immigrants from the former Soviet Union having been employed there as professionals, scientists, engineers or technical staff.

The wave of immigrants since 1990 led to significant growth in the Israeli labor force. In 2007, Israel’s civilian labor force consisted of 2.9 million people compared to 1.9 million in 1992.

The recession that began in late 2000 caused the unemployment rate to increase from 8.8% in 2000 to 10.3% in 2002. Despite the economic recovery that began in 2003, the unemployment rate continued to climb in 2003 to a rate of 10.7%. The unemployment rate decreased to 10.4% in 2004, 9.0% in 2005 and 8.4% in 2006. In 2007, the unemployment rate continued to decline to an average of 7.3%. The number of Israeli employees, and, the rate of civilian labor force as a percentage of the population over the age of 15 (the “labor participation rate”) rose in 2007. In Israel, the labor participation rate is negatively affected by the relatively large number of soldiers. The average labor participation rate increased from 54.1% in 2002 to 56.3% in 2007. Compared with 2004 figures, in 2007, the number of employed Israelis increased by 281,200. The increase in the participation rate and the number of Israelis employed is attributed, among other factors, to the successful implementation of government policy of cutting transfer payments and reducing the number of foreign workers. In 2007, business sector employment increased by 76,000 (compared with an increase of 65,000 in 2006) and employment in public services increased by 29,000 (compared with an increase of 15,000 in 2006).

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Table No. 12

Structure of Employment in Israel


	Year
	2003			2004			2005			2006			2007
Total workers⁽¹⁾ (in thousands)		2,330.20			2,400.80			2,493.70			2,573.60			2,682.00
Employed Persons, As Percent Of Labor Force
By Sector
Business sector		68.90	%		69.94	%		69.87	%		70.21	%		70.31	%
General government		31.10	%		30.06	%		30.13	%		29.79	%		29.69	%
By Industry
Manufacturing		16.2			16.1			15.7			15.6			15.7
Agriculture		1.9			2.0			2.0			1.8			1.6
Water and electricity		0.8			0.8			0.9			0.7			0.6
Construction		5.6			5.4			5.1			5.2			5.6
Trade		13.6			13.5			13.5			13.1			13.4
Catering		4.0			4.3			4.6			4.7			4.6
Banking and financial services		3.3			3.3			3.3			3.4			3.5
Business services		12.9			13.3			13.4			13.8			14.0
Public administration		5.2			4.6			4.7			4.5			4.5
Education		12.7			12.6			12.6			12.7			12.8
Health, welfare and social work		10.7			10.6			10.7			10.2			10.0
Transport		6.4			6.4			6.5			6.7			6.4
Personal and other services		1.4			1.6			1.6			1.8			1.8
World Jewish organizations		0.1			0.1			0.1			0.1			0.05
Not known		0.5			0.7			0.7			0.8			0.8

(1)

Israeli workers only; as of 2003, according to the Standard Industrial Classification of All Economic Activities 1993 — Second Edition, 2003.

Sources: Central Bureau of Statistics, Bank of Israel and Ministry of Finance calculations.

The unemployment rate among immigrants in 2006 was 7.2%, even less than that of the native-born population (8.4%). Surveys undertaken by the Israeli Central Bureau of Statistics indicate that immigrant unemployment declines with length of stay in the country. Immigrant participation rate in the labor force stood at 59.5% in 2006 compared to 56.3% for the working age population as a whole.

Despite the initial difficulties experienced by many of the professional and other highly skilled immigrants in finding suitable employment, statistical data regarding employment in Israel suggest that immigrants have moved from their original jobs into jobs better suited to their education and other employment qualifications. One important factor in this transition has been the professional requirements of Israel’s high-tech companies, which have matched well with the educational and professional background of many of the immigrants.

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Table No. 13

Principal Labor Market Indicators
(Annual Average)


	Year
	2003			2004			2005			2006			2007
Permanent average population (thousands)		6,690			6,809			6,931			7,053			7,180
Population aged 15+ (thousands)		4,792			4,876			4,963			5,053			5,142
Civilian labor force (thousands)⁽¹⁾		2,610			2,679			2,740			2,810			2,894
Labor-force participation rate⁽²⁾		54.50	%		55.00	%		55.20	%		55.60	%		56.30	%
Unemployment rate		10.70	%		10.40	%		9.00	%		8.40	%		7.30	%

(1)

The sum of the number of civilian workers and the number of job seekers.

(2)

Civilian labor force as a percentage of the population over the age of 15.

Source: Central Bureau of Statistics.

The General Federation of Labor in Israel (the “Histadrut”) has historically played a significant role in the Israeli economy and social system. As part of a structural and organizational reform, the Histadrut concentrates today on its function as a trade union and a social organization. The Histadrut also has a major influence on labor and social legislation in the Knesset.

Over 30 trade unions are members of the Histadrut. Although the percentage of union workers has been declining (mainly due to the termination of the link between membership in the Histadrut and the General Health Insurance Organization, which is the largest provider of health services), a considerable part of the Israeli labor market is unionized. The Histadrut signs collective bargaining agreements, which affect workers in both the public and private sectors. In addition to nationwide agreements (such as the cost-of-living agreement), the collective bargaining network includes collective agreements between occupation or industry unions and employers’ associations. Such agreements predominantly affect the public sector. Collective agreements cover issues related to wages, conditions of employment and social benefits.

Role of the State in the Economy

Historically, the Government has been involved in nearly all sectors of the Israeli economy, particularly in defense-related and monopolistic businesses. Before the privatization process, ownership of industry in Israel was divided between the Government, the Histadrut and the private sector, with the Government and the Histadrut owning prominent interests in several key industries. In recent years, the Government has made significant progress towards the privatization of state-owned enterprises. As part of this process, the Government has implemented structural reforms aimed to enhance competition in some essential monopolistic sectors such as the communication sector, oil refineries and the seaports. In addition, the Government has begun the process of introducing competition to additional sectors and industries, such as the electricity sector and capital markets.

As of April 2008, there are 97 state-owned enterprises, 37 of which are business-oriented enterprises. The remaining state-owned enterprises include funds established as vehicles for employee savings or educational institutes.

State-owned enterprises are divided, by law, into two main categories: Government Companies (including their subsidiaries) and Mixed Companies. In addition to state-owned enterprises, the Government is also involved in some sectors through statutory authorities.

Government Companies (a category that excludes state-owned banks acquired pursuant to the Bank Shares Arrangement, see “ — Privatization” below) are those where the Government owns more than 50% of the voting shares and which are subject to the provisions of the Israeli Government Companies Law and the regulations promulgated thereunder (collectively, the “GCL”), as well as the directives of the Government Companies Authority (see “ — Privatization” below). The GCL regulates the management and operation of Government Companies and the circumstances under and procedures by which the Government may sell shares in Government Companies or reorganize Government Companies.

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Mixed Companies are companies in which the State owns 50% or less of the voting shares. Under the GCL, Mixed Companies are not subject to the same degree of regulation as Government Companies. However, Mixed Companies are subject to certain limited provisions of the GCL, including the Government’s appointment and qualification of certain directors.

Government Companies play a significant role in the Israeli economy. Although they employed only 2.1% of the Israeli work force, in 2006 Government Companies accounted for 9.5% of total exports and 7.83% of investment in fixed assets. These companies include several public service monopolies and a number of companies that either engage in activities considered crucial to Israeli national security or provide important services to the Government.

To increase competition in the markets in which these companies participate and thus prepare them for privatization, the Government has initiated a number of regulatory arrangements with the major Government Companies. Nevertheless, the pace of privatization may be affected by the need for further regulatory and structural reforms and formulation of policies that will define the post-privatization environment in which these companies will operate. The development and implementation of some of these policies and reforms may take a considerable period of time.

Privatization. An essential element of the broader structural reforms initiated by the Government over the past several years to promote the growth of the private sector and to enhance competition is the Government’s move towards privatizing its business holdings. Privatization efforts have included the full or partial sale of state-owned companies and banks and the transfer of activities that were previously performed by the Government or statutory authorities to private entities. From 1986 through April 2008, 95 companies changed their status as Government Companies and the Government’s proceeds from privatization from 1986 through April 2008 were approximately $14.2 billion. In 2007, proceeds from privatization totaled NIS6.4 billion.

Privatization of all state-owned enterprises, other than banks, is conducted by the Government Companies Authority. The responsibility for privatization of banks is vested with the Ministry of Finance, through M.I. Holdings Ltd., a wholly-owned Government Company. M.I. Holdings Ltd. advises the Minister of Finance regarding bank privatizations and manages the process in accordance with the Minister’s instructions. The Ministerial Privatization Committee (the “Privatization Committee”), consisting of the Minister of Finance, as chairman, the Minister of Justice and three other ministers, has the power to initiate the privatization of any Government Company or Mixed Company without the consent of the minister directly responsible for such Government Company or Mixed Company, and to authorize preparatory measures necessary to effect such privatization. The Government Companies Authority also has general authority relating to the supervision of Government Companies, including the right to convene board meetings, to set reporting and supervision instructions and to issue directives to Government Companies in connection with decisions of the Privatization Committee.

In 1983, as a result of the collapse in the share prices of several large banking institutions on the TASE, the Government entered into an arrangement (the “Bank Shares Arrangement”) with the shareholders of several banking institutions, whereby the State purchased shares from the banks’ shareholders at the time of the crisis. As a result, the State gained a controlling stake in five of the six largest Israeli banks (although the State did not exercise any management control over these banks). The Government’s current privatization program is intended to result in the sale of the Government’s controlling interest in these banks. Implementation of this program is ongoing as the Government continues to reduce its bank holdings through a variety of public and private transactions.

Between 1993 and 2001, the Government sold 27.7% of the total outstanding shares of Israel Discount Bank Ltd. In February 2005, the Government sold control of the bank, 26% of the bank’s issued share capital for a total of NIS1.3 billion. This sale was completed in January 2006, following the approval of the Bank of Israel. With the controlling share of the bank, the buyer bought the option to purchase an additional stock package totaling 25% of the issued share capital of the bank. In May 2006, the Government sold an additional 6.09% of the bank’s shares. As of April 2008, the State still holds 25.0% of the shares in Israel Discount Bank Ltd. If the option is exercised, the holdings of the State in the bank will decrease to zero.

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Between 1997 and 2000, the State sold 72.4% of the total outstanding shares of Bank Hapoalim Ltd. in private sales for a total of $2.3 billion. In July 2005, the State sold its remaining holdings of Bank Hapoalim Ltd. which comprised 0.01% of the bank’s outstanding shares.

Between 1993 and 1999, the State sold 97.2% of the total outstanding shares of United Mizrahi Bank Ltd. in both public and private sales, for a total of $525.5 million. In July 2005, the State sold its remaining holdings of United Mizrahi Bank Ltd. which comprised 0.5% of the bank’s outstanding shares.

Between January 2000 and July 2005 the State sold 24.85% of the total outstanding shares of Bank Leumi Ltd. In November 2005, the State sold a share package of 9.99% coupled with an option to purchase an additional 10.01% of the issued and outstanding shares of the Bank. This option was not exercised due to the buyer’s failure to obtain Bank of Israel’s authorization for the transfer of the controlling means in the bank. In May 2006, the State sold 2.85% of the bank’s shares to the employees of the bank. As of April 2008, the State owns 11.53% of Bank Leumi Ltd.

Table No. 14

Selected State-Owned Companies
(At, or for the Period Ended, December 31, 2007)⁽¹⁾
(In Millions of Dollars, Except Percentages)


	Percentage Direct and Indirect Ownership of Government			Total Assets		Long-Term Liabilities		Total Revenues
Bezeq, the Israel Telecommunications Corp. Ltd.⁽²⁾		16.38	%	$	3,941	$	1,454	$	3,224
Israel Electric Corporation Ltd.		99.8			17,850		12,181		5,009
Israel Aircraft Industries Ltd.		100.0			3,376		515		3,316
Rafael-Armament Development Authority Ltd.		100.0			1,253		277		1,374

(1)

Based on consolidated, NIS reported financial statements as of December 31, 2007, according to Israeli generally accepted accounting principles. Amounts converted from NIS to dollars at the exchange rate on December 31, 2007 ($1=NIS3.846).

(2)

In case of a full exercise of all the options, the State’s holdings will comprise 1% of the shares. Since November 2003, Bezeq is a mixed company.

Sources: Ministry of Finance, Government Companies Authority.

Below are summary descriptions of the state-owned companies included in the above table. Also described below are specific steps planned or taken by the Government to prepare companies for privatization or reform their structure and operations.

Bezeq is a state-owned (Mixed Company) that specializes in telecommunications. Its operations are subject to regulatory arrangements by the Government, such as tariff and structural supervision. Arrangements implemented since 1994 are designed to increase competition in the communications sector. International telephony services are provided by four companies (of which one is a wholly-owned subsidiary of Bezeq). Cellular services are provided by four companies (of which one is wholly-owned by Bezeq). In June 1999, Bezeq’s exclusive right to supply fixed telecom services was terminated. Since the end of 2000, initial steps have been taken to introduce competition into the supply of fixed telecom and other internal communication services, including competition from other communication companies involved in the cellular and cable services. Between July 1997 and February 1998, the State sold a 21.4% interest in Bezeq in a sale to Merrill Lynch & Co. and in a public offering in Israel, which together raised a total of $508.7 million and reduced the State’s ownership level to 54.6% (fully diluted). In 2003 the State reduced its holdings in Bezeq in two dispositions, representing 3.6% and 5.8%, and resulting in income to the Government of more than NIS1 billion. As of November 2003, the State held 49.1% of Bezeq’s shares. As a result of these sales, Bezeq (with its subsidiaries) became a Mixed

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Company. In June 2004, the State sold 2.7% of Bezeq’s issued share capital on the TASE, which raised a total of $76.2 million, and after which the State’s holdings in Bezeq declined to 46.4%.

In October 2005, the State sold the controlling shares in Bezeq, through the sale of 30% of the total outstanding shares of the company coupled with a four-year option to buy another package of 10.66%, for a total of $972 million. Additionally, in November 2005, Bezeq’s employees were granted an option to purchase 4.71% of Bezeq’s shares. If all outstanding options are exercised by the new owners of Bezeq’s shares and by the employees, the State’s ownership in Bezeq will be reduced to 1.01% on a fully-diluted basis.

As of December 31, 2007 the State owned 16.38% of Bezeq. Since January 2008, Bezeq’s employees began exercising the options that were granted to them as part of the privatization program. In addition, the company has allocated securities to the its employees and officers. As a result, as of April 2008, the State’s share in Bezeq was reduced to 15.69% of Bezeq.

Israel Electric Corporation Ltd. (IEC) is a legal monopoly responsible for the entire Israeli electricity industry. Since 1992, IEC has been subject to tariff supervision that includes efficiency incentives. In March 1996, IEC’s exclusive concession from the Government expired, the Electricity Industry Act was enacted, and an authority for the supervision of public electric utility services was established. The purpose of the Act is to regulate activity in the electricity industry for the benefit of the public, by achieving reliability, availability, quality, efficiency and cost minimization within a competitive market. The Act, as amended, provides for an eleven-year transition period, during which IEC has a license to transmit, distribute, supply and market electricity. Under the Act, the owner of a license for transmission or distribution functions will be required to purchase electricity from other generators of electricity, and to enable other licensed generators to use the same transmission and distribution channels to supply electricity to their customers. On January 1, 1998, IEC received licenses to produce electricity at each of its 67 generation units. These licenses were extended until mid 2008. The generation and transmission licenses have been extended several times and are valid until mid 2008, and the licenses for distribution and supply have been extended until mid 2009, when the licenses are expected to be revised and extended.

In August 1999, the Government decided to implement structural changes in the electricity sector in order to open the electricity sector to competition as is common in other developed countries. For this purpose, the Minister of Finance and the Minster of National Infrastructures appointed an inter-ministerial committee headed by the Director General of the Ministry of Finance and the Director General of the Ministry of National Infrastructures. The committee was empowered to prepare a detailed proposal to accomplish the structural change.

In recent years, the Government has began to open up the electricity industry to competition by setting rules for the entry of private electricity producers into co-generation of electricity and publishing a tender for electricity generation. The Government’s goal is to achieve a decentralized competitive industry, divided into the following segments: generation, which the Government expects to be competitive; transmission, where the Government expects a natural monopoly to take hold; and distribution, where the Government expects regional monopolies to take hold.

In March 2003, the Government decided to reform the electricity sector in accordance with the recommendations of the Committee and amended the Electricity Industry Act accordingly. On May 29, 2003 the Knesset approved changes in the Electricity Industry Act that are designed to achieve a decentralized competitive structure of the electricity sector. The purpose of extending the IEC licenses was, among other things, to enable the Government and the employees to complete negotiations regarding the structural reforms and the resulting employee rights.

In February 2007, an amendment to the Electrical Industry Act was passed, providing for a change in the structure of the IEC. Pursuant to the amended law, starting in 2008, IEC’s operations will gradually split into several generation, distribution and transmission subsidiaries and into a number of other services companies. In addition, a Government Company will be formed and be in charge of the system’s management and will coordinate between the various companies. Such Government Company shall balance supply and demand, supervise competition and plan future development. Regulatory requirements applicable to the power generation and to the retail segments will be lifted gradually with a view to achieving competitive market conditions. By 2013, the Government intends to privatize 49% of the distribution and retail subsidiaries.

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The Ports Authority, which had centralized operations, assets and control of all of Israel’s ports, was traditionally one of the strongest and most significant monopolies in Israel. On July 22, 2004, the Knesset passed a law to abolish the Ports Authority and to divide the Ports Authority’s activities and framework among three newly-formed Government Companies each of which would operate either the Haifa, Ashdod or Eilat port. An additional Government Company would hold and manage the ports’ assets and lease them to the three port operating companies. In February 2005, the Port Authority was abolished and the four successor companies commenced operations. As part of the privatization process, the three ports companies are expected to be competitive, and portions of these companies are to be sold to the public.

Israel Railways was separated from the Ports and Railways Authority pursuant to a December 2002 amendment to the Ports and Railways Authority Law. On July 1, 2003, Israel Railways began operating as a Government Company. In 2003 the company commenced a five year, $4.5 billion investment plan that is expected to have a long term positive impact on the Israeli transportation system and the Israeli economy generally. In 2004, the Government and Israel Railways signed an agreement that set forth the principles applicable to the State’s subsidy of the company’s ongoing activity. This agreement was followed by a detailed contract signed in 2005. As consideration for the subsidy, the company committed to implement the government policy in the railways transportation system.

Bazan Oil Refineries Ltd. (“Bazan”) is the only oil refinery company in Israel. Bazan operates in the framework of Government reforms that have linked fuel prices in Israel to fuel prices in the international market. Bazan is permitted to sell its products only to wholesalers and certain key customers. In May 1971, the Government, who had held 100% of the company, sold 26% of its interest to The Israel Corporation Ltd., a public company, through a private placement. In December 2004, the Government decided to separate and privatize the refinery facilities.

The Government, as a preliminary step prior to the planned privatization of Bazan, purchased back the minority shares of 26% from The Israel Corporation Ltd. in the first quarter of 2006 for $137 million. In September 2006, the State of Israel, along with Bazan, sold their holdings in Oil Refinery Ashdod Ltd. in a private placement for $756.6 million. In February 2007, 44% of the shares of Bazan were sold in a private placement, followed by a sale of the remaining 56% through an IPO. The proceeds from these two sales totaled $1.538 billion.

El Al Israel Airlines Ltd. used to be the Israeli national air carrier. El Al operates in a competitive market with foreign airlines under the Government’s “open sky” policy. In 1995, El Al emerged from a reorganization program that it had operated under since 1982 due to labor difficulties at that time. In July 2002, after canceling a prior privatization plan, the Privatization Committee decided to privatize the State’s holdings in El Al in stages. In June 2003, the Government began the El Al privatization process by offering 15% of El Al’s shares on the TASE. The shares were bundled with two sets of options for the remaining 85% of the shares. The first set of options was exercisable within the year. The second set of options were exercisable between 18 months and four years from the offering date. In addition, El Al employees were offered the opportunity to purchase shares and options for approximately 9% of El Al. The total amount raised through the initial offering (which did not include the exercising of options) was NIS64 million, of which El Al received NIS22.1 million and the Government received the remainder. As of June 2007, all of the options had been exercised, and as of April 2008, the State owns 1.1% of El Al, and a special State share.

Zim Israel Navigation Company Ltd. is the largest shipping company in Israel and most of its operations are in international shipping markets. In 1970, the Government sold control of Zim to The Israel Corporation Ltd., a public company. Prior to February 2003 Zim was a Mixed Company, with the State and The Israel Corporation Ltd. holding 48.6% and 48.9% of the company’s share capital, respectively. In February 2003 the State sold the balance of its holdings to The Israel Corporation Ltd. for $113 million.

Israel Aircraft Industries Ltd., Israel Military Industries Ltd. and Rafael-Armament Development Authority Ltd. (“Rafael”) are three defense-related Government Companies. Currently, the State holds 100% of each of these companies’ share capital. Over the past several years, these three companies have been restructuring and streamlining their operations, primarily in preparation for privatization. Rafael was formerly an authority under the Ministry of Defense; in January 2002, it was converted into a Government Company. Israel Aircraft Industries Ltd. has reduced the number of its employees and is consolidating some of its operations. Israel Military

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Industries Ltd., which is experiencing financial difficulties, was partially privatized through the sale of several factories. The privatization of Israel Military Industries Ltd. (“Military Industries”) has begun with a sale, which has not yet been completed, of Military Industries’ subsidiary, Ashot Ashkelon Ltd., to Tabcall-Burg Group (the transaction is on hold pending a judicial hearing process) and with preparations within Military Industries, including a reorganization plan that calls for separation of the various units within the company.

Mekorot Water Company Ltd. (“Mekorot”) is the state-owned water company. It supplies approximately 65% of the water Israel consumes. Approximately 27% of Mekorot’s income from supplying water is subsidized by the Government through payments intended to compensate Mekorot for the below-market fees charged mainly from agricultural and other consumers. In 1993, Mekorot and the Government agreed on an arrangement establishing efficiency incentives for the years 1993 through 1998 and securing Mekorot a normative return on equity, thereby enabling it to raise capital in private capital markets rather than receiving subsidized loans from the Government, and reorganizing Mekorot and the Government water factories. In 2002, the Government and Mekorot agreed to continue to operate under a similar arrangement, which had been extended until 2009 with an option for an additional one-year extension.

As part of the structural reorganization plan, in July 2003, two new Government Companies were established: Mekorot National Carrier Ltd. and Mekorot Initiatives and Development Ltd. These companies, as well as Mekorot Water Company Ltd., are now subsidiaries of the new parent company, Mekorot Holdings Ltd.

Mekorot Water Ltd. serves as the National Water Authority under the Water Law (and would be responsible for operation of the water system, including production and establishment and renewal of water enterprises). Mekorot National Carrier has the leasehold on the properties of the National Carrier (and would be responsible for the maintenance and development of real property and other assets). Mekorot Initiatives and Development Ltd. manages and operates various water-related projects (including cooperation with private entrepreneurs on new water and sewage infrastructures, wastewater purification and other activities in the competitive segment).

Petroleum and Energy Infrastructures Ltd. (“PEI”) provides infrastructure services for the petroleum industry, and acts as the sole provider of transportation services for refined oil. PEI’s subsidiaries plan, build, operate and maintain systems and facilities for the transportation distribution and storage of petroleum products. The State controls the rates of PEI’s products and services. Through January 2001, PEI operated under a concession from the Government. In January 2001, an agreement in principle was signed between the State and PEI to govern PEI’s activities after the end of the concession. Implementation of this agreement is currently under negotiation.

INRC was establishedin September 2003 as a state-owned enterprise, replacing the government agency of the Ministry of Transport (MAA’TZ), which ceased operations. The company assumed responsibility for the inter-urban road system, traffic management and control, planning, development and maintenance of the roads and their safety. INRC operates as the Government inter-urban sole planner and developer managing a perennial development plan with an estimated budget of NIS19 billion.

The state-owned Israel Postal Company Ltd. and its subsidiary, the Postal Bank Ltd., were established in March 2006 so as to replace the Israel Postal Authority. These steps were made in order to enhance efficiency in the postal services in Israel and provide a base for enhancing competition in the postal and banking service sectors.

In July 1996 the Knesset decided to transfer the supervisory authority over the Israel Railway from the Ports and Railway Authority to a designated Government Company established specifically for this purpose. Israel Railways Ltd. was formed in January 1998 as a Government company and commenced activities in July 2003. As part of its plan to develop the railway system, the company invested NIS1.8 billion during 2006.

Following the Ministerial Committee for Privatization’s decision in May 2005 to privatize Pi Glilot Petroleum Terminals And Pipelines Ltd. (“Pi Glilot”), Pi Glilot’s fuel terminals were sold to Delek The Israel Fuel Corporation in August 2007 for NIS800 Million. The proceeds of the sale were used to repay Pi Glilot’s debts and for a dividend distribution to the State.

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Government Subsidies. Prior to 1985, the Government heavily subsidized certain segments of the Israeli economy, including basic foodstuffs and agricultural products. Since 1985, the level of direct Government subsidies has been significantly reduced. The remaining direct Government subsidies consist primarily of subsidies for water, public transportation and agricultural investments and production. Government subsidies for public transportation totaled NIS2.4 billion during 2007. Government subsidies for water totaled approximately NIS277 million and government subsidies for agricultural investments and production totaled NIS408 million during 2006.

Economic Incentives. The Government provides significant assistance to the manufacturing sector under laws designed to encourage investment in “approved enterprises,” mainly in peripheral regions of the country. A project that qualifies as an “approved enterprise” is eligible for assistance in the form of cash grants or tax benefits.

Beginning in January 1997, the Government significantly reduced the rate of grants. For the purpose of determining eligibility for grants, three industrial regions were identified: Region A, generally the most remote regions of the country; Region B, generally the peripheral regions of the country (closer to the central regions than A); and Region C, all other regions. The grant rate for Region A is 24% for investments up to NIS50 million and 20% for investments above this limit, compared to 10% for Region B for all levels of investments, and 0% for Region C for all levels of investments. The Negev area has a unique grants program, where the rate of grants can reach up to 32% for investments up to NIS140 million and up to 30% for investments above this limit. In 2005, the Government started implementing a three-year experimental program targeted to encourage employment in regions A and B. Under this program, industrial factories that increase the number of employees will be eligible for grants up to 15% of salary costs. As of March 2008 this program has not yet been implemented.

In the 2008 budget, the Government commitment for grants to the manufacturing sector totaled NIS260 million, compared to NIS150 million in each of 2006 and 2007 budgets.

Kibbutzim and Moshavim

Kibbutzim are collective settlements that traditionally were primarily agricultural. However, most kibbutzim now derive a majority of their revenues from manufacturing, tourism and other services. There are approximately 267 kibbutzim in Israel with approximately 123,200 inhabitants. Moshavim are cooperative settlements, most of which consist of individual owners of small farms. Moshavim derive a large percentage of their revenues from agriculture. There are approximately 442 moshavim with approximately 230,400 inhabitants. Kibbutzim and moshavim both experienced financial crises in the 1980s.

In 1988, the Government and the bank creditors of the moshavim agreed on a rescue and recovery program for the moshavim. In 1992, the Knesset approved legislation requiring partial debt forgiveness by the moshavim’s bank creditors, partial repayment of moshavim debt using the proceeds of certain required asset sales by the moshavim, and restructuring of the remaining moshavim debt at below-market interest rates. The total outstanding amount of the moshavim debt, subject to the 1992 legislation as of December 31, 2007, is NIS15.17 billion. Implementation of the 1992 legislation remains ongoing, and as of December 31, 2007, the 1992 legislation had been implemented with respect to approximately 96.6% of the individual moshavim members and 98.5% of the moshavim union obligors on the moshavim debt.

Pursuant to agreements signed between the kibbutzim, their bank creditors and the Government between 1989 and 1999, in order to establish a rescue and recovery program for the kibbutzim, an aggregate of NIS15.2 billion (as calculated for December 31, 2007) was written off by the banks, of which NIS6.37 billion was paid to the banks by the Government. An additional NIS13.3 billion of the kibbutzim’s outstanding loans from the banks were restructured and funded entirely by below-market loans from the Government to the kibbutzim’s creditors.

The Environment

Since the establishment of the Ministry of the Environmental Protection (“MOEP”) in 1989, many laws and regulations relating to the protection of the environment have been promulgated. The MOEP seeks: (i) to incorporate environmental considerations into decision-making and planning processes; (ii) to promote sustainable development; (iii) to implement programs for pollution control, monitoring and research; (iv) to develop

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and update legislation and standards, and to ensure effective enforcement and supervision; (v) to improve environmental education and awareness; and (vi) to advance regional and global cooperation on the environment. The country’s environmental legislation encompasses laws for the protection of natural resources, for the abatement and prevention of environmental nuisances and for the safe treatment of certain contaminants and pollutants. Israel’s legislation also includes comprehensive laws, such as the Planning and Building Law and the Licensing of Businesses Law, that provide a framework for controlling the use of resources and promoting sustainable development.

Israel has ratified nearly all of the major international conventions on environmental matters and has ensured that its national legislation conforms with these conventions. Israel is a party to international conventions on such subjects as climate change, transboundary movements of hazardous waste, protection of the ozone layer, biological diversity, wetlands protection, international trade in endangered species, and protection of the Mediterranean Sea from pollution. Israel ratified the Kyoto Protocol to the UN Framework Convention on Climate Change in February 2004 and soon thereafter created a Designated National Authority (“DNA”) for the Clean Development Mechanism (“CDM”). The CDM in Israel provides investors from countries under Annex I of the Kyoto Protocol with opportunities to implement projects in a wide variety of fields, most notably in the waste and energy sectors. By June 2007, 17 projects have been approved by the DNA, and the carbon credit market from the CDM project in Israel is currently estimated at €25 million per year, which will be used to advance environmental projects in Israel.

Several other environmental laws and regulations were promulgated in Israel in recent years, ranging from regulations on the collection of beverage containers (deposits) for recycling (2001) to several sets of regulations on the prevention of water pollution, including requirements for wastewater treatment plants to stabilize and treat the sludge generated for agricultural use or soil conditioning (2004). Revised regulations on environmental impact assessment, which introduce environmental considerations in earlier stages of planning and decision making processes and incorporate sustainable development principles, came into force in September 2003. In January 2004, regulations were promulgated to implement the Montreal Protocol, by restricting production, consumption, importation and exportation of substances that deplete or are likely to deplete the ozone layer. In August 2004, the Knesset enacted the Law for the Protection of the Coastal Environment, which recognizes the coastal environment as a national resource that must be protected for the benefit and enjoyment of the general public and establishes principles for the sustainable management, development and use of the coastal environment. To encourage the reduction of air pollution from vehicular sources, purchase taxes on hybrid cars were reduced from 90% in 2004 to 30% in 2005, the sulfur content of fuels was significantly reduced, new diesel vehicles are required to comply with stringent Euro4 standards and cars are now required to go through stricter annual air pollution checks. In this regard, the Knesset is currently working on a Clean Air Law aimed at reducing air pollution from vehicles and immobile emitting sources.

The Non-Ionizing Radiation Law, which aims to protect the public and the environment from the harmful impact of exposure to non-ionizing radiation (including radiation from cellular base stations and electricity network installations), was enacted in January 2006. A Tire Disposal and Recycling Law was enacted by the Knesset in January 2007 and a landfill levy, which seeks to internalize the external costs of landfilling, was approved in February 2007. Limits on pollution from industrial sources are imposed by a variety of methods, including by ambient and emissions standards.

Along with governmental and financial measures, the State has been convincing industries that pollution prevention and waste reduction are cost-effective. Hundreds of Israeli companies are voluntarily adopting environmental management systems, such as ISO 14000, as they recognize their importance in creating international business opportunities. The Government has also taken several steps to promote environmental quality and sustainable development. In May 2003, the Government decided to prepare a sustainable development strategy for the country. Economic ministries, especially the Ministry of Finance and the Ministry of Industry, Trade and Labor, have taken the lead and initiatives such as green taxes and environmental fair disclosure have been promoted in recent years.

The Government has taken several steps to decrease pollution produced by public utility providers. A November 2002 Government decision called for the introduction of renewable energy into the electricity sector.

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Within the framework of this decision, the public utility commission (see “The Economy — Water and Electricity” above) has established tariffs for the production of energy from renewable sources, based on the estimated costs of pollution prevention per ton of emissions. The introduction of natural gas to the electricity sector (see “The Economy — Energy” above) is expected to have major consequences on pollution abatement from the electricity sector.

In November 2004, the Government approved an action plan to reduce pollution from the industrial zone of Ramat Hovav, which includes some of Israel’s major chemical industries. The plan includes actions to advance wastewater treatment, remediate the evaporation ponds and the national hazardous waste treatment site and prevent pollutant emissions into the atmosphere. Industrial plants in the Ramat Hovav industrial park have already begun establishing in-house effluent pretreatment facilities in accordance with the Government decision. In 2006, the Government approved the allocation of NIS230 million for the remediation of hazardous waste treatment at the site.

While the prospect of membership in the OECD is first and foremost an economic priority, it has major ramifications on environmental protection, as, upon joining the OECD, Israel intends to comply with the organization’s policy papers, including the utilization of financial means and public participation in the decision making process.

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BALANCE OF PAYMENTS AND FOREIGN TRADE

General

As a small country with a relatively limited domestic market, Israel is highly dependent on foreign trade. International trade (exports plus imports) of goods (excluding diamonds) and services amounted to 77.1% of GDP in 2007.

Following a goods and services trade deficit of $3.5 billion in 2002 and $1.0 billion in 2003, the goods and services trade balance in 2004 was a surplus of $0.4 billion, which balanced ($0.0 billion) in 2005 and increased to a surplus of $1.1 billion in 2006. In 2007, the goods and services trade balance was deficit of $2.4 billion. This drop in the trade balance was the result of a significant increase in imports of goods and services, and a moderate increase in exports of goods and services.

Economic and military assistance furnished by the United States, German reparations and personal and institutional remittances decreased by 2.4% in 2007 to $7.2 billion after an increase of 23.8% in 2006, and following decreases of 4.9% in 2005 and 2.1% in 2004.

Official reserve assets declined during 2007 by 2.1% to $28.9 billion, compared to $29.6 billion in 2006 and $6.9 billion at the end of 1994.

As of December 31, 2007, Israel’s net external debt was negative $40.8 billion (negative 25.2% of GDP), as compared to positive $11.1 billion (8.6% of GDP) at the end of 1995.

Balance of Payments

Israel’s balance of payments consists of two parts: (i) the current account, which measures the trade balance (receipts and payments derived from the sale of goods and rendering of services), and the balance of income payments and transfer payments; and (ii) the capital and financial account, which reflects borrowing by the Government and the private sector, foreign direct investment in Israel and investment by Israeli residents abroad and assets and liabilities of commercial banks.

In the second half of the 1990s, the current account deficit steadily decreased, due mainly to an improvement in Israel’s terms of trade and a greater increase in exports than the increase in imports. In 2002, the current account deficit was 0.6% of GDP. Israel’s current account deficit of the balance of payments transitioned into a small surplus in 2003, which grew in 2004, 2005 and 2006. In 2003 and 2004, the current account surplus was $1.4 billion and $2.9 billion, respectively. In 2005, the current account surplus was $4.3 billion and in 2006 it grew to $8.5 billion. Current account had a surplus of $5 billion in 2007. The surplus in the last five years attests to the high external stability both by international standards and relative to the deficits of the mid-1990s.

Table No. 15

Balance of Payments
(In Millions of Dollars)⁽¹⁾


	Year
	2004		2005		2006		2007
Current account
Receipts
Exports of goods and services		52,697		57,551		62,991		71,422
Income		2,999		5,588		8,383		10,190
Current transfers		7,358		7,010		8,576		8,535
Total current account receipts		63,054		70,148		79,950		90,147
Payments
Imports of goods and services		52,313		57,586		61,925		73,781
Income		6,702		7,248		8,369		10,120
Current transfers		1,081		1,038		1,111		1,252
Total current account payments		60,096		65,872		71,404		85,153

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	Year
	2004		2005		2006		2007
Balances
Trade in goods and services		384		-36		1,067		-2,359
Net income		-3,703		-1,659		15		69
Net current transfers		6,277		5,972		7,465		7,283
Current balance		2,958		4,277		8,547		4,994
Capital balance		667		727		904		1,006
Financial account
Investments abroad
Direct investment		4,548		2,941		14,992		7,064
Portfolio investment		2,381		8,244		9,790		6,649
Other investments		6,214		5,134		8,985		5,841
Financial derivatives		26		-30		23		-10
Reserves assets		304		2,009		434		-1,680
Total investments abroad		13,472		18,299		34,224		17,865
Investments in Israel
Direct investment		2,012		4,868		14,694		10,276
Portfolio investment		7,251		4,217		8,798		270
Other investments		488		463		2,121		2,299
Total investments in Israel		9,751		9,549		25,613		12,845
Net financial transactions
Direct investment		2,535		-1,928		298		-3,212
Portfolio investment		-4,870		4,027		992		6,379
Other investments		5,727		4,671		6,864		3,542
Financial derivatives		26		-30		23		-10
Reserve assets		304		2,009		434		-1,680
Total net financial transactions		3,722		8,750		8,611		5,020
Statistical discrepancies⁽¹⁾		97		3,746		-839		-980

(1)

Many of the Balance of Payments figures are based on temporary estimations, and therefore are subject to significant adjustments over time.

Source: Central Bureau of Statistics.

Foreign Trade

Export growth has played a significant part in Israel’s overall economic growth and demonstrates the growing competitiveness of the Israeli economy. In 2000, industrial exports grew by 26.6% in dollar terms (27.9% excluding diamonds) due to fast economic growth in the United States and the European Union and a worldwide technology boom. However, in 2001, as a result of the slowdown in economic activity in the European Union and the United States and the global crisis in the high-tech sector, industrial exports decreased by 6.4% in dollar terms (6.8% excluding diamonds). In 2002, industrial exports decreased by 1.2% in dollar terms, and industrial exports excluding diamonds fell by 6.5% in dollar terms. The main reason for this contraction was the character of growth in the United States and other countries, which focused on traditional industries rather than on the high-tech industries that account for much of Israel’s exports. Industrial exports have since recovered and in 2005, industrial exports grew by 9.7% in dollar terms (7.7% excluding diamonds) and in 2006 they grew by 13.4% (excluding diamonds). Growth of industrial exports accelerated in 2007 to 18.7% (excluding diamonds). The recovery in exports reflects the effect of the real depreciation of the NIS in 2002 through 2006, the global economic recovery, the expansion of global trade and high-tech activity, the decrease in real domestic wages in 2002 and 2003 and gains in corporate efficiency.

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Exports of goods grew by 8.9% and 21.1% in dollar terms in 2003 and 2004, respectively. In 2005, exports grew by 8.2%, in 2006 by 13.6% and in 2007 by 17.3%. In 2007, exports of goods to European Union countries (as denominated in dollars,including diamonds returned by importers abroad and other returns to exporters in Israel) increased by 22.8%, exports of goods to the United States increased by 5.2%, and exports to the rest of the world grew by 21.2%. When compared to other destinations, the relatively slow growth in exports to the United States may be explained by the real appreciation of the NIS against the USD since 2007.

Exports of services grew by 7.3% in 2007, following a 6.7% increase in 2006. The tourism sector increased in 2007 by 17.0%, compared to zero growth in 2006, reflecting a recovery from the sharp decline in tourism in the second half of 2006 as a result of the outbreak of the Second Lebanon War. Exports of agricultural products recorded fast growth of 30.7% in 2007 after relatively stable results in 2006 and following an increase of 13.0% in 2005. The growth in USD terms is partly attributable to the increase in input and output prices in agriculture.

In 2007, imports of goods increased by 19.2% in dollar terms, following a 9.0% growth in 2006. The rise in imports in 2007 reflects mostly an increase in imports of consumer goods (29.1%) and imports of investment goods (excluding aircrafts and ships) (24.5%).

Trade Liberalization. The principal features of the Government’s trade liberalization program, which began in 1991, include the elimination of certain non-tariff barriers designed to protect local manufacturers (with the exception of fresh agriculture products) and the gradual decrease of custom tariffs. In 1994, Israel signed the GATT accords on agricultural products, and, since Israel has replaced most import restrictions with import duties. In 2006, average customs duties on the imports subject to the taxes were approximately 3.5%, down from an average of 25% or more in 1991. Accordingly, custom revenues in 2006 totaled only 0.9% of the total imports.

Notwithstanding the Government’s trade liberalization policy and the significant decrease in the customs burden, Israel has a number of trade restrictions, including quotas, licensing restrictions and outright prohibitions on certain goods. Israel also imposes a post-duty surcharge, called TAMA, that varies in amount by product and is included in the import duty estimation. The TAMA rate is determined according to the importer’s average profit margin for a specific category of goods, and reflects the difference between the wholesale price in Israel for a domestic product and the import price of the imported goods. Insurance and freight also tend to increase importer’s costs — in 2006, the Cost-Insurance-Freight (c.i.f.)-Free-on-Board (f.o.b.) differential was approximately 5% of civilian goods imports.

The Government’s authority in setting compulsory standards for products sold in Israel is limited to certain purposes, such as safety, public health, environmental protection and security considerations, and does not extend to protectionist purposes. Many standards have been changed in recent years to conform with international standards.

In 2007, Israel had a trade surplus of goods (excluding diamonds) of $3.5 billion with the United States, compared with a surplus of $4.3 billion in 2001. In 2007, Israel had a $4.2 billion trade deficit of goods with the European Union, similar to the deficit in 2006.

Israel primarily exports manufactured goods, many of them related to high-tech industries. Exports of low tech industries in 2007 accounted for 7% of the industrial non-diamond goods exports. High and mid-high technologies exports accounted for 75% of industrial non-diamond exports.

Raw materials and unfinished goods (including diamonds and fuels) made up 74.3% of Israel’s imports in 2006. The remainder of imports consist of investment goods (14.3%) and consumer products (12.5%).

Since 1948, members of the Arab League have maintained a trade boycott of Israel (see “State of Israel-International Relations” above). In September 1994, the Gulf Cooperation Council, which includes Qatar, Oman, Bahrain, the United Arab Emirates, Saudi Arabia and Kuwait, suspended their secondary and tertiary trade boycotts of Israel. These Gulf States, as well as four other Arab League members (Algeria, Djibuti, Mauritania and Somalia) no longer enforce the secondary and tertiary boycotts of Israel. Nevertheless, some Arab states continue to maintain their trade boycott of Israel. It is difficult to determine the impact on Israeli trade of the remaining elements of the boycott.

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Table No. 16

Exports of Goods by Major Groups
(In Millions of Dollars, f.o.b.)


	Year
	2003		2004		2005		2006		2007

Total (net)⁽¹⁾⁽²⁾	$	27,913.3	$	33,812.6	$	36,610.8	$	39,700.5	$	45,889.7
Agricultural
Total		714.7		908.3		1,027.1		1031.2		1347.6
Vegetables and field crops		288.1		417.8		417.5		470.4		657.4
Fruits		150.3		174.6		259.9		241.5		329.2
Other		276.3		315.9		349.7		319.3		361
Industrial (excl. polished diamonds)
Total		19,450.0		23,731.0		25,566.0		29,335.5		34,251.1
Mining, quarrying and non-metal minerals		619.0		856.0		863.0		798.2		1140
Food and beverages		510.0		598.0		659.0		710.1		848.4
Textiles, clothing and leather		993.0		1,093.0		1,074.0		1,082.2		1018.1
Wood, furniture, paper and printing		300.3		331.6		353.7		338		381.5
Chemicals and refined petroleum		4,591.1		5,792.1		6,935.5		8,323.1		9,548.8
Rubber and plastics		1,282.0		1,511.7		1,606.7		1,784.5		2,040.1
Basic metal products		1,015.9		1,379.8		1,622.2		1,989.3		2,382.1
Machinery and equipment		1,106.9		1,371.1		1,557.5		1,840.5		2,338.4
Electronic components and computers		2,192.2		2,596.2		2,415.7		2,621.6		2,504.5
Communication, control, medical and scientific equipment		4,574.6		5,728.2		6,024.6		7,101.7		7,994.9
Electrical equipment and motors		430.8		445.6		513.1		693.7		851.3
Transport equipment		1,223.5		1,358.6		1,294.2		1,300.6		2,004.1
Jewelry, goldsmith and silversmith		457.3		498.6		489.3		537.3		607.3
Miscellaneous		153.6		170.3		158.7		167.5		200.6
Diamonds
Total		7,868.0		9,285.5		10,150.6		16,129.0		18,395.7
Polished		5,636.2		6,363.6		6,658.4		12,979.7		14,546.5
Rough		2,231.8		2,921.9		3,492.2		3,149.3		3,849.2
Used ships and aircraft		3.5		0.0		111.4		222.2		0.0
Other goods		50.2		42.2		47.3		71.5		70.8
Returned goods		-172.8		-154		-291.7		-246.4		-247

(1)

Excludes trade with the West Bank and the Gaza Strip.

(2)

Net exports equals total gross exports less goods returned to Israeli exporters.

Source: Central Bureau of Statistics.

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Table No. 17

Imports of Goods by Major Groups
(In Millions of Dollars, c.i.f.)


	Year
	2003		2004		2005		2006		2007
Total (net)⁽¹⁾⁽²⁾	$	33,707.40	$	40,356.70	$	44,456.70	$	47,317.80	$	56,621.40
Consumer Goods
Total		4,256.50		4,977.20		5,329.50		5,900.50		7,512.40
Vehicles		723.00		931.90		985.00		1,045.00		1,569.50
Other		1,009.80		1,218.30		1,326.80		1,468.20		1931.30
Non-durables		2,523.70		2,827.00		3,017.70		3,387.30		4,011.60
Production Inputs (excl. diamonds)
Total		16,856.30		20,742.20		23,735.20		26,100.80		30,453.30
For agriculture		364.20		518.30		404.10		449.00		613.20
Raw food products		931.50		1,055.40		1,058.30		1,107.10		1,310.40
Fabrics and yarn		591.70		684.40		682.20		632.40		683.10
Wood and related products		281.60		312.80		334.50		355.70		492.80
Chemical products		2,319.90		2,697.20		2,860.60		3,284.30		3,624.10
Rubber and plastics		1,044.20		1,372.80		1,509.40		1,806.90		2,148.70
Paper-making material		512.90		600.50		658.80		700.90		801.10
Iron and steel		876.30		1,181.00		1,302.10		1,446.90		1,952.20
Precious metals		119.10		173.50		220.40		210.70		232.90
Non-ferrous metals		494.50		609.50		724.50		954.30		1,090.60
Machines and electronics		4,678.60		5,840.60		6,159.90		6,594.60		7,257.80
Other industries		942.30		1,193.00		1,056.20		1,102.40		1,311.20
Fuels		3,699.50		4,503.20		6,764.20		7,455.60		8,935.20
Diamonds (net)		7,739.90		9,193.50		9,604.50		9,054.20		10,035.60
Investment Goods
Total		5,341.50		6,020.40		6,325.70		6746.30		8,570.80
Machinery and equipment		4,399.30		4,875.80		4,948.90		5242.10		6,466.10
Transport vehicles⁽³⁾⁽⁴⁾		826.40		1,018.20		1,165.00		1,245.00		1,514.10
Ships and aircraft		73.00		27.80		132.90		172.90		539.60
Other goods		29.90		35.40		39.00		38.80		49.30
Returned goods		-114.50		-134.90		-152.50		-127.70		-124.30

(1)

Excludes trade with the West Bank and the Gaza Strip.

(2)

Net imports equals total gross imports less goods returned to the suppliers.

(3)

Excluding ships and aircraft.

(4)

Due to changes in classification, there are updates to figures reported in previous years.

Source: Central Bureau of Statistics.

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Table No. 18

Exports of Goods by Region
(In Millions of Dollars, f.o.b., Except Percentages)⁽¹⁾


Year
Region	2003				2004				2005				2006				2007
Americas		13,517.7	42.5	%		15,936.1	41.3	%		17,312.7	40.5	%		19,930.4	42.6	%		21,239.0	39.3	%
USA		12,088.5	38.0	%		14,175.1	36.7	%		15,500.1	36.2	%		17,957.2	38.4	%		18,892.9	34.9	%
Other		1,429.2	4.5	%		1,761.0	4.6	%		1,812.6	4.2	%		1,973.2	4.2	%		2,346.1	4.3	%
Europe		10,442.3	32.9	%		13,047.1	33.8	%		14,996.3	35.1	%		16,024.3	34.2	%		19,244.5	35.6	%
EU⁽²⁾		8,917.1	28.1	%		10,720.9	27.8	%		12,490.1	29.2	%		13,046.2	27.9	%		16,024.3	29.6	%
EFTA		557.1	1.8	%		839.6	2.2	%		970.3	2.3	%		872.7	1.9	%		1,104.7	2.0	%
Other		968.1	3.0	%		1,486.6	3.8	%		1,535.9	3.6	%		2,105.4	4.5	%		2,115.5	3.9	%
Asia		5,588.3	17.6	%		7,120.5	18.4	%		7,684.1	18.0	%		8,607.0	18.4	%		9,738.4	18.0	%
Africa		400.7	1.3	%		533.8	1.4	%		769.0	1.8	%		1,048.3	2.2	%		1,185.4	2.2	%
Oceania		306.5	1.0	%		449.4	1.2	%		455.3	1.1	%		493.4	1.1	%		564.3	1.0	%
Unclassified		1,527.8	4.8	%		1,531.5	4.0	%		1553.0	3.6	%		1,160.9	2.5	%		2,093.6	3.9	%
Total		31,783.3	100.0	%		38,618.4	100.0	%		42,770.4	100.0	%		46,789.4	100.0	%		54,065.2	100.0	%

(1)

Gross exports (including diamonds returned by importers abroad and other returns to exporters in Israel).

(2)

European Union data for 2000 – 2004 have been adjusted to reflect the enlargement of the European Union to 25 countries.

Source: Central Bureau of Statistics.

Table No. 19

Imports of Goods by Region
(In Millions of Dollars, c.i.f., Except Percentages)⁽¹⁾


Year
Region	2003				2004				2005				2006				2007
Americas		5,983.20	17.49	%		6,949.20	16.96	%		7,377.30	16.38	%		7,295.90	15.25	%		9,503.70	16.78	%
USA		5,330.80	16.10	%		6,099.10	14.89	%		6,042.10	13.42	%		5,919.50	12.37	%		7,848.40	13.86	%
Other		652.4	1.97	%		850.1	2.07	%		1,335.20	2.96	%		1,376.40	2.88	%		1,655.30	2.92	%
Europe		18,398.50	55.57	%		21,788.40	53.18	%		22,592.90	50.17	%		23,526.20	49.18	%		26,832.00	47.39	%
EU⁽²⁾		14,402.30	43.50	%		16,813.10	41.04	%		17,588.20	39.05	%		18,027.90	37.68	%		20,686.60	36.53	%
EFTA		2,153.40	6.50	%		2,775.60	6.77	%		2,545.50	5.65	%		2,893.00	6.05	%		2,960.70	5.23	%
Other		1,842.80	5.57	%		2,199.70	5.37	%		2,459.20	5.46	%		2,605.30	5.45	%		3,184.70	5.62	%
Asia		5,454.40	16.48	%		7,132.20	17.41	%		8,214.20	18.24	%		9,404.70	19.66	%		11,907.40	21.03	%
Africa		375.80	1.14	%		380.90	0.93	%		303.00	0.67	%		270.50	0.57	%		336.50	0.59	%
Oceania		135.20	0.41	%		81.50	0.20	%		125.70	0.28	%		118.50	0.25	%		150.50	0.27	%
Unclassified		3,864.70	11.67	%		4,636.50	11.32	%		6,421.40	14.26	%		7,224.80	15.10	%		7,891.30	13.94	%
Total		34,211.80	103.34	%		40,968.70	100.00	%		45,034.50	100.00	%		47,840.60	100.00	%		56,621.40	100.00	%

(1)

Gross imports (including unworked diamonds returned to suppliers abroad and other returns to exporters abroad).

(2)

European Union data for 2000 – 2004 have been adjusted to reflect the enlargement of the European Union to 25 countries.

Source: Central Bureau of Statistics.

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Table No. 20

Merchandise Trade Indices
(Base: 2000=100)


	Year
	2002		2003		2004		2005		2006		2007
Indices of Physical Volume
Exports		89.5		99.3		114.5		117.2		123.0		134.1
Imports		90.8		92.0		103.1		105.3		105.6		114.3
Indices of Prices
Exports⁽¹⁾		97.4		101.9		107.4		116.2		121.1		128.4
Imports⁽¹⁾		97.8		104.4		111.8		120.0		127.1		138.1
Terms of Trade⁽²⁾		99.6		97.6		96.1		96.8		95.3		93.0

(1)

Excluding ships and aircraft.

(2)

The price index of exports divided by the price index of imports, multiplied by 100.

Source: Central Bureau of Statistics.

Anti-Money Laundering Law

On August 2, 2000, the Knesset enacted the Prohibition on Money Laundering Law, which established the Israel Money Laundering Prohibition Authority to collect and process reports received and, upon suspicion of money laundering activity, disseminate the reports to the proper authorities. The law, which took effect in January 2002, makes money laundering a criminal offense punishable by imprisonment and large fines. The law also requires various financial institutions (including banks, portfolio managers, insurance companies and agents, members of the TASE, provident funds and companies managing provident funds, providers of currency services and the postal bank) to identify their clients before performing a financial transaction (“know your customer”), to report certain financial transactions to the Money Laundering Prohibition Authority and to maintain records of such transactions. There are two types of required reports: reports of transactions of a certain amount and type and reports of suspicious activity. These reporting requirements took effect on February 17, 2002.

In recognition of the steps taken by the State to combat money laundering activity, in June 2002 the Financial Action Task Force (“FATF”), the international task force on money laundering, which is affiliated with the OECD, removed Israel from its list of states deemed non-cooperative in the campaign against money laundering. In July 2002, the U.S. Treasury Department lifted its 2000 order to banks and other financial institutions requiring business transactions originating in Israel or for which funding passed through Israel to be subjected to enhanced scrutiny. Israel was removed from the FATF watchlist in 2003.

Foreign Exchange Controls and International Reserves

As of January 1, 2003, all activities and transactions in foreign currency between resident individuals, businesses and nonresidents are permitted.

As is common in Western economies, the expansion and enhancement of reporting procedures regarding external transactions accompanied the removal of foreign exchange controls in Israel. The freedom to engage in transactions with nonresidents is subject to the obligation of either the person carrying out the transaction or the financial intermediary through which it is carried out to report the transaction in detail to the Bank of Israel.

As part of the deregulation of financial markets, the reserve requirements on domestic foreign currency deposits were also reduced. The reserve requirements are currently 6% for current accounts (up to six days), 3% for time deposit accounts with a maturity of up to one year and 0% for time deposit accounts with a maturity exceeding one year. Since January 1998, local currency has served as the reserve requirement on domestic foreign currency deposits.

In recent years, net external liabilities (debt instruments) have declined dramatically, reaching a record level of negative $38.2 billion at the end of 2007.

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Table No. 21

External Assets and Liabilities (Debt Instruments)
(In Millions of Dollars)


	Year
	2003		2004		2005		2006		2007
External Debt
Public sector		29,923		31,253		31,089		33,305		31,817
Private sector		17,298		23,432		23,458		28,846		31,840
Banking system		24,745		23,989		23,189		24,988		26,287
Total		71,966		78,674		77,736		87,139		89,945
External Assets
Public sector		28,499		29,256		28,979		29,883		29,313
Private sector		32,719		38,184		43,497		53,875		62,659
Banking system		17,764		21,678		26,006		35,357		36,196
Total		78,981		89,118		98,481		119,115		128,168
Net External Debt		-7,015		-10,445		-20,746		-31,976		-38,222

Source: Bank of Israel.

Foreign currency reserves grew from $8.3 billion at the end of 1995 to $28.4 billion at the end of 2007.

Table No. 22

Foreign Currency Reserves at the Bank of Israel
(In Millions of Dollars)


For Period Ending on December 31,
2003	2004		2005		2006		2007
25,788		26,631		27,858		29,028		28,433

Source: Bank of Israel.

Foreign Exchange Rates

Until July 1985, the Israeli shekel was periodically depreciated at a rate consistent with inflation. On September 2, 1985, the Knesset approved the NIS, valued at 1,000 times the then-existing shekel. Since August 1, 1986, only the NIS has circulated. Until May 1, 2007, the NIS has been referenced to a basket of major currencies, which includes the U.S. dollar, British pound sterling, Japanese yen and euro. This basket approximated the composition of Israel’s external trade, including both imports and exports. The composition of the currency basket and the number of units of each currency comprising the basket were last updated on May 1, 2006. As of this date, the currencies’ weights were 65.7% U.S. dollar, 22.9% euro, 5.7% pound sterling and 5.7% Japanese yen.

In December 1991, the Bank of Israel introduced the “diagonal band” or “crawling peg system” to reduce business sector uncertainty and speculative cycles that had caused sharp capital movements under prior exchange rate systems. Under this system, the slope of the band was adjusted on a daily basis on a gradual, constant and predetermined path. Initially, the slope of the band was derived from the difference between the Government’s inflation target for the following year and predictions of inflation abroad. The width of the band, its midpoint rate and its slope were determined jointly by the Bank of Israel and the Ministry of Finance.

When the diagonal band was first introduced, its slope was 9%, with a limit of 5% above or below the midpoint rate. Since then, the slope has been gradually reduced, and, on December 24, 2001, the lower limit of the

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band was set at zero at a constant rate of NIS4.1021 to the currency basket. As such, the exchange rate band could no longer be considered diagonal. At the end of 2004, the width of the band was 60.2%, based on the average of the two limits. On June 9, 2005, the exchange rate band was abolished. Consequently, the Bank of Israel discontinued the use of the currency basket as a tool for monitoring or analysis and as of May 1, 2007, the Bank of Israel ceased calculating and publishing the currency basket exchange rate.

The Bank of Israel has sole responsibility for the daily management of exchange rates. Prior to February 1996, it was the practice of the Bank of Israel to use market intervention to maintain the exchange rate near the midpoint of the band. Since February 1996, the policy has been to intervene only to prevent the rate from moving outside the band. Since June 1997, the Bank of Israel has not intervened in the foreign currency market, with the exception of six days near the end of 1997. On March 24, 2008, the Bank of Israel announced its plan to increase Israel’s foreign currency reserves by $10 billion over the next two years by buying an average of $25 million per day.

Foreign Investments

Net foreign investment in Israel totaled $13.6 billion in 2007, compared with $25.8 billion in 2006, as a result of fewer large investments in 2007. Nevertheless, the steady flow of foreign direct investment (FDI) is an indication of the attractiveness of the Israeli economy.

Net FDI totaled $10.3 billion, less than the $14.6 billion invested in 2006, which was an extraordinary year, but more than $7.2 billion, which had been the average in 2004 – 2006. Israel’s economy is affected by trends in global capital flows, which in recent years have seen an increase in FDI, mainly in the form of mergers and acquisitions. Nevertheless, Israel is different from most emerging markets, a category in which Israel is sometimes included, since the main sector that attracts FDI to Israel is the high-tech sector, and not, as in most emerging markets, natural resources and the service sector. Despite its poor natural resources, investments, especially direct investments, in industries such as energy, renewable energy and food increased in 2007, an increase which is likely thanks to Israel’s advantage as one of the leading countries in agricultural and renewable energy technology and is related to the sharp rise in world prices of energy and food.

A significant share of the FDI in Israel is made in start-up companies, real estate and reinvestment of accumulated profits in Israeli companies. These transactions comprise a rather stable component of total FDI, which is otherwise generally considered to be volatile. In 2007, FDI in start-up companies totaled about $1.2 billion, compared with $0.8 billion in 2006. The sectors that benefited most were: communications, software and life sciences. Indicators such as commitments to Israeli venture capital funds and a comparison with capital raised by US venture capital funds showed the relative strength of investment in Israel. Investment in real estate totaled $1.6 billion, compared with $1.4 billion invested in 2006. Accumulated profits in Israeli companies continued to grow, and totaled $1.3 billion.

Nonresidents’ net portfolio investment fell sharply from $8.8 billion in 2006 to just $0.4 billion in 2007. This fall may be attributed to two main factors: (i) investors’ nervousness over the turmoil caused by the subprime crisis, growing concerns over inflation, and the change in monetary policy resulted in a decrease in investments in Israeli Government bonds, which dropped from $2.3 billion invested by nonresidents in this channel in 2006 as part of the anticipated market makers reform to a negative $1.6 billion in 2007; (ii) the 2006 results were highly affected by a sizeable issue abroad by a large Israeli corporation. In this respect, the decrease was more of a technical nature.

Nonresidents’ net equity portfolio investment on the TASE increased, mainly during the first quarter, and totaled $1.3 billion compared with net redemptions of about $0.1 billion in 2006. The improvement in the macro environment of the economy and a global trend of record flows into emerging markets had a positive influence on portfolio investment.

Nonresidents’ other investment — comprised of deposits in local banks and direct as well as trade credit — totaled $3.1 billion compared with $2.6 billion in 2006. The major decrease was in net direct credit to the non-banking private sector.

Issues of securities by Israeli companies abroad totaled $0.5 billion in 2007, and included seven initial public offerings (IPOs). While relatively low (due, in part, to redemption of bonds during 2007), the volume and

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number of transactions was similar to the average in the years following the hi-tech bubble burst (with the exception of 2006, when a large equity issuance was carried out for a specific transaction).

Despite the declines in certain investments, Israel still benefited from improved fundamentals in 2007, such as high economic growth, a current account surplus, high fiscal performance and continuing market reforms. These improved fundamentals were reflected, among others, in Israel’s nomination as a candidate for OECD membership.

Table No. 23

Average Exchange Rates
(NIS Per Currency Unit)


	Year
	2003		2004		2005		2006		2007
U.S. dollar		NIS4.548		NIS4.482		NIS4.488		NIS4.456		NIS4.108
British pound sterling		7.428		8.205		8.162		8.200		8.219
Currency basket		4.948		5.057		5.056		5.018		4.775*
Euro		5.136		5.569		5.583		5.592		5.624
Japanese yen (per 100 yen)		3.926		4.145		4.079		3.833		3.489

Source: Bank of Israel.

Average during the period: January – April 2007

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THE FINANCIAL SYSTEM

Bank of Israel

The Bank of Israel is the country’s central bank and functions independently of the Government. It is responsible for formulating and implementing Israel’s monetary policy. The Bank of Israel also manages foreign exchange reserves, supervises Israel’s banking system and issues bank notes and coins. The Governor of the Bank of Israel acts as an economic advisor to the Government. In addition, the Bank of Israel works jointly with the Government in formulating and implementing foreign exchange policy (see “Balance of Payments and Foreign Trade — Foreign Exchange Rates” above). In May 2005, Professor Stanley Fischer assumed office as Governor of the Bank of Israel.

As stipulated in the Bank of Israel Law, the Bank of Israel is not allowed to finance Government deficits or to lend the Government money to finance its expenditures in any fiscal year, except to provide temporary advances to the Government to bridge seasonal cash flow requirements when expenditures exceed revenues during the fiscal year (provided that the outstanding amount of such temporary advances at any time does not exceed 1.6% of the Government’s current expenditures budget for the year in which the advances are made). Twice a year, such advances are permitted to equal up to 3.2% of the current budget for a period of up to thirty days.

The Government is required to deposit all Government revenues, including proceeds of foreign debt (except for certain earmarked funds deposited with commercial banks), in the Bank of Israel, which is responsible for managing the Government’s foreign exchange reserves. The Bank of Israel is prohibited by law from investing in equity securities or private bonds and is subject to internal limitations on the amount of investments it may make in a single country or financial institution. The majority of the Bank of Israel’s reserves is held in securities issued by foreign sovereign issuers.

At the end of 1997, the Prime Minister appointed a committee of outside experts to suggest changes to the Bank of Israel Law, in light of the considerable institutional and economic changes that had taken place in Israel since the Bank was established in 1954 and in light of similar actions taken in many other countries in recent years. The committee submitted its report to the Government in December 1998. In March 2002, the Government submitted to the Knesset a proposal to amend the Bank of Israel Law. The Government’s report proposed modifying the Bank of Israel’s role, making it similar to the role of central banks in other developed economies and establishing the maintenance of price stability as the Bank of Israel’s main objective. Furthermore, in order to improve the policy-making process of the Bank of Israel, the Government proposed establishing a monetary committee within the Bank of Israel, composed of well-recognized and experienced professionals in the fields of finance, monetary policy and macroeconomic policy. In order to minimize any possibility of political interference, the members of the monetary committee would be nominated by an independent panel and chaired by a retired Supreme Court justice. In addition, in order to expand the transparency of its operations, the Bank of Israel would be required to report to the Government and the public on its monetary policy on a regular basis. The proposal is currently under discussion.

Monetary Policy

Since 1985, when the Economic Stabilization Plan was adopted, Israel has made significant progress in stabilizing inflation through effective implementation of monetary policy by the Bank of Israel, and fiscal restraint and trade liberalization by the Government. The primary objective of the Bank of Israel is to insure price stability over time. Another central goal is to promote the orderly functioning of the financial system and its stability. To the extent not interfering with these two objectives, the Bank of Israel strives to support other economic policy objectives of the Government, such as promoting high production rate and high labor participation rate.

The Bank of Israel’s principal instruments of monetary control are auctioned time deposits for banks and a discount window facility. Auctions for interest-bearing deposits are currently the main tool for implementing monetary policy and are similar to reverse repurchase agreements. The interest rate received by the banks is determined in the auction. Maturities are one week and overnight. In the past, the Bank of Israel injected liquidity using monetary collateralized loans, which were allocated to the banking system by periodic auctions of a predetermined amount and were used in a manner similar to repurchase agreements. The auction of overnight

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funds and deposits of various maturities and the rate of interest determined therein is the key determinant of short-term interest rates in Israel. The Bank of Israel utilizes the daily auctions primarily to offset flows from Government activities and the balance of payments. Through the discount window, Israeli banks can obtain overnight loans to fill temporary funding needs.

In previous years, in order to offset capital inflows, the Bank of Israel operated NIS/USD swaps, absorbing NIS in return for USD for a given period of time. The Bank of Israel ended this practice during the third quarter of 2005.

The Bank of Israel may absorb liquidity by selling non-indexed zero-coupon bills of up to one year maturity (known as “Makam”). Unlike Bank of Israel’s other monetary instruments, these securities are traded in the secondary market and are accessible to all of the investing public. Since the mid-1990s the Bank of Israel has gradually expanded the use of Makam issues as a monetary instrument to absorb excess liquidity in the banking system. The Makam market has advanced in recent years in a manner that enabled the Bank of Israel, since March 2007, also to actively increase liquidity banking system by reducing the issuance of Makam.

At the end of 1991, the Bank of Israel and the Ministry of Finance began publicly announcing annual inflation targets, with the intention of reducing inflation gradually from the 15% – 20% range that had prevailed since the Economic Stabilization Program was introduced in 1985 to the low single-digit levels typical in developed countries. At the time, Israel was one of the first emerging market economies to adopt the inflation-targeting approach to monetary policy as a tool in reducing inflation. Inflation targeting was implemented with some doubt in its first three years (1992 – 1994), but, when actual inflation significantly exceeded its target in 1994, the Bank of Israel implemented more restrictive monetary measures in order to prevent inflation from reverting to its pre-1992 levels.

The Bank’s tight monetary policy since the fourth quarter of 1994 has been a key factor in attaining the current low inflation levels. This monetary policy has been part of a three-pronged approach to macroeconomic policy that is designed to facilitate stable economic growth over the long run by promoting monetary and financial stability and by providing a favorable business environment. The other key features of the Bank’s monetary policy are fiscal restraint and structural reform, with the latter also geared to spurring economic growth from the supply side.

From the summer of 1997 through the end of 2001, the annual rate of inflation was below 3%, with the exception of the last quarter of 1998 when an international financial crisis led to a significant depreciation of the NIS and a significant one-time increase in price levels spaced over three months. A significant depreciation and an increase in price levels also took place in early 2002.

In August 2000, the Government set inflation targets for future years. For 2001, the target was 2.5% – 3.5%, for 2002, 2% – 3%, and since 2003, it is set at 1% – 3%, a level of measured inflation that is defined as “price stability.” These targets are consistent with the explicit or implicit inflation targets of nearly all other developed countries.

The end-of-year inflation rate was 0% in 2000, 1.4% in 2001, 6.5% in 2002, negative 1.9% in 2003, 1.2% in 2004 and 2.4% in 2005. The 2000 rate was below the yearly target, and, in 2002, the end-of-year inflation rate exceeded the target; however, the 2003 rate was again below the yearly target. The 2004 and 2005 end-of-year inflation rates were within their respective targets.

The focus of macroeconomic policy on financial stability during the past few years paid off handsomely between 1999 and 2001, as most financial indicators suggest a degree of stability despite the very significant shocks that hit the economy during that period. These shocks included the end of the high-tech boom, the sharp decline of the NASDAQ and the uncertain security situation.

Monetary policy since 1997 has emphasized the inflation-targeting regime, with exchange rate policy effectively having evolved to a free float policy. Until June 1997, the parameters of the upwardly sloping exchange rate band were such that the Bank of Israel was required to frequently intervene in the foreign exchange market to prevent appreciation. Continued intervention was viewed as untenable, and the band was widened considerably with provisions enacted for further gradual widening. These measures have thus far effectively removed the exchange rate constraints on monetary policy, and the Bank of Israel has been able to adjust its key interest

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rate to meet the inflation target without having to intervene in the foreign exchange market. The perception of risk in the foreign exchange market is now centered on small, day-to-day fluctuations rather than the larger, less frequent ones typical of a more tightly managed exchange rate regime. The current perception is more amenable to creating a more stable financial system. It appears that the policy measures in 1997 sent a signal to the public about the policymakers’ resolve to reduce inflation to levels similar to those in other developed countries.

In June 2005 the NIS/currency-basket exchange-rate band was officially abolished by a joint resolution of the Prime Minister’s Office, the Ministry of Finance and the Bank of Israel. In effect, since mid-1997, with the exception of a few days at the beginning of 1998, the Bank of Israel has not exercised its authority to intervene directly in foreign-currency trading in order to defend the crawling band. Thus, in effect, the exchange rate has evolved freely since 1998.

In the first half of 2002, in light of an ongoing rapid exchange rate depreciation and a subsequent rise in inflation expectations, the Bank of Israel raised the monetary interest rate by 5.3 percentage points, from 3.8% at the end of December 2001 to 9.1% in July 2002. Most of that increase in the interest rate (cumulatively 4.5 percentage points) came in June and July. Following the Government’s decision to adjust the State budget, the upsurge in the exchange rate and prices ceased. During the second half of the year, prices rose by only 0.4% in annual terms. From August 2002 until the end of the year, the Bank of Israel left the interest rate at 9.1% in order to restore price stability. The Bank of Israel lowered the interest rate by 0.2 percentage points in the beginning of 2003, when relevant inflation indicators suggested some improvement. The interest rate was unchanged in February and March 2003, due to deterioration in the inflation indicators in January 2003 and the first half of February 2003. Background indicators began improving in mid-February 2003 contemporaneously with the formation of a new Government, the approval of an economic plan by the Government and the Knesset, the approval of the loan guarantee program by the United States and the temporary cessation of major combat activities in Iraq. These events reduced uncertainty regarding expected yields on local currency-assets, supported continuous capital inflow, lowered the exchange rate and interest rates determined by the markets, and reduced expected inflation.

Against this background, the Bank of Israel accelerated the reduction of interest rates. In April, May and June of 2003, the Bank of Israel cut interest rates by 0.2, 0.3 and 0.4 percentage points, respectively. The interest rate was reduced by 0.5 percentage points in each of July, August and September of 2003. In October, November and December of 2003 the interest rate cuts were 0.4, 0.5 and 0.4 percentage points, respectively. Over the course of 2003, the Bank of Israel reduced interest rates by 3.9 percentage points, from 9.1% in December 2002 to 5.2% in December 2003. In real terms (deducting one-year inflation expectations derived from the capital market), interest rates declined from 7.2% at the end of 2002 to approximately 4.6% at the end of 2003, thereby exceeding the rate of decline of expected inflation.

During the first four months of 2004, the Bank of Israel decided to maintain the interest rate reduction that began in 2003. This decision was motivated by the low level of inflation expectations for 2005 (as reflected by capital market data) in the first quarter of the year, a level that was below the center of the targeted range of inflation. From January through April 2004, the Bank of Israel cut the interest rate by a cumulative 1.1 percentage points. From May to November 2004, the interest rate was unchanged. From December 2004 to February 2005, the interest rate was cut gradually to 3.5%.

The interest rate was left unchanged from February through September 2005 due to the absence of clear evidence of a build-up of inflationarypressure. Towards the fourth quarter of 2005, in light of increased indications of the likelihood of the inflation rising above the upper limit of the target range in the course of 2006, the interest rate was gradually increased, reaching 5.25% in June 2006. In August 2006, concerns over a possible rise in Israel’s sovereign risk premium as a result of the Second Lebanon War, led the Bank of Israel to raise the interest rate by another 25 basis points to 5.5%.

In the last quarter of 2006 economic activity recovered from the effects of the war, and returned to the level that had prevailed prior to the onset of hostilities. In addition, the strengthening of the NIS that had started in April 2006 continued and even intensified, concurrently with the falling of world fuel prices. These factors exerted a downward pull on prices, as a result of which the Bank of Israel initiated a series of cuts in interest rate. The rate was reduced by 25 basis points in November and by another 25 basis points in December, bringing the rate at the end of the year to 5%. In the first half of 2007, the NIS continued to appreciate against the

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USD, which acted to moderate prices. This occurred despite a rapid and sustained growth rate in the last four years. As a result, during this period, inflation reached the lower part of its 1% – 3% target range, and even dipped below it. In 2007, the Bank of Israel cut the interest rate by 50 basis points in January, and by 25 basis points in each of February, April, May and June, bringing the interest rate at the end of the first half of the year to 3.5%.

The second half of 2007 began with a sharp depreciation of the NIS, and despite a subsequent appreciation, other strong forces, such as the steep increase in energy and food prices throughout the world and the economy’s high growth rate, exerted upward pressure on prices. In this period the Bank of Israel raised the interest rate twice — by 25 basis points in each of August and September, reaching a rate of 4%, where it remained till the end of the year. In the first quarter of 2008 upward pressure on prices stemming from the level of real activity and prices abroad persisted but were balanced by the continued appreciation of the NIS. In January 2008 the interest rate was increased by 25 basis points to a level of 4.25%. Since then a series of reductions brought the interest rate to 3.25% in May 2008, and on May 26, 2008 the interest rate was increased by 25 basis points by 3.5%.

Table No. 24

Selected Interest Rates⁽¹⁾


	(Short-Term Local) Currency to the Public						Average Cost of Monetary Loans⁽²⁾			Self-Renewing Overnight Deposits (CDs)⁽³⁾			Yield to Maturity of 12-Month Treasury Bills
	Line of Credit⁽⁴⁾			Term Credit			Average Cost of Monetary Loans⁽²⁾			Self-Renewing Overnight Deposits (CDs)⁽³⁾			Yield to Maturity of 12-Month Treasury Bills
2003		11.6	%		9.5	%		7.9	%		6.2	%		6.9	%
2004		8.6	%		6.5	%		4.4	%		3.1	%		4.8	%
2005		8.1	%		6.0	%		3.7	%		2.8	%		4.8	%
2006		10.3	%		7.4	%		5.3	%		4.1	%		5.5	%
2007		9.9	%		6.3	%		4.1	%		3.0	%		4.3	%

(1)

Percentage per annum.

(2)

The weighted average of the marginal cost of monetary loans of various maturities.

(3)

Excluding large negotiable SROs (self-renewing overnight, local currency, interest-bearing deposits).

(4)

Monthly average until the end of June 2007. Overnight facilities were discounted on July 1, 2007, following new regulations enacted by the Supervisor of Banks at the Bank of Israel.

Source: Bank of Israel.

Table No. 25

Monetary Indicators


	Year
	2003			2004			2005			2006			2007
Monetary aggregates⁽¹⁾
M1(in millions of NIS, annual average)⁽²⁾		NIS31,629			NIS37,322			NIS43,836			NIS49,835			NIS57,478
M2 (in millions of NIS, annual average)⁽³⁾		284,900			303,713			331,015			353,093			392,847
M1		0.5	%		18.0	%		17.5	%		13.7	%		15.3	%
M2		7.8	%		6.6	%		9.0	%		6.7	%		11.3	%
Public sector injection/GDP⁽⁴⁾⁽⁵⁾		0.7	%		0.3	%		-0.2	%		-0.6	%		-1.6	%
Bank of Israel injection/GDP⁽⁵⁾⁽⁶⁾		0.3	%		0.2	%		1.7	%		0.6	%		2.4%

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	Year
	2003			2004			2005			2006			2007
Nominal interest rate
SRO (CD)⁽⁷⁾		6.2	%		3.1	%		2.8	%		4.1	%		4.0	%
Unrestricted credit in local currency⁽¹⁾		10.6	%		7.5	%		6.8	%		8.1	%		6.9	%
USD Interest rate (average)		1.1	%		1.5	%		3.4	%		5.1	%		4.2	%
NIS/USD (during period)		-6.4	%		-1.2	%		6.2	%		-8.9	%		5.8	%
Real yield to maturity on five-year bonds		4.9	%		3.8	%		3.0	%		3.7	%		3.2	%
Nominal yield on equities (during period)⁽⁸⁾		55.7	%		17.4	%		33.2	%		5.4	%		23.3	%
Nominal GDP (average)⁽⁵⁾		1.7	%		5.1	%		6.3	%		7.5	%		5.0	%

(1)

Includes mortgage banks.

(2)

Currency in circulation plus demand deposits.

(3)

M1 plus treasury bills and interest-bearing local currency deposits with maturities shorter than 12 months.

(4)

Contributions to monetary expansion. The change observed with respect to past reports is due to the fact that since 1995, the redemption of Government bonds held by the Bank of Israel is no longer considered part of the public sector injection. The change is retroactive as of 1995.

(5)

The national accounting data include backward revisions since 1995.

(6)

As of 1995 includes SWAP transactions, with respect to the redemption of Government bonds held by the Bank of Israel. See footnote 4.

(7)

Self-renewing, overnight deposit.

(8)

Includes convertible securities and warrants, as adjusted for dividends and stock splits.

Source: Bank of Israel.

Banking Institutions

Israel has a highly developed banking system. At the end of 2007, there were twenty-six banking corporations registered in Israel, including sixteen commercial banks, three mortgage banks, one financial institution, two joint-service companies and four foreign banks. In November 2006, BNP Paribas opened a branch in Israel and the State Bank of India opened its Israeli branch in March 2007.

The five largest banking groups — Bank Hapoalim, Bank Leumi Le-Israel, Israel Discount Bank, Mizrahi Tefahot Bank and The First International Bank of Israel — constitute approximately 95% of the banking market in Israel. The total assets of the five major banking groups increased by 5.5% from the end of 2006 and amounted to NIS961.8 billion at the end of 2007. Assets of the banks denominated in local currency increased by 6.6% in 2007, while their foreign currency assets comprising about 37% of the banks assets decreased by 3.3%. The number of domestic bank branches decreased from 1,000 in 2006 to 990 as of 31.12.2007.

The gradual decrease in the number of commercial banks in recent years (from 22 at year-end 2002 to 15 at year-end 2005) is a result of the voluntary closing of very small banks and the amalgamation of several banks (including mortgage banks). The recent contraction of the very small banking industry is a result of the pronounced policy released by the Bank of Israel to encourage these banks to merge with larger ones or to voluntarily terminate their operations. The capital base of these banks was diminutive (up to NIS100 million) hindering their ability to develop and invest in the resources needed to equip and maintain necessary managerial infrastructure, technology and controls.

The positive trend in the economy was reflected in the performance of the five largest banking groups. Credit extended to the public increased by 9.0% (1.9% in 2006) and net income from ordinary activities after tax increased by 45.2% in 2007. However, net income increased by a mere 0.8% due to the sharp decline in

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non-recurring profit. While non-recurring profit in 2006 amounted to NIS3.7 billion (as a result of the divestitures of the banks’ mutual and provident funds mandated by law), non-recurring profit reached NIS1.7 Billion in 2007. The net return on capital (ROE) slightly dropped to 16.0% in 2007 (17.5% in 2006) but, as mentioned above, after deducting non-recurring profit, the return on capital (ordinary profit) after tax increased to 13% in 2007, compared with 10.3% in 2006. The ratio of provisions for loan losses to outstanding credit has been declining in recent years from the trough of the recession years of 2001 and 2002 and has reached 0.5% in 2006 and declined to 0.28% in 2007. Nevertheless, there is a continuous trend of improvement in the quality of the credit portfolio of the Israeli banks as loans that are in non-accrual status as a ratio of total loans reached 1.46% at the end of 2007 compared to 1.95% at the end of 2006 and 2.27% at the end of 2005.

All Israeli banking groups and each banking corporation must satisfy the minimum capital adequacy requirement of 9% prescribed by the Bank of Israel in accordance with international standards prescribed by the Basel Committee on Banking Supervision. The Supervisor of Banks at the Bank of Israel announced that Israel will adopt the Basel II regime by the end of 2009. It is anticipated that at the preliminary phase of the Basel II regime, banks will be allowed to implement either the Standardized Approach or the Foundation Internal-Ratings-Based (FIRB) approach to credit risk and the Standardized Approach to operational risk. Draft guidelines addressing the Standardized Approach to credit risk, operational risk, accounting and disclosure issues in compliance with the Basel II standards have been circulated to the banks. The banks participated in a quantitative impact study (QIS) pertaining to the Standardized Approach to credit risk and responded to a preparatory questionnaire regarding their progress towards implementation of the Standardized Approach.

Although net income rose very moderately, the five largest banking groups demonstrated a favorable increase in capital amounting to 9.2% during 2007. The capital adequacy ratio (Basel) of these banking groups reached 11.0% at year-end 2007, up from 10.8% year-end ratio of 2006.

Amendments to the banking laws which were enacted in 2004 reinforced the importance of banking supervision by expanding its purview and creating a legal framework for banks to operate without a controlling shareholder group by means of a diverse group of investors electing the board of directors of a bank via the stock exchange. The Amendment also formalized the mandatory disclosure of information to foreign supervisors on cross-border banking issues so as to be in accordance with Basel standards. In addition, the Amendment empowered the Supervisor of Banks in the Bank of Israel to dismiss directors and managers under certain circumstances.

In 2005, the recommendations of the inter-ministerial committee chaired by Dr. Yossi Bachar, the former Director General of the Ministry of Finance, were enacted by the Knesset in the form of additional amendments to the banking laws. These amendments addressed capital market structural reforms, such as the divestiture of the banks holdings and management of provident and mutual funds. Banks were sanctioned to expand their scope of non-banking activities — to engage in the rendering of financial investment advisory services pertaining to pension investment products and to purchase insurance agencies that engage solely in providing life insurance and residential property policies. The Amendment also included provisions that authorize the Supervisor of Banks in the Bank of Israel to promulgate directives designed to ensure the banks safety, soundness and fair practices with regard to consumer protection. The Supervisor of Banks in the Bank of Israel and the Supervisor of Insurance and Capital Markets in the Ministry of Finance were both empowered to levy fines on banks, insurance companies and capital market companies (i.e. provident funds) in cases of noncompliance with the supervisors’ directives.

The Anti-Money Laundering Law was enacted in August 2000 and the sections pertaining to the obligations imposed on financial entities took effect on February 17, 2002 (see “Balance of Payments and Foreign Trade-Anti — Money Laundering Law” above). In January 2001, the Governor of the Bank of Israel issued a Prohibition on Money Laundering Order. This Order included requirements regarding identification, reporting and recordkeeping by banking corporations. The regulation regarding business customer identification and recordkeeping (a regulation that has been in effect since 1995) has been amended in light of the declaration of principles of the Basel Committee on Banking Supervision of October 2001 on Customer Due Diligence for Banks. The regulation now incorporates directives on customer acceptance policy, management and monitoring of high-risk accounts. The regulation also contains special directives on private banking and correspondent banking accounts.

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The Banking Supervision Department of the Bank of Israel conducts on-site examinations on an ongoing basis to determine compliance of banks with anti-money laundering laws and directives. A Sanctions Committee, authorized to impose financial penalties for infractions, commenced operations in April 2003. In the beginning of 2005, the Prohibition on Terrorist Financing Law went into effect and Israel’s banking directive was modified to include combating terrorism financing. This modification stemmed from the international collaborative efforts in the areas of anti-money laundering and combating terrorism financing, which are reflected in the standards set by the Basel Committee (Consolidated KYC Risk Management, October 2004) and Israel’s legislation.

Additional steps in the fight against terror financing were taken in November 2006, when the Knesset approved an amendment to the Prohibition on Money Laundering Order and approved regulations on the Prohibition of Terror Financing. The Prohibition on Money Laundering Order was expanded and now requires financial institutions to check the identification of parties to a transaction against list of declared terrorists and terrorist organizations, as well as obligations to report the type and size of transactions above NIS5,000 whenever it involves a high-risk country or territory. The Amended Order also requires credit card companies to identify the parties to transactions, report to the Israel Money Laundering Prohibition Authority and maintain records of transactions.

The Bank of Israel is also taking steps to regulate the business ties between the Israeli banking system and banks operating in areas under the Palestinian Authority including scrutiny of money transfers and prevention of transfers intended to finance terrorism, as included in a circular sent to the Israeli banks by the Supervisor of Banks in the Bank of Israel in August 2007.

The privatization of the Israeli banking system has received special emphasis in recent years (see “The Economy — Role of the State in the Economy” above). The Government sold almost all of its shares in Bank Hapoalim Ltd., the largest bank in the Israeli banking system, during the 1990s. In 2005, the State completed the sale of all its remaining shares in the bank. Therefore, the State no longer has any holdings in Bank Hapoalim Ltd.

Israel Discount Bank Ltd. began its privatization process during 2004, and in February 2005, the Government sold its controlling share (26% of the issued share capital of the bank, coupled with an option to purchase a stock package totaling 25% of the issued share capital of the bank). According to the sale agreement, the option was exercisable within a three-year period. In May 2006, the Government sold an additional block of shares totaling 3.06% of Israel Discount Bank Ltd.’s capital with the option, which has since been exercised, to buy an additional 3.03% of the shares. As of June 2006, the State owns 25.0% of Israel Discount Bank Ltd. Once the sale of the shares underlying the option sold on February 2005 is consummated, the holdings of the State in the Israel Discount Bank will decrease to zero.

As of December 31, 2004, Israel owned 36.3% of Bank Leumi Ltd. On January 2005, a block of options was exercised, reducing the Government’s holdings in Bank Leumi Ltd. to 34.8%. In March 2005, the Government sold shares totaling 6.5% of Bank Leumi Ltd.’s capital. An accompanying option to buy an additional 3.5% of the shares on the following day, which was coupled with the sale, was not exercised. In July 2005, the State sold 3.5% of the shares of the bank. In November 2005, the State sold a share package of 9.99% with an option to purchase an additional 10.01% of the shares in Bank Leumi Le-Israel Ltd. This option was not exercised due to the buyer’s failure to obtain Bank of Israel’s authorization for the transfer of the controlling means in the bank to the buyer. Therefore, and in accordance with the sale agreement, the buyer sold 4.99% of the bank’s shares. In May 2006, the State sold 2.85% of the bank’s shares to the employees of the bank. As of June 2008, the State owns 11.53% of Bank Leumi Ltd.

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Table No. 26

Assets, Liabilities and Equity Capital of the Five Major Banking Groups
(In Millions of NIS)⁽¹⁾


	For Year Ending December 31,
	2003⁽²⁾		2004⁽²⁾		2005⁽²⁾		2006		2007
Assets
In local currency⁽³⁾		475,377		478,557		511,926		534,529		569,811
In foreign currency		326,752		350,726		363,791		377,448		364,974
Total assets		802,129		829,283		875,717		911,977		961,785
Liabilities and Equity Capital
In local currency⁽⁴⁾		498,090		505,361		531,795		562,971		602,946
In foreign currency		304,039		323,922		343,922		349,006		358,839
Total liabilities and equity capital		802,129		829,283		875,717		911,977		961,785
Equity capital		41,793		44,364		47,812		53,490		58,574

(1)

The five major banking groups are the Bank Hapoalim group, the Bank Leumi group, the Discount Bank group, the First International Bank of Israel group and the Mizrahi Tefahot Bank group.

(2)

The division into local and foreign currency for 2003, 2004 and 2005 was adjusted according to the published financial statements for those years.

(3)

Including non-financial items.

(4)

Including non-financial items, minority interests and equity.

Sources: Bank of Israel, Supervisor of Banks.

Capital Markets

Israel’s capital markets and the laws regulating them are highly developed. The principal regulatory body responsible for administering the Israeli securities laws is the Israel Securities Authority (“ISA”). The ISA’s main function is to protect the interests of investors by overseeing the activities of the TASE, supervising public securities offerings, and mandating disclosure of material information by listed companies by means of publications such as prospectuses, financial reports and other periodic reports. Companies whose securities have been offered to the public in Israel by prospectus or whose securities are traded on the TASE are required to file quarterly and annual reports and certain current event reports with the ISA, the TASE and the Registrar of Companies. The ISA monitors ongoing reports, such as periodic reports that include financial statements, a directors’ report on the status of the corporation’s affairs, and an additional information report, quarterly financial reports and immediate reports, which are filed immediately after the occurrence of certain events that could have a material influence on the corporation or on the price of its securities. These reporting requirements are enforceable by the Israeli courts upon the petition of the ISA, which also has certain powers to direct the TASE to suspend trading of a company’s securities. The ISA also regulates the mutual fund industry’s activities, supervises, licenses and disciplines portfolio managers and investment advisors and conducts investigations into violations of securities laws.

The TASE is the only stock exchange and the only public market for trading securities in Israel. The TASE is highly regulated, both internally and externally, by the ISA. Internal regulations include automatic rejection of a trade at a price that deviates more than 35% from the last trade for that security, circuit breakers, and 45-minute halting of trade in a company’s securities on the day that the company publishes price-sensitive information, so that the information can be widely disseminated. The TASE has a computerized trading system with real-time information. The TASE’s rules govern membership, registration of securities, conditions for suspending trading and obligations of listed companies. All shares, convertibles, treasury bills, government bonds and derivatives are traded via TACT, the TASE’s fully automated trading system. The TASE has 27 members and, as of December 31, 2007, 654 companies had equity securities listed on the TASE. Between 2003 and 2007, share prices on the TASE rose sharply. The General Index of shares and convertible securities (which is comprised of all shares

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and convertible securities tradable on the TASE) increased in USD terms by 35.0% in 2007, compared with an increase of 15.3% in 2006 and an increase of 24.3% in the General Index in 2005. During 2007, the Tel Aviv 100 Index and the Tel Aviv 25 Index increased in USD terms by 37.6% and 44.3% respectively, compared with an increase of 22.0% and 22.6%, respectively, in 2006. As of December 31, 2007, the total market value of all listed equity securities was $235.2 billion, compared with $161.4 billion in 2006 and $122.6 billion in 2005. The average daily trading for equity securities increased to $505 million during 2007, compared with $326 million in 2006 and $223 million in 2005.

The Dual Listing Law that took effect in October 2000 enables companies listed in United States or London to dual-list on the TASE with no additional regulatory requirements. As of December 31, 2007, 45 Israeli companies have dual-listed on the TASE, in compliance with this framework.

Active involvement of foreign investors in the TASE began in 1994. In 2007, international holdings increased to 16% of the total market capitalization of the shares and convertible securities tradable on the TASE, compared to 15% in 2006 and 14% in 2005.

The Government bond market in Israel is highly developed, and Government bonds account for the vast majority of publicly issued debt securities. In 2007, the Government raised $7.6 billion in the TASE, mostly through non-indexed bonds. The bond market in Israel has been a growing source of capital for Israeli corporations. In 2007, the amount of capital raised by the corporate sector through bond issues (including issues to institutions and issues of structured bonds) totaled $21.2 billion compared with $10.8 billion in 2006.

In 2006, a broad reform in the Government bonds market was implemented, with the appointment of 19 primary dealers in the Government bonds market (the “Primary Dealership Reform”). This reform has helped to increase the liquidity and transparency of the capital market, encouraged the entry of international investors into the market, upgraded the trading and clearing systems and promoted the development of diverse derivative fixed income instruments.

In recent years, the role of institutional investors in the Israeli capital markets has increased significantly. The principal types of institutional investors are pension funds, provident funds, severance pay funds (special funds established to hold assets set aside by employers for the payment of severance obligations owed to their employees), advanced study funds, mutual funds and a variety of life insurance savings plans. As of December 31, 2007, assets held by pension funds totaled $58.2 billion, assets held by provident funds and severance pay funds totaled $48.8 billion, assets held by advanced study funds totaled $23.3 billion, assets held by life insurance savings plans totaled $38.1 billion and assets held by mutual funds totaled $31.1 billion.

Gold Reserves

The State has not maintained gold reserves since 1992.

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PUBLIC FINANCE

General

The Government’s annual budget covers the expenditures and revenues of the central Government only and does not include the accounts of the National Insurance Institute (“NII”), the National Institutions, local authorities, the Bank of Israel, or surpluses and deficits of Government authorities.

The Budget Process, Limits on Expenditure and Deficit Reduction

The Government’s fiscal year ends on December 31. The Government’s annual budget process generally begins in May of each year when the Budget Department of the Ministry of Finance coordinates budget discussions with the various Government ministries. During August and September, the details of the budget are finalized within the Government. A budget bill, together with supporting data, must be submitted to the Knesset for its approval no later than sixty days before the end of the fiscal year. At the time the Government submits the annual budget to the Knesset, the Government is required by law to submit a three-year projected budget, which is non-binding and does not require Knesset approval. Following discussions on the proposed annual budget at the Finance Committee of the Knesset with the participation of the relevant Government Ministers and other officials, the Knesset votes on the approval of the annual budget law.

In response to persistent budget deficits, the Knesset passed the Deficit Reduction Law in 1992. This law required that the domestic budget deficit ceiling (excluding credit granted by the Government), as a percentage of GDP, decrease each year during the period between 1993 and 1997, as compared to the domestic budget deficit ceiling (excluding credit granted by the Government) for the preceding year. The amount of the year-to-year decrease was not specified, however, in 1996, the Government submitted a new Deficit Reduction Law, which was subsequently approved by the Knesset in January 1997. This new law contained specific ceilings for the total deficit for each year until 2001, rather than ceilings for the domestic deficit only, as under the previous law. In recent years, the Government submitted amendments to the Deficit Reduction Law, which were approved by the Knesset, with new specific deficit ceilings. Accordingly, the total budget deficit, as a percentage of GDP, was targeted not to exceed 4% in 2004, 3% in each of the years between 2005 through 2008 and 1% from 2009 onwards.

In amendments to the Deficit Reduction Law, the Knesset approved additional restrictions on Government expenditures. Pursuant to these restrictions, the aggregate Government expenditures (excluding expenditures on hospitals) may not increase by more than 1% (indexed to the CPI) in each of 2005 and 2006, and should not increase by more than 1.7% (indexed to the CPI) from 2007 onwards. Adjusting expenditures upwards is subject to preserving the annual deficit ceiling.

Absent an approval of the Knesset, Government ministries may not spend in excess of their respective budgets. However, budgeted amounts not spent by the Government in a given year may, upon notice to the Finance Committee of the Knesset, be spent in the following year. The deficit ceiling established pursuant to the Deficit Reduction Law refers to the budget as proposed by the Government, rather than actual expenditures and revenues. Therefore, no adjustment to Government expenditures is required by law if the actual deficit missed the deficit ceiling due to either Government revenues or actual GDP that was different than had been anticipated. The Government finances its deficits mainly through a combination of local currency and foreign currency indebtedness and proceeds from privatization.

In 1997, the Government decided to replace the domestic deficit target with a total deficit target. From 1997 through 2007, the total deficit, excluding net allocation of credit, as a percentage of GDP, was 3.2%, 3.1%, 3.2%, 0.7%, 4.2%, 3.6%, 5.4%, 3.6%, 1.9%, 1.0% and 0.0%, respectively. The deficit target was achieved in 2004 despite tax reductions implemented throughout the year. In each of 2005, 2006 and 2007 the deficit was lower than its target by approximately 1%, 2% and 1.6% of GDP, respectively, mainly due to higher than expected revenues and growth in GDP.

In order to reduce the budget deficit for 2003 and following years, a comprehensive economic plan (the “Economic Plan”), was approved in mid-2003. The first stage of the Israeli Economic Plan of 2003 was initiated in order to stabilize the economy, reverse the economic slowdown in the short term and create conditions that would enable the economy to return to a sustainable growth trajectory. The 2004 budget, which promoted sustainable growth in the Israeli economy represented the second stage of the Economic Plan. The 2005 budget

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represented the third step of the Economic Plan and focused on the measures necessary to consolidate growth and improve the standard of living across socioeconomic classes.

Following the implementation of the Economic Plan of 2003 – 2005, the 2006 – 2007 budgets had four stated overarching objectives: establishing growth, strengthening economically disadvantaged groups, making public services more efficient and protecting consumers by weakening public and private monopolies.

The following table sets forth the Government deficit and its financing. Domestic expenditures constitute all expenditures by the Government made in Israel. Domestic revenues constitute all taxes raised in Israel. The Government accounts for domestic expenditures and revenues as a method of measuring the influence of the Government on the domestic economy. Table 27 presents the gross budget figures, including revenue-dependent expenditures and contributions from the budget to the NII. Table 29 presents the budget net of these expenditures.

Table No. 27

The Budget Deficit and Its Financing
(In Thousands of NIS at Current Prices)


	Actual 2004			Actual 2005			Actual 2006			Actual 2007			Original Budget 2008
Revenues and Grants
Tax revenues		NIS152,677,923			NIS163,123,228			NIS177,256,574			NIS192,089,665			NIS191,867,183
Non-tax revenues		36,434,585			38,832,995			39,240,029			38,754,188			39,985,994
Foreign grants		10,512,602			11,480,280			12,374,289			10,428,988			10,384,500
Total		199,625,110			213,436,503			228,870,892			241,272,841			242,237,677
Gross Expenditure and Lending
Current and capital expenditures		103,167,311			105,413,565			110,309,232			113,453,197			116,959,728
Transfer payments and subsidies		72,631,235			72,262,781			76,807,625			81,405,848			84,811,262
Interest payments and commissions⁽¹⁾		31,938,430			33,193,167			35,074,583			34,281,084			34,547,584
Loans		3,052,686			3,016,674			2,567,243			2,113,538			1,554,575
Other expenditures		6,116,040			7,783,501			6,934,630			6,724,095			12,038,703
Total		216,905,702			221,669,688			231,693,313			237,977,762			249,911,852
Surplus (Deficit)		(17,280,592	)		(8,233,185	)		(2,822,241	)		(3,295,079	)		(7,674,175	)
Financing
Foreign borrowings⁽²⁾		17,929,808			16,215,889			11,745,106			4,644,822			7,980,000
Foreign loan repayments		10,059,863			10,097,964			13,574,218			10,426,000			13,068,000
Foreign financing (net)		7,869,945			6,117,925			(1,829,112	)		-5,781,178			-5,088,000
Domestic borrowings		39,953,680			35,999,214			34,444,730			42,913,698			61,513,175
Domestic loan repayments		27,967,383			38,136,038			38,825,983			47,686,461			52,783,000
Domestic financing (net)		11,986,297			(2,136,824	)		(4,381,253	)		-4,772,763			8,730,175

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	Actual 2004			Actual 2005			Actual 2006		Actual 2007		Original Budget 2008
Proceeds from Privatization		1,020,014			8,572,595			4,668,758		6,268,393		4,032,000
Cash Balance of the Government (at end of period)⁽³⁾⁽⁴⁾
Deposits in NIS		(7,407,000	)		(48,000	)		1,259,000		2,055,000
Deposits in foreign currency		13,215,000			6,680,000			6,066,000		6,314,000
Total		5,808,000			6,632,000			7,325,,000		8,369,000

(1)

Interest payments and commissions are net of amounts attributable to indexation of NIS-linked Government bonds and that portion of the interest payments on NIS loans attributable to inflation for the year of payment. These amounts are included in the capital expenditures portion of the budget as domestic loan repayments.

(2)

Including certain proceeds borrowed under the U.S. loan guarantee program during the 1990s.

(3)

Includes the accounts of NII.

(4)

Changes in cash balances of the Government result also from activities not included in the budget.

Sources: Ministry of Finance, Bank of Israel.

Taxation and Tax Revenues

In 2007, the Israeli total tax burden was 37.2% of GDP, compared to 38.1% in 2000.

As of 2008, Israel has a progressive personal income tax with a top rate of 47%, supplemented, up to a ceiling, by a 17% health and social security tax (including the employer’s contribution) and a 27% corporate tax rate. Indirect taxes consist primarily of a 15.5% V.A.T. In addition, a high purchase tax is levied on cars, alcohol, fuel and cigarettes. All imports from the European Union and the United States are duty-free, whereas customs are applied on selected imports from other countries.

In recent years, further changes to the tax system were adopted to integrate Israel more firmly into the global economy. As part of this policy, customs duties on imports continued to decline. Israel has signed free trade agreements which lowered customs duties on imports with the United States and the European Union and the EFTA countries, as well as with Canada, Turkey and Mexico.

On January 1, 1995, a double taxation treaty with the United States went into effect. This treaty governs the income taxation of residents of the United States or Israel who conduct business or otherwise derive income in the other country subject to the treaty jurisdiction. Among other things, the treaty provides for reduced rates of withholding tax on certain non-business income, such as dividends, interest, and royalties, that is sourced in Israel and derived by a resident of the United States. The treaty provides rules for the avoidance of double taxation through a foreign tax credit mechanism and allows for the resolution of disputes arising under the treaty through a mutual agreement procedure involving the governing taxing authorities.

In January 2003, Israel implemented a comprehensive multi-year reform of the direct-tax system. In the first stage, direct taxes on labor were reduced while the tax burden on capital income and income from foreign sources was increased. By the end of the process in 2010, taxes on labor (income tax, health tax and social security tax) will be further reduced to a maximum of 44% and the corporate tax will be reduced to 25%.

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Table No. 28

Government Taxes
(In Billions of NIS at Current Prices)⁽¹⁾


	Actual 2004		Actual 2005		Actual 2006		Actual 2007		Original Budget 2008
Income tax		NIS66.9		NIS73.5		NIS86.9		NIS90.6		NIS89.8
Value added tax		52.8		55.0		57.0		61.4		62.4
Other		31.8		33.1		34.2		39.1		37.8
Total		151.5		161.6		178.1		191.1		190.0

(1)

Not including social security contributions, local authorities taxes and VAT on defense imports.

Source: Ministry of Finance.

Table No. 29

Government of Israel Statement of Net Expenditures
(Excluding Capital Expenditures)
(In Millions of NIS at Current Prices)


	Actual 2004		Actual 2005		Actual 2006		Actual 2007		Original Budget 2008
Government Expenditures
Government administration		NIS20,158		NIS23,897		NIS25,642		NIS26,382		NIS30,254
Local authorities		3,692		4,060		4,043		4,144		3,865
Defense		45,762		48,344		51,737		53,580		48,322
Social services		74,846		75,651		79,049		83,757		86,406
Economic services		7,613		6,943		6,728		7,011		7,740
Interest payments		31,917		33,178		35,048		34,264		34,523
Credit subsidies		29		22		27		16		25
Reserves		—		—		—		—		5,343
Total expenditures (other than capital expenditures)		184,018		192,096		202,273		209,154		216,478
Development and Capital Account Expenditures
Development expenditures (including repayments of debt)		56,421		65,368		69,590		75,493		85,040
Repayments of debt		44,243		54,627		59,087		64,696		72,674

Source: Ministry of Finance.

Government Budget for 2008

The original State budget for 2008 is NIS301.5 billion and the deficit ceiling for 2008 is 1.6% of GDP. The gross Government expenditures (excluding payment of principal) are to be NIS249.9 billion. These expenditures (excluding payment of principal) are to be 34.9% of the originally projected 2008 GDP.

Budget Framework. The main components of the 2008 budget are the Government budget adjustment as required according to the total Deficit Reduction Law and the Sum of the Government Expenditures Law, the continuation of the tax reform, high investment in infrastructure, education and defense, further strengthening of disadvantaged social groups, and the further reduction of Israel’s debt to GDP ratio.

Increased Infrastructure Investment. In the 2008 budget, NIS16.5 billion has been allocated to investments in infrastructure. This includes allocations for developing the railway network throughout the country

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and promoting the construction of access roads to the Cross-Israel Highway. Over the next several years, this investment is expected to play a crucial role in accelerating economic activity and shortening distances between the central and peripheral areas of the country.

Reform in the Labor Market and Streamlining of Transfer Payments. In 2007 the Israeli Government adopted an economic-social agenda for 2008-2010, setting forth two major goals: reduction of poverty by generating growth; and leveraging long term, balanced growth by enhancing education. An expansion of employment is marked as one of the key factors for achieving the goals of the Agenda. Stimulating employment among unemployed people of working age is of paramount importance to the Government. The 2008 budget intends to stimulate employment by reducing the number of foreign workers employed in Israel so as to transfer jobs to Israeli citizens and encouraging populations dependent on Government assistance to join the labor market. These are to be supported in part by a welfare to work program entitled “Orot Leta’asuka” which has operated in a pilot format since August 2005. The program’s budget for 2008 is NIS212 million. As part of the program, job centers were opened in four regions in the country to assist the unemployed and equip them with the tools required to integrate into the job market, thereby decreasing their dependence on unemployment benefit support from the state. The program’s effect on the labor market was monitored and assessed by a public committee, which has recommended the deployment of the program throughout the country.

Tax Reform. The tax reform program was approved by the Knesset in June 2002 and took effect in January 2003. The reform includes labor tax reductions, capital income taxation, the abolishment of certain tax exemptions, global taxation and incentives for investments in the high-tech sector. The measures approved as part of the tax reform are expected to facilitate the creation of a more equitable tax system, stimulate employment and economic growth and enhance Israel’s further integration into the global economy. In July 2005, the Knesset approved some amendments to the program, to be implemented from 2005 to 2010, which include an accelerated implementation of the direct tax reform, an additional reduction of the tax on labor to a maximum rate of 44%, a reduction of the V.A.T. to 16.5%, a gradual reduction of the corporate income tax to 25%, and an increase and equalization of tax rates on the capital market. In June 2006, the Minister of Finance decided to further reduce the V.A.T. to 15.5% effective July 1, 2006.

Financing the Costs of the Second Lebanon War. Following a special NIS1 billion budget allocation in August 2006, the State’s budget expenditures for 2007 and 2008 were increased by an additional 1.6% (NIS3.5 billion) and 1.0% (NIS2.2 billion), respectively, in order to finance unexpected expenses related to the war. These expenses include reserve duty costs, the restocking of the army’s munitions inventory, maintenance of equipment used during the fighting, various logistical costs, and strengthening the local authorities in northern Israel.

Implementation of the Disengagement Plan. The total cost of the plan (for a description of the Disengagement Plan, see “State of Israel — International Relations” above), including compensation payments to settlers and the construction of temporary and permanent residential areas, is estimated at NIS9 billion, of which a total of NIS7 billion was spent by the end of 2007. The expenditures for this plan in 2008 are NIS1.1 billion. The rest of the expenditures for this plan (NIS0.9 billion) is expected to be spent in 2009 – 2010. In order to finance those expenses, the State’s budget expenditures for the years 2006, 2007 and 2008 were increased by an additional 1.0% (NIS2.2 billion), 0.5% (NIS1.1 billion) and 0.5% (NIS1.1 billion), respectively.

Local Authorities

Local authorities in Israel include 72 municipalities, 125 local councils, 54 regional councils and two industrial councils. The local authorities are obligated by law to provide a number of basic social services. Local authorities generally finance the provision of such services through local taxes (primarily taxes based on the use of property) and through transfer payments from the Government. In addition, under certain circumstances, local authorities may finance a portion of their activities through borrowing, while less financially sound local authorities may receive supplementary grants from the Ministry of the Interior. As of December 31, 2006, the total outstanding debt of the local authorities was approximately NIS13.6 billion. Transfer payments from the Government are allocated among all local authorities based on fixed criteria and for specific purposes, such as social services or education. The Government currently retains authority to approve changes in the level of taxes imposed by local authorities. The aggregate deficit of all local authorities in 2006 was approximately NIS6.0 billion. The Government transfers to the local authorities in 2006 totaled approximately NIS12.4 billion.

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Social Security System

National Insurance Law. Under Israel’s National Insurance Law, the National Insurance Institute of Israel (NII), an independent institution, provides a wide range of social security benefits, including old age pension benefits, unemployment insurance, long-term disability payments, workers’ compensation benefits, maternity support benefits and child support payments. In 2007, total expenditures by the NII were NIS47.0 billion as compared with NIS45.8 billion in 2006. The NII funds its expenditures using the proceeds of social security taxes paid by employers and employees, transfer payments from the Government pursuant to the National Insurance Law and interest income on deposits representing surpluses from previous years. The NII also receives separate funds for non-contributory NII benefit payments, including payments to new immigrants and other payments not covered by social insurance programs. In 2007, the Government’s transfer payments to the NII and the Government’s share of the NII provision for non-contributory payments totaled NIS15.7 billion and NIS8.7 billion, respectively. The aggregate amount of Government transfer payments to the NII in the 2008 budget is NIS25.5 billion, compared to an actual total Government transfer of NIS23.9 billion in 2007.

Health Care. Israel has an advanced medical system, with four public health insurance organizations and a ratio of one doctor for approximately every 220 people. A health care tax, which varies based on gross salary and averages 4.2% of an individual’s gross salary, funds a portion of health care benefits, with the remainder funded by the Government. In 1997, the Government enacted legislation in order to enhance efficiency in the health care market. The legislation expands the flexibility, authority and responsibility of the health funds and gives them incentives to make their services more efficient. Additional changes relate to the reduction of systematic redundancies and the introduction of bookkeeping arrangements among agencies in the system. These changes are aimed at improving savings and efficiency. In 1998, due to long waiting periods for surgical operations, new health care corporations were established. These corporations operate the Government-owned hospitals beyond regular operating hours. Each hospital is given a share of the income from the fees that are paid by patients to the health care corporations in return for the use of the hospital’s facilities.

In 2002, after approval of new regulations by the Knesset, the Government started to regulate the financial relations between the health care corporations and the hospitals. The Government developed an arrangement that would allow patients to choose any physician that works in a Government-owned hospital. In 2004 the Knesset decided to authorize the sale of non-prescription over-the-counter drugs in places other than pharmacies. This reform was implemented in May 2005.

In 2007, the Government enacted legislation designed to decrease the share of private health expenditures in the total expenditures on health. This legislation restricts health insurance organizations from including expensive life-saving medications as part of their supplementary insurance plans. In addition, this legislative act provides that life-saving medications should be supplied exclusively by basic health insurance plans, provided by the health insurance organizations.

In 2008, the Government decided to form a new, fifth health fund, in order to improve competition in the health system.

In 2008, the Government intends to transfer responsibility for psychiatric services to the health insurance organizations. The Government hopes this transfer will stimulate the conversion of some of the Government-owned hospitals into non-profit self-managing organizations or corporations owned by one of the health insurance organizations and decrease hospitals’ expenditures on medical malpractice insurance. These structural reforms are expected to make the Israeli health system more effective, to decrease the Ministry of Health’s involvement in providing services and to increase its regulatory authority.

The 2008 Government health care budget is approximately NIS26 billion. Health care expenditures (including expenditures by the public) were 7.8% of Israel’s GDP in 2006.

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Pension Funds

Pension funds, together with life insurance policies and provident funds, are the principal instruments in Israel for the accumulation of retirement savings and provision of retirement income. Most employees who participate in a pension fund do so pursuant to an agreement between the pension fund, the employer (or a representative organization for such employer) and the representative organization for such employee. These agreements require that the employer and the employee each make contributions to the pension fund. At retirement age, or at the time of another insurable event, the employee becomes entitled to receive pension payments.

There are generally two types of pension funds in Israel: an older defined benefits pension fund and a newer defined contribution pension fund. In March 1995, in response to large and rising actuarial deficits of Israel’s pension funds, the Government adopted a new pension policy, including a comprehensive plan of recovery for existing pension funds. The primary elements of the recovery plan were: (i) then-existing pension funds would be closed to new participants, but existing participants would continue to be covered under the existing plans for the life of such plans, subject to certain limitations on the future accumulation of benefits; (ii) the Minister of Finance was empowered by the Government to draft recovery plans for pension funds that were in actuarial deficit, according to the principles established by the Government; (iii) the Minister of Finance, at his discretion, was authorized to continue to issue special Government bonds to pension funds in actuarial deficit for an interim period; and (iv) new members enrolling in pension programs would join newer, actuarially balanced funds that would operate separately and independently from existing funds, while benefits payable by the new pension funds would be subject to automatic reductions, to the extent necessary, to eliminate any actuarial funding deficit of such new funds.

As of May 2003, the estimated actuarial deficits of the older pension funds were NIS109 billion. In May 2003, as part of a general economic recovery plan, the Knesset approved a recovery plan for the older pension funds in order to solve the problems of the active members and pensioners of the pension funds with actuarial deficits and to ensure continued payments to pensioners and those who will reach retirement age. As of December 2006, Government obligations under this plan stood at NIS82.4 billion over the next 32 years. In 2006, the Government transferred NIS1.6 billion from the State budget to the older pension funds that had actuarial deficits. The funds will make up the remainder of the deficit by adjusting members’ benefits. Steps taken to adjust members’ benefits include Government-mandated uniform regulations for all funds, including a uniform method of calculating wages for the purpose of calculating pension benefits, increased employee and employer contribution rates, and an increase in the retirement age to limit the actuarial deficit and improve fund management. In addition, the Government ceased issuing certain types of designated Government bonds in which the older pension funds were heavily invested, and removed restrictions on both older and newer funds that required a high percentage of assets to be invested in designated Government bonds. In order to ensure professional and responsible management of the funds, a Government committee appointed new managers for the pension funds with actuarial deficits in June 2003. These new managers have replaced the existing managers, who had been appointed by the Histadrut. In January 2004, a Memorandum of Understanding between the Minister of Finance and the head of the Histadrut was signed, completing the pension reform process as a cooperative effort among the Government, the Histadrut and employers.

In December 2004, the Minister of Finance approved a procedure for the transfer of financial aid to the older pension funds that had been actuarially balanced, based on their assets. The financial aid was needed due to the aforementioned changes in the issuance of Government bonds.

As of December 3, 2007 the total long-term investments totaled NIS470 billion, of which NIS147 billion is invested in new pension funds, NIS159 is invested in old pension funds, NIS97 billion is invested in life insurance policies and NIS166 billion in provident funds.

An agreement singed between the Histadrut and the Economic Organizations Coordination Bureau provides that as of January 1, 2008, employers must provide a defined contribution pension plan for all employees.

During 2007 and 2008 two reforms dealing with long-term pension saving plans were implemented with a view to expanding consumer choice and competition, while ensuring that all employees enjoy a decent income during retirement. First, funds saved in provident funds after 2008 may only be withdrawn as an allowance during an employee’s retirement years and not as a one-time disbursement. The second reform allows unrestricted transfer of pension money among different saving vehicles and funds.

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The actuarial liabilities of the Government with respect to pension benefits payable under this plan were approximately NIS390.876 billion as of December 31, 2007.

The Government signed an agreement with the Histadrut. According to the agreement new Government employees will not participate in the existing unfunded Government pension plan. The Government will instead make contributions on behalf of such employees in the same manner as any other employer, i.e., by contributing to the new, fully funded plans, chosen by each employee. This agreement prevents the participation of additional employees in the unfunded Government pension plan and is designed to ultimately reduce the actuarial Government obligations. As an additional step to reduce the actuarial liabilities of the Government, beginning on January 2004, all Government employees who are covered by unfunded Government pensions must contribute 1% of their salary to the plan. In January 2005, this contribution was increased to 2%. At the present, public sector employees are transitioning from a “pay-as-you-go” pension plan to defined contribution plans. The transition process is done by dividing the government employees into two groups: Group A is generally comprised of government employees whose start of employment was prior to the implementation of the reform in 2003/2004. Group A is closed to new employees and its members continue to accumulate benefits under a defined benefit plan; Group B is comprised of employees whose start of employment is after the implementation period during 2003/2004 (including a small number of employees whose employment started prior to the transition period but had been enrolled in a defined contribution plan). Group B is on a defined contribution plan, and its members do not accumulate defined benefits. The group is open to new members and will include all future government employees.

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PUBLIC DEBT

General

Public sector debt (“public debt”) in Israel consists of the local currency and foreign currency debt of the public sector. Net public debt as of December 31, 2007 was NIS459.3 billion (68.1% of GDP), of which NIS4.8 billion was net foreign currency debt. As of December 31, 2006, the net public debt was NIS473.2 billion. Following four years of increases, in the last two years, net public debt as a percentage of GDP declined, marking a return to the pre-2001 trend. The main factors that contributed to the decrease of the public sector debt in 2007 were the low government deficit (-0.01%), and the depreciation of the U.S. dollar as compared with the NIS.

Table No. 30

Net Public Debt
(At End-of-Year Current Prices in Billions of NIS)⁽¹⁾


	Year
	2003		2004		2005		2006		2007
Local Currency⁽²⁾		NIS444.7		NIS464.9		NIS468.9		NIS463.0		NIS454.5
Foreign Currency⁽³⁾⁽⁴⁾		17.2		20.2		14.2		10.2		4.8
Total		461.9		485.1		483.1		473.2		459.3

(1)

The net public debt includes debt of local authorities, except the local authorities’ debt to the Government.

(2)

In 2007, the domestic net public debt decreased in real terms (at end-of-year 2006 constant prices) by 5.08% to NIS439.53 billion.

(3)

External public debt equals the Government’s foreign currency liabilities less foreign exchange reserves (change in foreign reserves less repayment of principal).

(4)

External debt, for this purpose, includes residents’ holdings of USD-denominated Government bonds issued in the global market and does not include nonresidents’ holdings of NIS-denominated Government bonds issued in the domestic market.

Source: Bank of Israel.

Table No. 31

Ratio of Net Public Debt to GDP
(Percentage of GDP at End-of-Year Prices)


	Year
	2003			2004			2005			2006			2007
Local Currency		86.1	%		83.6	%		78.0	%		73.6	%		67.4	%
Foreign Currency⁽¹⁾		3.3	%		3.6	%		2.4	%		1.6	%		0.7	%
Total		89.4	%		87.2	%		80.4	%		75.2	%		68.1	%

(1)

External public debt equals the Government’s foreign currency liabilities less foreign reserves (change in foreign reserves less repayment of principal).

Source: Bank of Israel.

Domestic Public Debt

Domestic net public debt is defined in the consolidated balance sheet of the Government and the Bank of Israel as the Government debt plus the debt of local authorities less the liabilities of private sector debtors to the public sector. The net public debt includes debt of local authorities, but excludes their debt to the Government. In 2007, the domestic net public debt was NIS463.0 billion, as compared with a domestic net public debt of NIS468.9 billion in 2006.

The domestic public debt is comprised of transferable and non-transferable debt, which is raised through issues of bonds denominated in NIS. Nontransferable debt is issued to financial institutional investors in Israel

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under set terms based on long-standing arrangements. In recent years, the size and share of nontransferable debt as a portion of the total domestic debt have decreased, mainly due to the reduction of designated bonds issuance to pension funds (see “Public Finance — Pension Funds” above).

In recent years, the Ministry of Finance took some major steps in order to increase the transferability and liquidity of its bonds. Between 1995 and 2007, the CPI-linked component in the overall domestic transferable debt decreased from 81.0% to 41.1%, and the USD-linked component decreased from 10.1% to 0.1%. Correspondingly, the Ministry of Finance reduced the number of issued bond series and increased their average size. As a result, the number of traded bond series fell sharply, from 265 in 1992 to only 46 at the end of 2007.

Table No. 32

Annual Local Currency Government Debt Issuances
(Gross Proceeds in Billions of NIS)


	2003		2004		2005		2006		2007
Total Issuances
Tradable		NIS44.4		NIS36.0		NIS32.2		NIS29.9		NIS31.1
Non-tradable		13.2		3.8		3.8		4.4		4.6
Total		57.6		39.8		36.0		34.3		35.7
Average Maturity (in years)
Tradable		8.0		8.8		9.9		9.6		11.1
Non-tradable		14.4		13.0		13.1		14.0		13.1
All		8.8		9.1		10.6		10.2		11.4

Source: Bank of Israel.

External Public Debt

Except as otherwise specified, and only for the purpose of the statistical data contained herein, Israel’s gross external debt is defined, in compliance with the International Monetary Fund definition, as all external liabilities to nonresidents required to be paid in both local and foreign currency by the public sector, the private sector and the banking system (not including mortgage banks, investment finance banks and financial institutions). For this purpose, public sector includes the government, the Bank of Israel and the National Institutions (i.e., The Jewish Agency). The data does not include currency swap transactions.

The Government is the principal public sector borrower. In 2007, the public sector’s share of Israel’s gross external debt was 35%, a slight decrease from the 38% level of 2006. The share of the Government’s gross external debt of its total debt was 26.4% in 2007 and in 2006, compared to 26.2% in 2005 and 24.9% in 2004.

Total public sector external debt in 2007 was $32.4 billion, a decrease of $1.1 billion from the 2006 level. The main factor that contributed to the decrease in the public sector external debt was the fact that Israel has not launched any foreign currency issuance during 2007 (other than State of Israel Bonds issuance discussed below). Total external assets of the public sector in 2007 were $29.3 billion, a slight decrease from $29.97 billion in 2006.

The net external debt of the public sector, defined as the public sector external debt less foreign assets of the public sector, decreased in 2007 to $2.5 billion from $3.4 billion in 2006. As a percentage of GDP, net public sector external debt as of December 31, 2007 was 1.4%. This level reflects a slight decrease compared to the 2.3%, 1.9% and 1.6% levels at the end of 2006, 2005 and 2004, respectively. The levels in recent years represent a sharp decrease from the peak of 55% in 1985. Furthermore, the average maturity of the net external debt has lengthened in recent years and the annual cost of servicing such debt has also declined in both absolute and relative terms.

As of December 31, 2007, approximately 88% of Israel’s public external debt is denominated in USD, approximately 9% is denominated in euros and approximately 3% is denominated in GBP.

Israel’s access to external funding has broadened increasingly over the past decade. From the mid-1980s to 1992, the major source of external net borrowings by the Government was State of Israel Bonds organization

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(“Israel Bonds”), with the remainder coming from foreign governments, international institutions and foreign banks. Israel Bonds raises capital through the following four organizations: Development Corporation for Israel, Israel Bonds International, Development Company for Israel (UK) Ltd. and Canada-Israel Securities Limited. Bonds and notes issued through Israel Bonds are not freely transferable. Israel Bonds has proven to be a reliable and important source of financing for Israel, particularly under adverse circumstances, because many purchasers are individuals and institutions, including the worldwide Jewish community, that have an interest in Israel. Israel expects to continue to issue bonds through Israel Bonds in the future.

By 1991, the annual amount raised by the Government through the sale of State of Israel Bonds reached an average of $1.0 billion per year. On December 31, 2007, the outstanding balance of bonds and notes issued through Israel Bonds was $9.76 billion, representing approximately 31% of Israel’s total public sector external debt.

From 1993 through 1998, the main source of external borrowings by the Government was the U.S. loan guarantee program. The U.S. loan guarantee program provided for the guarantee of up to $10.0 billion in principal amount of loans to Israel during U.S. government fiscal years 1993 through 1998. Under the program, the United States guaranteed all payments of principal and interest on bonds issued by Israel.

During 1998, Israel completed its borrowings under the first U.S. loan guarantee program. Israel borrowed a total of $9.3 billion under this program through the issuance of guaranteed notes having various terms, interest rates and maturity.

In April 2003, the United States approved a new loan guarantee program that provided for the guarantee of up to $9 billion in principal amount of loans to Israel during U.S. government fiscal years 2003 through 2005, with the unused balance available for financing in 2006. In 2005, the program was amended to permit financing through the end of United States fiscal year 2008, and in 2006 it was extended until 2011. Under the program, the United States issues guarantees with respect to all payments of principal and interest on bonds issued by Israel. The aim of the program is to support Israel’s comprehensive economic program and to create conditions for higher and sustainable growth. The proceeds of the guaranteed loans may be used to refinance existing debt. The Government has made certain commitments with respect to its comprehensive economic plan in connection with the loan guarantee program. Under the loan guarantee program, between September 2003 and November 2004 Israel issued notes totaling $4.1 billion face value. Israel did not issue any notes under the loan guarantee program since November 2004. As of June 2008, $3.8 billion remains available under loan guarantee program.

During 2007, Israel borrowed a total of approximately $1.09 billion foreign currency debt, all of which was through Israel Bonds and redeemed a principal amount of $2.63 billion.

At the end of 2007, 62% of the external public debt was transferable, similar to the 64% ratio of transferable debt at the end of 2006.

Credit Rating

Standard & Poor’s upgraded its ratings in November 2007 for the Government of Israel’s long-term local currency from ‘A+’ (A plus) to ‘AA-’ (AA minus), and long-term foreign currency from ‘A-’ (A minus) to ‘A’ (A flat). The short-term local and foreign currency ratings are both ‘A-1’. Standard & Poor’s outlook for Israel is “Positive.”

Moody’s Investors Services upgraded its ratings for the Government of Israel’s long-term foreign and local currency bonds from ‘A2’ to ‘A1’ in April 2008. The State of Israel’s country ceiling for long-term foreign currency debt of ‘Aa1,’ was affirmed as well as the P1 short term foreign currency rating. Moody’s outlook for Israel “Stable.”

Fitch Ratings’ Issuer Default ratings for the State of Israel was upgraded in February 2008. The current rating is ‘A+’ (‘A plus’) on the long-term local currency, ‘A’ (A flat) on the long-term foreign currency and ‘F1’ on the short-term foreign currency. Fitch’s outlook for the State of Israel is “Stable,” and the country’s ceiling for bonds is ‘A+.’

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Table No. 33

Outstanding Public Sector External Debt
(In Millions of Dollars)


	Balance at Year End
	2003		2004		2005		2006		2007
Public sector external debt⁽¹⁾
Foreign governments and international institutions	$	2,630	$	2,452	$	2,082	$	1,926		2,089
Negotiable bonds guaranteed by the U.S. government		13,894		14,992		14,734		14,544		14,100
Negotiable bonds – unguaranteed		2,808		3,247		4,091		6,897		5,072
State of Israel bonds		10,123		10,150		10,136		9,993		9,764
Other		468		429		367		129		166
Total		29,923		31,269		31,409		33,490		31,191
Total public sector external assets		28,499		29,256		28,979		29,883		29,313
Net public sector external debt		1,424		2,013		2,431		3,607		1,878

(1)

Includes accrued interest.

Sources: Ministry of Finance, Bank of Israel.

Israel’s major sources of foreign currency financing have been low-cost, long-term debt backed by guarantees of the United States and bonds and notes issued through Israel Bonds. Consequently, the majority of Israel’s outstanding public sector external debt was issued at favorable interest rates with a maturity of 10 years or more. However, since 2005 Israel has been issuing foreign currency debt with shorter terms than in the past and has increased the levels of financing in international financial markets without United States guarantees.

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Table No. 34

Forward Amortization of Public Sector External Debt — Principal Payments
(In Millions of Dollars)⁽¹⁾⁽²⁾



	Debt Outstanding as of December 31, 2007		2008		2009		2010		2011		2012		2013 Onwards
US government (USD)		875		125		87		86		87		85		405
Other foreign governments and international institutions of which USD		105				3								103
of which Euro		848		48		162		81		44		44		469
Negotiable bonds guaranteed by the US government (USD)		14,112		724		667		530		485		393		11,314
Negotiable bonds – unguaranteed
of which USD		1,877						313						1,564
of which EUR		1,098				386								712
of which GBP		190												190
of which NIS		2,673												2,673
State of Israel bonds		8,679		1,694		1,111		1,296		793		830		2,955
of which USD		8,088		1,547		1,029		1,219		721		774		2,798
of which CAD		558		136		69		70		72		55		157
of which GBP		10		0		2		6		1		0		0
of which EUR		23		11		12		0						1
Foreign banks and others		103		4		4		4		4		79		10
of which USD		75										75
of which CHF		25		3		3		3		3		4		8
of which EUR		3		0		0		0		0		0		1
Total public sector		30,561		2,595		2,419		2,309		1,414		1,432		20,393

(1)

Repayments are for originally long term loans (for more than one year).

(2)

Data include accrued interest (which is excluded from the interest payment table).

Sources: Bank of Israel and Ministry of Finance calculations.

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Table No. 35

Forward Amortization of Public Sector External Debt — Interest Payments
(In Millions of Dollars)⁽¹⁾



	Outstanding Amounts as of December 31, 2007		2008		2009		2010		2011		2012		2013 Onwards
US government (USD)		178		41		34		29		24		20		30
Other foreign governments and international institutions (Euro)		111		14		13		12		11		10		51
Negotiable bonds guaranteed by the US government (USD)		10805		796		786		777		776		812		6858
Negotiable bonds – unguaranteed:
of which USD		1327		172		172		153		133		133		563
of which EUR		396		77		77		42		42		42		118
of which GBP		356		14		14		14		14		14		287
of which NIS		15		15
State of Israel bonds:		1552		384		312		205		179		255		218
of which USD		1406		368		302		190		149		226		171
of which CAD		143		14		9		14		30		29		47
of which in other currencies		1		1		1		0		0		0		0
Foreign banks and others:		69		1		1		1		1		66		1
of which USD		65		0		0		0		0		65		0
of which in other currencies		5		1		1		1		1		0		0
Total public sector		14809		1513		1408		1232		1180		1351		8125

(1)

Repayments are for originally long-term (over a year) loans.

Sources: Bank of Israel and Ministry of Finance calculations.

Government Guarantees

In certain cases, the State may issue financial guarantees of third-party obligations if the Government determines that the issuance of such guarantees is in the best interest of the State. These guarantees are generally made on a secured basis and require the payment of a fee to the State. Each guarantee or guarantee program must be specifically approved in advance by the Finance Committee of the Knesset, and the aggregate obligations issued under such guarantees may not exceed 10% of the total budget expenditures of the same year. Government guarantees fall into three general categories: (i) guarantees to support economic activities, including encouragement of capital investment; (ii) special guarantees to support Government-controlled entities, particularly those in the defense sector, or to support other enterprises or activities on a case-by-case basis; and (iii) guarantees given to support foreign trade made through the Israel Export Insurance Corporation Ltd. (ASHR’A), a Government-controlled company that provides export guarantees, guarantees against foreign political and commercial risks on a transaction-by-transaction basis and direct guarantees for certain large individual transactions, particularly those involving military equipment. These guarantees, fees and other receipts associated with them are included in the national accounts but, other than some of the guarantees listed in clauses (i) and (ii), are not part of the Government’s annual budget.

As of December 31, 2007, approximately $2.6 billion in Government guarantees were outstanding.

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The following table sets forth the outstanding Government guarantees of third-party indebtedness by category.

Table No. 36

Government Guarantees by Category
(As of December 31, 2007)
(In Millions of NIS)

Guarantee Programs

State-Owned Enterprises

International Trade

Hotel Funds

NIS49.9

Israel Electric Corporation Ltd.

NIS6,762.4

Foreign Trade Insurance

NIS2,756.8

Small Business Funds

23.6

Israel Aircraft Industries Ltd.

93.5

Capital Investment Law

6.9

Israel Military Industries Ltd.

142.8

Absorption and Construction

15.6

El-Al Israel Corporation

164.7

Total

96.0

Total

7,163.4

Total

2,756.8

Source: Ministry of Finance.

DEBT RECORD

Israel has never defaulted in the payment of principal or interest on any of its internal or external indebtedness.

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TABLES AND SUPPLEMENTARY INFORMATION

Foreign Currency Debt of the Government of Israel

Interest Rate (%)

Issue Date

Maturity

Currency

Outstanding Amount on
December 31, 2007
(In Millions)

Loans from the Government of the United States of America

3.000%

Oct. 1976

Oct. 2016

USD

97.1

3.000

Apr. – Aug. 1977

Apr. – Aug. 2017

USD

125.9

3.000

Jan. – Nov. 1978

Jan. – Nov. 2018

USD

222.5

8.606

Mar. 1978

Jan. 2008

USD

36.6

9.228

Jan. 1979

Dec. 2008

USD

48.8

3.000

Dec. 1979

Mar. 2009

USD

12.2

3.000

Apr. 1983

Nov. 2019

USD

139.8

7.753

July 1984

July. 2014

USD

30.7

8.359

Mar. 1986

Aug. 2011

USD

48.8

8.689

Sep. 1986

Aug. 2014

USD

234.2

Bonds Issued under the U.S. Loan Guarantee Program

Zero Coupon

Mar. 1993

Mar. 2023

USD

280.8

⁽¹⁾

Zero Coupon

Sep. 1993

Sep. 2023

USD

289.4

⁽¹⁾

6.600

Mar. 1994

Feb. 2008

USD

35.7

6.800

Mar. 1994

Feb. 2012

USD

333.1

Zero Coupon

Sep. 1994

Feb. 2012 – Aug. 2024

USD

196.8

⁽¹⁾

Zero Coupon

Sep. 1994

Aug. 2024

USD

182.2

⁽¹⁾

Zero Coupon

Nov. 1994

Nov. 2024

USD

222.6

⁽¹⁾

Zero Coupon

Sep. 1995

Aug. 2025

USD

207.5

⁽¹⁾

Zero Coupon

Jan. 1996

Aug. 2025

USD

343.3

⁽¹⁾

Zero Coupon

Aug. 1996

Aug. 2026

USD

427.9

⁽¹⁾

Zero Coupon

Jan. 1997

Nov. 2026

USD

343.1

⁽¹⁾

Zero Coupon

Sep. 1997

Feb. 2009 – Aug. 2027

USD

256.8

⁽¹⁾

Zero Coupon

Jan. 1998

Nov. 2027

USD

787.0

⁽¹⁾

5.5

Sep. 2003

Sep. 2023

USD

1,150.0

5.5

Sep. 2003

Sep. 2033

USD

450.0

5.5

Dec. 2003

Dec. 2023

USD

750.0

5.5

Apr. 2004

Apr. 2024

USD

1,000.0

5.125

Nov. 2004

Nov. 2024

USD

750.0

Housing Loans Guaranteed by the U.S. Government

8.723

Apr. 1991

Mar. 2021

USD

334.3

(1)

Proceeds realized, not face amount.

Source: Ministry of Finance.

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Interest Rate (%)

Issue Date

Maturity

Currency

Outstanding Amount on
December 31, 2007
(In Millions)

Loans from the Government of Germany

4.500

Dec. 1988

Dec. 2008

EUR

3.5

2.000

Nov. – Dec. 1989

Dec. 2019

EUR

42.5

2.000

Jan. 1991

Dec. 2020

EUR

46.5

2.000

Dec. 1991

Dec. 2021

EUR

50.1

2.000

Dec. 1992

Dec. 2022

EUR

53.7

2.000

Dec. 1993

Dec. 2023

EUR

73.6

2.000

Dec. 1994

Dec. 2024

EUR

43.5

2.000

June 1995

June 2025

EUR

62.6

2.000

Dec. 1996

Dec. 2026

EUR

43.7

2.000

Jan. 1998

Dec. 2027

EUR

25.6

2.000

Sep. 2000

Dec. 2030

EUR

4.6

2.000

Dec. 2001

Dec. 2030

EUR

10.4

2.000

Dec. 2003

Dec. 2030

EUR

1.2

2.000

Dec. 2004

Dec. 2030

EUR

2.0

2.000

Aug. 2005

Dec. 2030

EUR

2.0

2.000

Dec. 2006

Dec. 2030

EUR

3.5

2.000

Dec. 2007

Dec. 2030

EUR

1.9

Source: Ministry of Finance.

Loans from Government Trusts backed by the U.S. Government
(In Connection with Refinancing of U.S. Foreign Military Sales Loans)


9.7450	Sep. 1988	Nov. 2013	USD	609.2
9.7410	Nov. 1988	May 2013	USD	236.9
8.9549	Aug. 1989	Nov. 2011	USD	93.8

Source: Ministry of Finance.

Loans from Various Financial Institutions in the United States Guaranteed by the U.S. Government

LIBOR + 0.375

Aug. 1990

July 2009

USD

5.1

LIBOR + 0.375

Sep. 1990

Aug. 2010

USD

8.5

Source: Ministry of Finance.

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Interest Rate (%)

Issue Date

Maturity

Currency

Outstanding Amount on
December 31, 2007
(In Millions)

Loans from Israeli and Non-Israeli Banks

4.15

Sep. 1997

June 2015

CHF

20.9

1.15

Sep. 1997

June 2015

CHF

7.6

4.69

Oct. 1998

June 2015

EUR

1.5

1.69

Oct. 1998

June 2015

EUR

0.5

Source: Ministry of Finance.

International Capital Markets Issues


7.25	Dec. 1998	Dec. 2028	USD	250.0
6.875	Oct. 1999	Oct. 2034	GBP	100.0
7.75	Mar. 2000	Mar. 2010	USD	500.0
5.875	Feb. 2002	Feb. 2009	EUR	400.0
6.45	Dec. 2002	Dec. 2012	USD	75.0
4.625	June 2003	June 2013	USD	750.0
5.125	Mar. 2004	Mar. 2014	USD	500.0
3.75	Oct. 2005	Oct. 2015	EUR	750.0
5.5	Nov. 2006	Nov. 2016	USD	1,000.0

Source: Ministry of Finance.

State of Israel Notes
(Issued through the Israel Bonds)

Issues

Interest
Rate (%)⁽¹⁾

Issue Date

Maturity

Currency

Outstanding
Amount on
December 31,
2007
(In Millions)

Average Prime Issues⁽²⁾

AP – 1.75%

May 1999 – Aug. 1999

May 2006 – Aug. 2006

⁽⁶⁾

USD

3.3

Libor Issues⁽³⁾

Libor + 0.4%

Dec. 1996 – Dec. 2001

Dec. 2003 – Dec. 2008

⁽⁶⁾

USD

52.1

Libor + 0.4%

Dec. 2001 – Dec. 2004

Dec. 2008 – Dec. 2011

USD

116.4

Libor Issues⁽⁴⁾

Libor + 0.6%

Jan. 2001 – Aug. 2003

Jan. 2006 – Aug. 2008

⁽⁶⁾

USD

41.6

Libor + 0.6%

Aug. 2003 – Mar. 2005

Aug. 2008 – Mar. 2010

USD

171.6

Libor + 0.4%

Jan. 2005 – June 2005

Jan. 2012 – June 2012

USD

42.1

Libor + 0.5%

Apr. 2005 – Aug. 2005

Apr. 2010 – Aug. 2010

USD

79.3

Libor + 0.2%

Jul. 2005 – Dec. 2005

Jul. 2012 – Dec. 2012

USD

16.1

Issues

Base Rate

⁽⁵⁾

1999 – 2006

2006 – 2012

GBP

5.0

(1)

All notes pay interest semiannually on June 30 and December 31.

(2)

The average prime rate is determined according to the average prime rates of Citibank N.A. and Bank of America Corp.

(3)

The Libor Rate is for a six-month period rounded upwards to the next 1/16%.

(4)

The Libor Rate is for a three-month period rounded upwards to the next 1/16%.

(5)

The base rate is determined according to the base rate of Barclays PLC, HSBC Bank PLC, National Westminster PLC and Lloyds Bank PLC. Notes issued in 2005 and thereafter bear interest of Base Rate + 0.5%.

(6)

Put option commencing five years from the issue date.

(7)

Issues previously matured for which outstanding amounts remain uncollected.

Source: Ministry of Finance.

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State of Israel Bonds
(Issued through the Israel Bonds)

Issues

Interest
Rate (%)

Issue Date

Maturity

Currency

Outstanding
Amount on
December 31,
2007
(In Millions)⁽¹⁾

Development Issue

7^th – CIB

4.0

Jan. 1993 – Jan. 1997

Jan. 2008 – Jan. 2012

USD

148.1

– Int’l savings

4.0

Jan. 1993 – Aug. 1996

Jan. 2008 – Aug. 2011

USD

52.0

– Amended CIB

4.0

Oct. 1996 – Feb. 2006

Oct. 2011 – Feb. 2021

USD

72.9

– Amended
Registered
Savings

4.0

Jun. 1996 – Feb. 2006

Jun. 2011 – Feb. 2021

USD

75.8

– Amended Int’l
savings

4.0

Sep. 1996 – Feb. 2006

Sep. 2011 – Feb. 2021

USD

36.7

Individual Variable Rate Issue (IVRI)

5^th

⁽²⁾

Jan. 1996 – Jun. 1997

Jan. 2008 – Jun. 2009

USD

36.2

6^th

⁽²⁾

May 1997 – May 1999

May 2009 – May 2011

USD

68.9

Chai Issue

3^rd

3.9 – 4.5

Jan. 2005 – June 2004

Jan. 2008 – June 2009

USD

14.4

Mazal Tov

1^st

3.7 – 4.25

Feb. 2004 – July 2005

Feb. 2009 – July 2010

USD

14.4

1^st Amended

3.7 – 4.4

Aug. 2005 – Jan. 2006

Aug. 2010 – Jan. 2011

USD

6.7

Canadian Issues

2^nd Floating Rate

⁽³⁾

Jan. 1996 – Apr. 2006

Jan. 2008 – Apr. 2018

Can. Dollar

22.34

2^nd EDI

3.65 – 5.8

Jan. 2003 – May 2006

Jan. 2008 – May 2011

Can. Dollar

181.41

Chai

5.8

Jan. 2003 – Apr. 2003

Jan. 2008 – Apr. 2008

Can. Dollar

2.75

2^nd Chai

3.4 – 4.5

Apr. 2003 – May 2006

Apr. 2008 – May 2011

Can. Dollar

13.8

Zero Coupon

6.15 – 7.45

Oct. 2000 – Nov. 2004

Oct. 2010 – Nov. 2014

Can. Dollar

105.5

2^nd Zero Coupon

4.3 – 5.60

Nov. 2004 – May 2006

Nov. 2114 – May 2116

Can. Dollar

17.04

Savings 2 Year

4.05 – 4.7

July 2006 – Jan. 2007

July 2008 – Jan. 2009

Can. Dollar

8.4

Savings 5 Year

4.15 – 4.6

May 2006 – Jan. 2007

May 2011 – Jan. 2012

Can. Dollar

5.84

Savings 10 Year

4.3 – 5.4

May 2006 – Jan. 2007

May 2016 – Jan. 2017

Can. Dollar

2.69

Jubilee 2 Year

3.90 – 4.65

May 2006 – Jan. 2007

May 2008 – Jan. 2009

Can. Dollar

20.41

Jubilee 5 Year

4.00 – 4.70

May 2006 – Jan. 2007

May 2011 – Jan. 2012

Can. Dollar

25.08

2^nd Savings 1 Year

3.98 – 4.85

Jan. 2007 – Jan. 2008

Jan. 2008 – Jan. 2009

Can. Dollar

27.54

2^nd Savings 2 Year

3.66 – 4.38

Oct. 2007 – Jan. 2008

Oct. 2009 – Jan. 2010

Can. Dollar

0.89

2^nd Savings 5 Year

3.95 – 4.76

Jan. 2007 – Jan. 2008

Jan. 2012 – Jan. 2013

Can. Dollar

5.04

2^nd Savings 10 Year

4.27 – 5.27

Jan. 2007 – July 2007

Jan. 2017 – July 2017

Can. Dollar

1.38

2^nd Jubilee 1 Year

4.00 – 4.83

July. 2007 – Jan. 2008

July 2008 – Jan. 2009

Can. Dollar

8.88

2^nd Jubilee 2 Year

3.7 – 4.37

Oct. 2007 – Jan. 2008

Oct. 2009 – Jan. 2010

Can. Dollar

0.73

2^nd Jubilee 3 Year

4.05 – 4.95

Jan. 2007 – Oct. 2007

Jan. 2010 – Oct. 2011

Can. Dollar

5.08

2^nd Jubilee 5 Year

3.91 – 4.99

Jan. 2007 – Jan. 2008

Jan. 2012 – Jan. 2013

Can. Dollar

16.41

Zero Coupon Issues

5^th

5.65 – 7.9

Jan. 1998 – Jan. 2000

Jan. 2008 – Jan. 2010

USD

117.8

6^th

6.65 – 8.0

Feb. 2000 – Apr. 2001

Feb. 2010 – Apr. 1011

USD

94.1

7^th

6.65 – 7.15

Apr. 2001 – Jan. 2002

Apr. 2011 – Jan. 2012

USD

101.9

8^th

4.25 – 7.00

Feb. 2002 – Mar. 2006

Feb. 2012 – Mar. 2016

USD

922.4

Floating Rate
Issue(FRI)

3^rd

⁽⁴⁾

Feb. 1998 – Oct. 1998

Jan. 2008

USD

57.1

4^th

⁽⁵⁾

July 1998 – May 1999

July 2008 – May 2009

USD

135.2

4^thadditional

⁽⁵⁾

Mar. 1999 – Jan. 2000

Mar. 2009 – Jan. 2010

USD

47.7

D-72

TABLE OF CONTENTS

Issues

Interest
Rate (%)

Issue Date

Maturity

Currency

Outstanding
Amount on
December 31,
2007
(In Millions)⁽¹⁾

Jubilee

3^rd 5 Years

3.50 – 5.60

Jan. 2003 – Aug. 2005

Jan. 2008 – Aug. 2010

USD

1,313.5

3^rd 5 Years Amended

4.15 – 4.95

Aug. 2005 – Mar. 2006

Aug. 2010 – Mar. 2011

USD

123.6

10 Years

5.50 – 7.70

Apr. 1998 – Jun. 2001

Apr. 2008 – Jun. 2011

USD

208.7

2nd 10 Year

6.40 – 7.0

July 2001 – Mar. 2002

July 2011 – Mar. 2012

USD

144.9

3^rd 10 Year

4.15 – 6.80

Mar. 2002 – Aug. 2005

Mar. 2012 – Aug. 2015

USD

1,039.3

3^rd 10 Year Amended

4.55 – 5.35

Aug. 2005 – Mar. 2006

Aug. 2010 – Mar. 2011

USD

17.6

4^th 2 Year

4.70 – 5.50

Mar. 2006 – Jan. 2007

Mar. 2008 – Jan. 2009

USD

408.8

4^th 5 Year

4.55 – 5.50

Mar. 2006 – Jan. 2007

Mar. 2011 – Jan. 2012

USD

116.1

4^th 7 Year

5.15 – 5.75

Mar. 2006 – Oct. 2006

Mar. 2013 – Oct. 2013

USD

9.3

4^th 10 Year

4.70 – 5.90

Mar. 2006 – Jan. 2007

Mar. 2016 – Jan. 2017

USD

46.8

5^th 1 Year

4.74 – 5.18

Jan. 2007 – Aug. 2007

Jan. 2008 – Aug. 2008

USD

488.9

5^th 2 Year

3.04 – 4.14

Aug. 2007 – Jan. 2008

Aug. 2009 – Jan. 2008

USD

78.7

5^th 3 Year

4.11 – 5.26

Jan. 2007 – Oct. 2007

Jan. 2010 – Oct. 2010

USD

24.4

5^th 5 Year

3.41 – 5.34

Jan. 2007 – Jan. 2008

Jan. 2012 – Jan. 2013

USD

53.1

5^th 10 Year

4.79 – 5.5

Jan. 2007 – July 2007

Jan. 2017 – July 2017

USD

11.6

Euro Bonds

Savings Bond 2 Year

3.45 – 3.9

Jun. 2006 – Jan. 2007

Jun. 2008 – Jan. 2009

EUR

3.55

Savings Bond
10 Year

4.25 – 4.7

Jun. 2006 – Jan. 2007

Jun. 2016 – Jan. 2017

EUR

0.035

Euro Floating Bond
7 Year

3.13 – 3.95

Jun. 2006 – Jan. 2007

Jun. 2013 – Jan. 2014

EUR

0.12

2^nd Savings Bond
2 Year

3.94 – 4.69

Jan. 2007 – Jan. 2008

Jan. 2009 – Jan. 2010

EUR

6.34

2^nd Savings Bond
10 Year

4.45 – 5.25

Jan. 2007 – July 2007

Jan. 2017 – July 2017

EUR

0.22

2^nd Euro Floating Bond 1 Year

4.42 – 4.88

July 2007 – Oct. 2007

July 2008 – Oct. 2008

EUR

3.78

2^nd Euro Floating Bond 2 Year

4.68 – 5.00

Oct. 2007 – Jan. 2008

Oct. 2009 – Jan. 2010

EUR

1.28

2^nd Euro Floating Bond 7 Year

3.96 – 4.39

Jan. 2007 – July 2007

Jan. 2014 – July 2014

EUR

0.06

Savings Bonds

2 Year Saving

4.7 – 5.55

Mar. 2006 – Jan. 2007

Mar. 2008 – Jan. 2009

USD

226.01

5 Year Saving
(Mazal Tov)

4.56 – 5.22

Mar. 2006 – Jan. 2007

Mar. 2011 – Jan. 2012

USD

19.29

10 Year Saving

4.75 – 6.05

Mar. 2006 – Jan. 2007

Mar. 2016 – Jan. 2017

USD

42.82

2^nd 1 Year Saving

4.42 – 5.14

Jan. 2007 – Sep. 2007

Jan. 2008 – Sep. 2008

USD

57.65

2^nd 2 Year Saving

3.00 – 4.15

Aug. 2007 – Jan. 2008

Aug. 2009 – Jan. 2010

USD

23.68

2^nd 3 Year Saving

4.51 – 5.28

Jan. 2007 – July 2007

Jan. 2010 – July 2010

USD

22.38

2^nd 5 Year Saving (Mazel Tov)

3.41 – 4.86

Jan. 2007 – Jan. 2008

Jan. 2012 – Jan. 2013

USD

23.67

2^nd 10 Year Saving

4.91 – 5.62

Jan. 2007 – July 2007

Jan. 2017 – July 2017

USD

14.51

2^nd 10 Year Saving (Mazel Tov)

4.71 – 5.07

Jan. 2007 – July 2007

Jan. 2017 – July 2017

USD

1.44

Libor Floating Rate Issue

1^st⁽⁶⁾

Libor +
.75% – .9%

Oct. 1999 – Aug. 2000

Oct. 2009 – Aug. 2010

USD

115.3

2^nd⁽⁶⁾

Libor +
.75

Jul. 2000 – Jan. 2001

Jul. 2010 – Jan. 2011

USD

86.4

3^rd⁽⁶⁾

Libor +
.75%

Dec. 2000 – Jun. 2001

Dec. 2010 – Jun. 2011

USD

91.8

4^th⁽⁶⁾

Libor +
.6% – .75%

Jul. 2001 – May 2005

Jul. 2011 – May 2015

USD

290.4

D-73

TABLE OF CONTENTS

Issues

Interest
Rate (%)

Issue Date

Maturity

Currency

Outstanding
Amount on
December 31,
2007
(In Millions)⁽¹⁾

5^th(f)

Libor +
.3% – .6%

May 2005 – Mar. 2006

Jan. 2010 – Mar. 2011

USD

88.3

6^th 4 Year⁽⁷⁾

Libor +
.0% – .004%

Mar. 2006 – Jan. 2007

Mar. 2010 – Jan. 2011

USD

91.6

6^th 10 Year⁽⁷⁾

Libor +
.1% – .2%

Mar. 2006 – Jan. 2007

Mar. 2016 – Jan. 2017

USD

28.7

5 Year Floating Rate⁽⁷⁾

Libor +
.2%

Mar. 2006 – Sep. 2006

Mar. 2011 – Sep. 2011

USD

46.6

7^th 2 Year⁽⁷⁾

Libor -
0.9% – 0.6%

Nov. 2007 – Jan. 2008

Nov. 2009 – Jan. 2010

USD

26.01

7^th 3 Year⁽⁷⁾

Libor +
(-06%) – 0.0

July 2007 – Nov. 2007

July 2010 – Nov. 2010

USD

71.62

7^th 3 Year –
Financing⁽⁷⁾

Libor

Jan. 2007 – Oct. 2007

Jan. 2010 – Oct. 2010

USD

38.59

7^th 5 Year⁽⁷⁾

Libor +
(-0.8%) – 0.1%

Jan. 2007 – Jan. 2008

Jan. 2012 – Jan. 2013

USD

38.88

7^th 10 Year⁽⁷⁾

Libor +
(-0.15%) – 0.1%

Jan. 2007 – July 2007

Jan. 2017 – July 2017

USD

6.44

Issues that previously matured for which there are outstanding amounts because holders have not requested these amounts

335.45

(1)

Not including USD 23.58 million awaiting Bond issuance by Fiscal Agent.

(2)

Interest rate equals 5% plus one-half of the difference between prime and 5% if prime is greater than 5% and equals prime if prime is less than 5%.

(3)

Interest rate equals Canadian prime minus 75 basis points.

(4)

Interest rate equals average prime minus 150 basis points.

(5)

Interest rate equals average prime minus 175 basis points.

(6)

The Libor rate is determined according to Bloomberg, for three months rounded upward to the 1/16%.

(7)

The Libor rate is determined according to Bloomberg, for six months rounded upward to the 1/16%.

Source: Ministry of Finance.

Balances of the Government’s Foreign Currency Debt by Currency
(As of December 31, 2007)


	Total (In Millions)
United States Dollars (USD)		23,113.3
Euro (EUR)		1,848.1
Canadian Dollar (CAD)		470.1
Swiss Francs (CHF)		28.5
British Pound Sterling (GBP)		105.0

Source: Ministry of Finance.

D-74

TABLE OF CONTENTS

Government Guarantees of Foreign Currency Indebtedness


To	For		Interest Rate (%)		Issue Date		Maturity		Currency		Outstanding Amount on December 31, 2007
U.S. Exim Bank		IEC Corporation		6.80		1996		2008		USD		7,365,892
U.S. Exim Bank		IEC Corporation		7.00		1996		2008		USD		1,229,644
Deutsche Bundesbank		IEC Corporation		8.10		1986		2008		USD		1,146,284
KFW Bank		IEC Corporation		5.23		2000		2009		EUR		3,776,272
EDC Bank		IEC Corporation		Libor + 0.5		1997		2013		USD		14,876,558
EDC Bank		IEC Corporation		Libor + 0.4		1997		2013		USD		2,6484,132
Citi		IEC Corporation		Libor + 0.2		2005		2026		USD		222,796,000

Source: Ministry of Finance.

Tradable Local Currency Direct Debt of the Government of Israel


Serial No.	Serial Name		Interest Rate		Issue Date DD/MM/YYYY		Maturity DD/MM/YYYY		Outstanding Amount on December 31, 2007 (In Millions of NIS)
Floating Rate Loans
9230137		Gilon Chadash		⁽¹⁾		29/04/1999		31/03/2009		NIS5,000.0
9230236				⁽¹⁾		02/12/1999		30/11/2009		2,650.0
9230335				⁽¹⁾		23/05/2000		30/04/2010		8,530.4
9230434				⁽¹⁾		08/03/2001		28/02/2011		10,700.0
9230533				⁽¹⁾		03/01/2002		30/12/2011		11,300.0
9231531				⁽¹⁾		05/01/2004		31/12/2008		12,001.7
Fixed Rate Loans
9266735		Shahar		6.0		07/02/2005		31/01/2010		NIS11,634.2
9267139				7.0		12/03/2002		27/02/2009		20,705.3
9268038				7.0		17/05/2001		29/04/2011		5,900.0
9268137				10.0		25/06/2002		31/05/2012		9,047.9
9268236				7.5		26/04/2004		31/03/2014		10,895.3
9268335				6.5		06/02/2006		31/01/2016		9,650.6
9269036				5.75		06/03/2006		29/02/2008		7,796.5
1099456		Israel Government Fixed		6.25		06/11/2006		30/10/2026		5,100.2
1107788				5.0		13/11/2007		31/03/2013		3,059.4
1101575				5.5		26/02/2007		28/02/2017		13,170.5
CPI linked Loans
9470337		Galil		CPI + 4.00		07/01/1997		31/01/2008		1,835.1
9541533				CPI + 4.00		05/01/1993		31/01/2008		249.4
9541632				CPI + 4.00		02/03/1993		31/03/2008		373.9
9541731				CPI + 4.00		16/07/1993		31/07/2008		309.8
9541830				CPI + 4.00		05/10/1993		31/10/2008		495.7
9541939				CPI + 4.00		07/01/1994		31/01/2009		474.0
9542036				CPI + 4.00		03/06/1994		30/06/2009		900.0
9542135				CPI + 4.00		09/09/1994		30/09/2009		626.0

D-75

TABLE OF CONTENTS

Serial No.

Serial Name

Interest Rate

Issue Date
DD/MM/YYYY

Maturity
DD/MM/YYYY

Outstanding
Amount on
December 31, 2007
(In Millions of NIS)

9542234

CPI + 4.00

08/11/1994

30/11/2009

634.3

9542333

CPI + 4.00

14/02/1995

28/02/2010

470.0

9542432

CPI + 4.00

06/06/1995

30/06/2010

530.0

9542531

CPI + 4.00

25/07/1995

31/07/2010

1,079.0

9542630

CPI + 4.00

05/10/1995

31/10/2010

1,285.0

9542739

CPI + 4.00

03/06/1997

30/06/2012

4,000.0

9547035

CPI + 5.00

24/11/1998

31/10/2013

3,750.0

9547134

CPI + 5.00

30/11/1999

31/10/2014

1,050.0

9547233

CPI + 5.00

25/05/2000

30/04/2015

11,357.7

9548033

CPI + 4.00

04/09/2001

31/08/2011

10,050.0

9548132

CPI + 5.00

03/09/2002

31/08/2012

11,763.8

9570433

CPI + 4.75

05/06/1990

30/06/2008

147.0

9570532

CPI + 4.75

06/07/1990

31/07/2008

82.0

9570631

CPI + 4.75

03/08/1990

31/08/2008

85.4

9570730

CPI + 2.50

06/11/1990

30/11/2008

7.4

9590134

CPI + 4.75

04/07/1989

31/07/2009

306.0

9590332

CPI + 4.00

21/08/2001

30/07/2021

15,100.2

9590431

CPI + 4.00

23/08/2004

31/07/2024

9,645.3

1097708

Israel
Government

CPI + 4.00

26/06/2006

30/05/2036

6,926.3

1106525

CPI linked

CPI + 2.5

06/08/2007

30/06/2010

7,533.4

Dollar-linked/Floating Rate Loans

9655135

Gilboa

5.55

24/01/2000

24/01/2010

NIS300.0

(1)

Annual interest rate equals weighted average of yields to maturity of Treasury Bills (Makam) with 3 to 12 months maturity.

Source: Ministry of Finance.

Non-Tradable Local Currency Direct Debt of the Government of Israel

Series Name

Interest Rate

Issue Date

Date of Maturity

Outstanding
Amount on
December 31, 2007
(In Millions of NIS)

CPI-linked Loans

Hetz

CPI + 4% – 6.2

1967 – 2006

2007 – 2031

32,656.6

Meron

CPI + 5.5

1987 – 2003

2007 – 2023

85,959.0

Arad

CPI + 4.8

1995 – 2006

2010 – 2021

14,711.0

D-76

TABLE OF CONTENTS

Various Loans of the Government of Israel

Name

Interest Rate

Issue Date

Date of Maturity

Outstanding Amount
on December 31, 207
(In Millions of NIS)

Emission and Funds⁽¹⁾

2% – 6

1984 – 2004

⁽²⁾

NIS7,467.0

Compulsory Bonds

N/A

582.3

(1)

The funds and emissions include mostly deposits at the Accountant General’s Office made by financial institutions and other entities.

(2)

Most of these amounts were deposited for 17 years and are re-financed. Some of the Depositing entities are able to withdraw their funds at any time and some of the deposits (those referred to as “emissions”) have an established maturity date.

Source: Ministry of Finance.

Balance of the Government’s Floating Rate Debt by Currency
(As of December 31, 2007)


	Total (In Millions)
United States Dollars (USD)		2,044.8
Euro (EUR)		5.7
Canadian Dollar (CAD)		23.4
British Pound Sterling (GBP)		5.0
New Israeli Shekel (NIS)		50,474.4

Source: Ministry of Finance.

D-77


Title of Issue	Amounts as to which registration is effective	Names of exchanges on which registered
N/A	N/A	N/A

		STATE OF ISRAEL

		By: /s/ Zvi Chalamish
		Zvi Chalamish Chief Fiscal Officer for the Western Hemisphere Ministry of Finance

		By: /s/ Ran Alon
		Ran Alon Deputy Chief Fiscal Officer for the Western Hemisphere Ministry of Finance

Exhibit No.		Page No.
A:	None
B:	None
C:	Copy of the State Budget Proposal for Fiscal Year 2008 (in Hebrew)*
D:	Current Description of the State of Israel	D-1

STATE OF ISRAEL

STATE OF ISRAEL

TABLE OF CONTENTS

LIST OF TABLES

Tables and Supplementary Information:

Table No. 1

NIS/U.S. Dollar Exchange Rates

SUMMARY INFORMATION

Table No. 2

Selected Economic Indicators (In Billions of NIS Unless Noted)

STATE OF ISRAEL

Introduction

Geography

Population

Immigration

Form of Government and Political Parties

Table No. 3

Distribution of Knesset Seats by Party

National Institutions

International Relations

Membership in International Organizations and International Economic Agreements

THE ECONOMY

Overview

Gross Domestic Product

Table No. 4

Main Economic Indicators (In Billions of NIS Unless Noted)

Table No. 5

Resources and Use of Resources (In Billions of NIS at Constant 2005 Prices)

Savings and Investments

Business Sector Product

Table No. 6

Composition and Growth of Business Sector Product

Table No. 7

Manufacturing by Category

Table No. 8

Industrial Production Index (Base: Year 2004)

Energy

Table No. 9

Imports and Production of Crude Oil, Coal and Natural Gas (In Thousands of Tons Oil Equivalent)

Tourism

Table No. 10

Tourist Arrivals by Area of Origin and Receipts (Arrivals in Thousands and Receipts in Millions of Dollars)

Research and Development

Wages and Prices

Table No. 11

Selected Price Indices (Percentage Change, Annual Average)

Employment and Labor

Table No. 12

Structure of Employment in Israel

Table No. 13

Principal Labor Market Indicators (Annual Average)

Role of the State in the Economy

Table No. 14

Selected State-Owned Companies (At, or for the Period Ended, December 31, 2007)(1)(In Millions of Dollars, Except Percentages)

Kibbutzim and Moshavim

The Environment

BALANCE OF PAYMENTS AND FOREIGN TRADE

General

Balance of Payments

Table No. 15

Balance of Payments (In Millions of Dollars)(1)

Foreign Trade

Table No. 16

Exports of Goods by Major Groups (In Millions of Dollars, f.o.b.)

Table No. 17

Imports of Goods by Major Groups (In Millions of Dollars, c.i.f.)

Table No. 18

Exports of Goods by Region (In Millions of Dollars, f.o.b., Except Percentages)(1)

Table No. 19

Imports of Goods by Region (In Millions of Dollars, c.i.f., Except Percentages)(1)

Table No. 20

Merchandise Trade Indices (Base: 2000=100)

Anti-Money Laundering Law

Foreign Exchange Controls and International Reserves

Table No. 21

External Assets and Liabilities (Debt Instruments) (In Millions of Dollars)

Table No. 22

Foreign Currency Reserves at the Bank of Israel (In Millions of Dollars)

Foreign Exchange Rates

Foreign Investments

Selected Economic Indicators
(In Billions of NIS Unless Noted)

Main Economic Indicators
(In Billions of NIS Unless Noted)

Resources and Use of Resources
(In Billions of NIS at Constant 2005 Prices)

Industrial Production Index
(Base: Year 2004)

Imports and Production of Crude Oil, Coal and Natural Gas
(In Thousands of Tons Oil Equivalent)

Tourist Arrivals by Area of Origin and Receipts
(Arrivals in Thousands and Receipts in Millions of Dollars)

Selected Price Indices
(Percentage Change, Annual Average)

Principal Labor Market Indicators
(Annual Average)

Selected State-Owned Companies
(At, or for the Period Ended, December 31, 2007)⁽¹⁾
(In Millions of Dollars, Except Percentages)

Balance of Payments
(In Millions of Dollars)⁽¹⁾

Exports of Goods by Major Groups
(In Millions of Dollars, f.o.b.)

Imports of Goods by Major Groups
(In Millions of Dollars, c.i.f.)

Exports of Goods by Region
(In Millions of Dollars, f.o.b., Except Percentages)⁽¹⁾

Imports of Goods by Region
(In Millions of Dollars, c.i.f., Except Percentages)⁽¹⁾

Merchandise Trade Indices
(Base: 2000=100)

External Assets and Liabilities (Debt Instruments)
(In Millions of Dollars)

Foreign Currency Reserves at the Bank of Israel
(In Millions of Dollars)

Average Exchange Rates
(NIS Per Currency Unit)

Selected Interest Rates⁽¹⁾

Assets, Liabilities and Equity Capital of the Five Major Banking Groups
(In Millions of NIS)⁽¹⁾

The Budget Deficit and Its Financing
(In Thousands of NIS at Current Prices)

Government Taxes
(In Billions of NIS at Current Prices)⁽¹⁾

Government of Israel Statement of Net Expenditures
(Excluding Capital Expenditures)
(In Millions of NIS at Current Prices)

Net Public Debt
(At End-of-Year Current Prices in Billions of NIS)⁽¹⁾

Ratio of Net Public Debt to GDP
(Percentage of GDP at End-of-Year Prices)

Annual Local Currency Government Debt Issuances
(Gross Proceeds in Billions of NIS)

Outstanding Public Sector External Debt
(In Millions of Dollars)

Forward Amortization of Public Sector External Debt — Principal Payments
(In Millions of Dollars)⁽¹⁾⁽²⁾

Forward Amortization of Public Sector External Debt — Interest Payments
(In Millions of Dollars)⁽¹⁾

Government Guarantees by Category
(As of December 31, 2007)
(In Millions of NIS)

Loans from Government Trusts backed by the U.S. Government
(In Connection with Refinancing of U.S. Foreign Military Sales Loans)

State of Israel Notes
(Issued through the Israel Bonds)

State of Israel Bonds
(Issued through the Israel Bonds)

Balances of the Government’s Foreign Currency Debt by Currency
(As of December 31, 2007)

Balance of the Government’s Floating Rate Debt by Currency
(As of December 31, 2007)