Directorate-General External Policies

Policy Department

The Political and Economic Situation in and its relations with the

NOTE

Abstract:

This note is one of a series of such notes produced for the information of MEPs and the delegations of the . It is a revised and updated version of an earlier note on Israel.

DGExPol/B/PolDep/Note/2005_044 3 February 2005

PE 351.340 EPADES\DELE\ISRAEL\NT\555430EN.doc EN This note was requested by: the European Parliament's Delegation for relations with Israel.

This paper is published in the following languages: English (original), French.

Author: Anthony Comfort DG External Policies, Policy Department SCH 06B014 European Parliament, Luxembourg

Manuscript completed in February 2005.

Copies can be obtained through: E-mail: [email protected]]

Brussels, European Parliament, 2005.

The opinions expressed in this document are the sole responsibility of the author and do not necessarily represent the official position of the European Parliament.

PE 351.340 EPADES\DELE\ISRAEL\NT\555430EN.doc 2 Political situation

Official name State of Israel

National legislature Unicameral of 120 members directly elected by proportional representation for a four-year term. Universal direct over the age of 18. Parliamentary election: 28 January 2003. Next elections must be held before November 2006. President, elected by Knesset majority for a five-year term.

Head of state

National Cabinet, responsible to the legislature; formed a with , National Union and the (NRP) on February 28th 2003. In June2004 the National Union was ejected from the coalition and two (out of six) NRP members also left. The remaining four NRP members quit the coalition in November, leaving the government with a 55-member minority government. On 1 December 2004 the prime minister dismissed Shinui's five government ministers, leading to the party's exit from the coalition and leaving only the 40-member Likud in government. A new coalition government was formed in January 2005.

Main political parties Likud (Yisrael Ba r Aliya immigrant party has merged with Likud); (consists of Labour Party and ); Shinui; ; National Union (consists of right-wing and Tkuma and immigrant party ); National Religious Party (NRP); ; United (includes Agudat Israel and Degal Hatora); ; ; (labour union party now merged with Labour); Balad (Arab party)

COALITION GOVERNMENT: (Formed 10 Jan 2005) (For party affiliations see end of list) Prime Minister...... SHARON (LIK) Deputy Prime Minister...... (LIK) (Also Foreign Minister) Vice Prime Minister...... (LIK) (Also Industry, Trade & Labour Minister) Vice Prime Minister...... (LAB) ------MINISTERS: Agriculture...... (LIK) Communications...... (LAB) Defence...... (LIK) , Culture & Sport...... (LIK) Environment...... (LAB) Finance...... (LIK) Foreign...... See Deputy PM Health...... Danny NAVEH (LIK) Housing...... HERZOG (LAB)

PE 351.340 EPADES\DELE\ISRAEL\NT\555430EN.doc 3 Immigration & Absorption...... (LIK) Industry & Trade...... see Deputy PM Interior...... Ophir PINES-PAZ (LAB) Internal Security...... (LIK) Justice...... Tzipi LIVNI (LIK) Labour...... see Deputy PM National ...... Benjamin BEN-ELIEZER (LAB) Science...... see PM Tourism...... HIRCHSON (LIK) Transportation ...... (LIK) Welfare...... see PM Without Portfolio...... (LIK), (LIK), (LAB), (LAB) ------PARTY AFFILIATIONS: LIK -- Likud LAB -- Labour ------Speaker of the Knesset...... ------Governor-elect of the central bank...Stanley FISCHER

Constitution, institutions and administration

Israel is a democratic republic with a unicameral 120-seat parliament, the Knesset, elected every four years under a system of proportional representation. The of the largest party or voting bloc is called on to form a government, and will, upon succession, function as prime minister. The formal head of state is the president, currently Moshe Katzav, elected by the Knesset every five years, but his role is essentially ceremonial. The country was founded as a Jewish state, the of about 80% of the population, but individuals of other faiths are free to practice. However, the power of the orthodox stream of Judaism means that reform and other streams of Judaism do not receive recognition in Israel, despite strong pressure from outside the country. The need to deal with pressing economic and security issues means that even with Shinui in government, radical changes have yet to be made. Matters pertaining to family , such as marriage and divorce, are administered by the respective religious institutions of the recognised bodies of the faiths.

Outlook for 2005-06

In 2004 prime minister controlled a minority government having lost all his coalition partners, while his right-wing Likud party, which has 40 seats in the 120-member Knesset (parliament), was also deeply divided over his pursuit of unilateral Israeli disengagement from the and from four small settlements in the . On 11 January 2005 a coalition government was sworn in and Mr Sharon brought into his government new partners - Labour and the ultra-orthodox United (UTJ). But broad ideological differences over security issues both among the coalition allies and within the Likud, as well as differences over socio-economic issues, still make Mr Sharon's government

PE 351.340 EPADES\DELE\ISRAEL\NT\555430EN.doc 4 vulnerable to collapse.

Mr Sharon does not have a permanent majority in the Knesset but is obliged to form coalitions for each new measure. In theory his government is supported by 64 members of the Knesset: 40 Likud, 19 Labour and 5 UTJ, but the vote of confidence was passed by only 56 to 54, with 13 Likud members voting against or abstained.

The disengagement from Gaza and the accompanying special budget must be approved by early March if it is to take place as planned by early July. The national budget must also be adopted by 31 March in order to avoid early elections. Because of various constraints on the opposition it is likely that these dates will be achieved.

With the death of the Palestinian leader, , the US appears more willing to push for a resumption of bilateral peace efforts, and domestic pressure to deal with the security situation has also intensified. The disengagement plan could provide the framework on which possible efforts to restart the road map to peace, or another bilateral process, may be based. The plan is strongly opposed by many in Israel, but - given the popularity of Mr Sharon's stance on the Palestinian-Israeli conflict and the political weakness of the centre-left, as well as an awareness in Likud that they would probably lose votes in an early election - the prime minister may be able to do enough to avoid a collapse, provided that violence remains at low levels.

If elections are called early, Mr Sharon could win a fresh mandate to continue peace talks, although the finance minister and former Likud prime minister, Binyamin Netanyahu, is a strong contender to succeed Mr Sharon as prime minister if opponents of disengagement gain the upper hand politically.

Recent political developments

The assassination of , a centrist Labour prime minister, by an ultra-nationalist Israeli Jew in November 1995 highlighted the political tensions generated by the peace process in Israel. Left-right rivalry on the Arab-Israeli question predates the foundation of the state. Labour (left) and Likud (right) are the two main parties representing this ideological divide. The differences between the two parties on economic issues are minor, with both cautiously espousing (if not always implementing) generally liberal economic policies, although in the past Labour pursued centrally planned economic policies. However, a new electoral system inaugurated in 1996 (see , institutions and administration) brought about another result: the fragmentation of Israeli politics.

The two major parties, Likud and Labour, which had previously tended to secure at least 80 seats between them, were able to muster only 66 seats in the 1996 election. This trend was intensified in 1999, when Likud and One Israel (Labour and its electoral bloc) managed to win only 19 and 26 seats respectively. By contrast, social issue parties increased their seat total from 22 in 1992 to 47 seats in 1999. In 2001 the Knesset approved a bill to reinstate the previous voting system, whereby the leader of the largest party or voting bloc is called on to form a government. Implemented in the 2003 election, the reversion to the old voting system stemmed the fragmentation of the political landscape but did not reverse it markedly: Labour and Likud secured 59 seats between them, while the smaller parties' representation fell to 39 seats from 47 seats in the previous Knesset. Although these figures suggest that some of the electorate is returning to its pre-1996 voting patterns, the days of single-party predominance in the Knesset

PE 351.340 EPADES\DELE\ISRAEL\NT\555430EN.doc 5 appear to be over. The two parties that have long been dominant are likely to continue to struggle to establish durable coalitions given the increased representation of religious, ultra- nationalist and other single- or narrow-issue parties. The Knesset has also voted in legislation raising the threshold for a party to gain a parliamentary seat from 1.5% of the vote - one of the lowest in the world - to a still low 2.5%, effective from the next general election.

The immigration of hundreds of thousands of Jews from the former Soviet Union from the beginning of the 1990s introduced a new force into Israeli politics. The considerable immigrant vote is generally liberal on domestic affairs but less compromising on security matters. Since the 1992 elections new immigrant voters have switched allegiance from the Likud to Labour and back.

A more recent development is the emergence of the ultra-secular Shinui party as the third largest . The secular-religious relationship has always been delicate in Israel, but with the impasse in the peace process, the growing focus on domestic policy and the troublesome , tensions have increased over this issue. Many ultra-orthodox Jews refuse to recognise the existence of the Israeli state, and have practically withdrawn from the wider Israeli society while many others refuse to serve in the Israeli army (which is conscription based). This in turn leads to their exclusion from the labour market, which, coupled with their relative poverty and large families, means that they are heavily dependent on state handouts.

However, in large part owing to Israel's political system of proportional representation, ultra- orthodox political parties are able to wield significant political influence. This, together with the fact that secular and traditional religious Zionists, such as those that support the NRP, bear the brunt of military service and also pay more in , has created a serious divide between secular and religious Jews.

As the political stalemate grew, the religious parties successfully utilised the fractious political system to retain control over the balance of power in a succession of both left- and right-wing . The most successful of these religious parties has been Shas, but the party has weakened recently as the narrow political focus of religious parties and their financial demands on governments has led to a backlash, most obviously when Shinui saw its Knesset representation leap from six to 15 seats in the 2003 election. Participating in government for the first time, Shinui is a centrist party on security issues and advocates economic liberalisation and the separation of state and religion. Shinui's voters are mostly middle and upper-middle class Ashkenazi (European) Jews (traditionally Labour voters). However, in the past centrist parties have performed strongly in an election and served in government only to disappear by the time of the next election.1

With the intent of strengthening government stability and efficiency, the Knesset passed a law in 1992 requiring the direct election of a prime minister. Under the law, the prime minister could be removed only if 61 Knesset members voted against him in a no-confidence motion "which would also trigger a legislative election" or if 80 members voted to replace him, in which case no new Knesset election would be necessary. The new law also limited the number of ministries to 18, although this figure has since been amended to 24. Since 1996, when the first election under the new system took place, voters have in practice cast their vote in the prime ministerial poll according to their general political tendency, but have selected the party that corresponds more closely to their individual preferences for the Knesset election. As a result, smaller parties

1 For election results see Annex 1

PE 351.340 EPADES\DELE\ISRAEL\NT\555430EN.doc 6 proliferated and the number of seats they held in the Knesset increased, the opposite of what electoral reform intended to achieve. One of the first steps of the new government formed in 2001 was the revocation of the 1992 law, and the return to the old voting system. Two changes were included in order to reinforce stability: • a requirement of at least 61 votes in the Knesset to pass a no-confidence measure, rather than a simple majority of those present; and • the opposition must present an alternative government with the support of at least 61 Knesset votes in order to replace the existing government.

International relations

The dominant factors shaping Israel's foreign and defence policies have been the Arab-Israeli conflict and Israel's with the US. Upon declaring independence in 1948 Israel and neighbouring Arab states went to war. Subsequent hostilities occurred in 1956, 1967, 1973 and 1982.

In 1991 Israel was attacked by Iraqi missiles during the Gulf war, in which it did not take part, but was not targeted by Iraq during the US war against the Iraqi leader, Saddam Hussein, in 2003.

The Israeli-Palestinian conflict has dominated Israel's relations with its neighbours. Until the 1990s one of the central tenets of Israeli diplomacy and domestic politics was its opposition to the idea of Palestinian political independence. The signing of the between Israel and the Palestine Liberation Organisation (PLO) in September 1993 signalled a new era in which the principle of partition, which was rejected by the Arabs when proposed by the UN in 1947, was accepted by the leadership of both peoples.

The hostile regional environment has compelled Israel to look further afield for political and military support. Since 1973 the US has filled this role, selling Israel advanced weapons systems and providing a diplomatic umbrella. The US has also been a source of economic and military aid. Since 1985 this has taken the form of an annual grant of US$3bn, of which US$1.8bn is military aid spent primarily on American equipment. In 2003 the US agreed to extend Israel a further US$1bn in military aid that year to cover the costs of defending itself during the Gulf conflict. Although civilian aid from the US is being phased out over a ten-year period, military support will continue.

Successive Israeli governments have made the link with the US a cornerstone of their policies. For this reason, the US is Israel's favoured broker of any Middle East settlement. Israel is wary of any diplomatic role for the EU, and even more so for the UN, as their policies are perceived by Israelis to be more sympathetic to the Palestinian plight. Nevertheless, since the Palestinian uprising began in September 2000, the US, the EU, Russia and the UN (both individually and, since 2002, collectively as the four members of the Middle East "Quartet"), along with Saudi Arabia and, to a lesser but still significant extent, Arab states such as Egypt and Jordan, have all attempted to provide diplomatic and practical solutions to the ongoing violence and to bring about a resumption of negotiations between Israel and the Palestinians. The level of hatred and mistrust has rendered all such proposals unworkable at present. The US put pressure on Israel (as well as the Palestinians) to accept and implement the international road map to peace drawn up by Quartet. The road map, adopted formally in Aqaba, Jordan, in June 2003, advocated a step-by-step approach towards a provisional Palestinian state, scheduled for 2005, but this

PE 351.340 EPADES\DELE\ISRAEL\NT\555430EN.doc 7 initiative failed amid renewed violence. International mediators have since focused on putting pressure on Israel to minimise the humanitarian impact of its security measures on the Palestinians, and, in the absence of a bilateral process, have given cautious support to Israel's disengagement plans and have sought to encourage the PA to take more comprehensive steps to reform its security and decision-making structures.

PE 351.340 EPADES\DELE\ISRAEL\NT\555430EN.doc 8 ECONOMIC SITUATION

Main economic indicators, 2003

GDP at current market prices (NIS bn) 496 Real GDP growth (%) 1.3 Consumer price inflation (av; %) 0.7 Population (av; m) 6.69 Exports fob (US$ m) 30,155 Imports fob (US$ m) -32,332 Current-account balance (US$ m) 153 Reserves excl. gold (US$ m) 26,315 Total external debt (US$ m) 70,974 Debt-service ratio (%) 13.2 Exchange rate (av; NIS:US$) 4.55

Source: Economist Intelligence Unit

Israel enjoys a diversified and sophisticated economy compared with its neighbours. Israel's sector product (which excludes government, public-sector and non-profit institutions from the overall GDP calculation) accounted for about 67% of GDP in 2003 compared with 68% in 2001. The main items of the business sector product in 2002 (not including net errors and omissions and imputed bank services) were: 59.8% commerce and services; 25.9% industry; 12.4% transportation and communications, 7.4% construction, 3.3% utilities; and 3% agriculture.

Manufacturing activity over the past decade has successfully branched out into new industries, such as electronics, albeit at the expense of traditional industries such as clothing and footwear. The traditional industries benefited from strong protectionist policies until the early 1990s. Most of these industries, especially the larger textile and clothing firms, have gone through a structural change and some have been outsourcing labour-intensive activities to neighbouring countries such as Jordan, Egypt and Turkey, where wages are substantially lower than in Israel. This has enabled Israeli manufacturers to focus on their relative advantage in product design and trade agreements with the US and the EU as part of a free-trade zone.

These and other medium- and low-technology export-oriented firms have fared relatively well during the economic recession period that started in late 2000. This is attributable to structural change, which has resulted in greater levels of efficiency in these industries, along with the substantial real depreciation of the shekel in 2002 (and against the in 2003) that has contributed to a major improvement in Israel's competitiveness.

Economic outlook

On the back of a pick-up in export demand, particularly for Israel’s high-tech goods and services, real GDP growth strengthened in 2004. In 2005 Israel should maintain most of the export competitiveness gains it has made since 2001, in part because of the stronger euro, but with the rate of global demand growth easing, economic expansion will be more evenly distributed, with a stronger recovery in the domestic economy. Investments in fixed assets - particularly in transport infrastructure - should rise at a modest pace, and residential construction will slowly expand to replenish the housing inventory, which has declined in recent years. FDI

PE 351.340 EPADES\DELE\ISRAEL\NT\555430EN.doc 9 inflows will also strengthen.

Growth in export volumes - though easing after a rapid rise in 2004 - should contribute to a steady fall in unemployment, further boosting private consumption, which has already begun to recover owing to cuts and a more stable security environment. Stronger private consumption should mitigate some of the effects of the slowdown in the average rate of export growth in 2005-06, as will higher government expenditure, although it will stay weak by historical standards. Imports - particularly of capital goods - will slow after the sharp rise in 2004 but will continue to increase, dampening overall GDP growth. As long as Israeli-Palestinian violence does not escalate, tourism will continue to recover, although it is unlikely to reach the record levels of 2000. Overall, real GDP expansion is expected to reach 3.6% in 2005, rising to 4% in 2006 as falling unemployment restores consumer confidence and as real government consumption and investment growth - particularly in energy and transport - continue to strengthen.

Policy trends

This government has been more active than its predecessor in promoting economic liberalisation, in setting realistic fiscal and other targets and in restarting the stalled privatisation programme. Steps to control government spending have helped stabilise the economy; a reduction in tax rates should stimulate domestic economic activity; and financial market reforms have provided greater financing options for . Given other pressing issues on the agenda and the government’s weakened position, some reforms will be delayed. The pace of change will be less steady than in the past year or so, with austerity measures facing stiff opposition and political parties demanding budgetary concessions in return for supporting the government. Nevertheless, despite the likely softening of the government’s focus on economic issues, and in particular the slowing of progress on fiscal reform in the run-up to and in the immediate aftermath of elections in 2005-06, the longer-term fiscal outlook will improve and some reforms will move rapidly forward, particularly less politically sensitive banking and financial sector restructuring. Bank of Israel (the central bank) concerns over government economic policy have eased, but it will remain worried about the impact of public debt on liquidity. However, the improving fiscal picture and continued privatisation should help reduce these concerns. With the currency more stable and price growth subdued, interest rates will start to rise from mid-2005.

Foreign trade & payments

Foreign trade, 2003 (US$ m; fob) Merchandise exports 30,155 Merchandise imports -32,332 Trade balance -2,177

Sources: Central Bureau of Statistics, Monthly Bulletin of Statistics. IMF, International Financial Statistics. During the 1990s rapid economic growth accelerated imports of production inputs, capital goods and consumer durable goods, causing the trade gap to widen rapidly. However, the slowdown in the economy during the second half of the decade caused the trade deficit to narrow. In 1999 the trade deficit rose temporarily to US$4.5bn owing to several one-off items, such as a rise in inventories in preparation for Y2K problems and large imports of equipment

PE 351.340 EPADES\DELE\ISRAEL\NT\555430EN.doc 10 during the final stages of the construction of a new Intel plant in Israel. The surge of high-tech exports in 2000 pushed down the trade deficit.

Israel's trade deficit declined significantly from a peak of US$7.2bn in 1995 to US$2.9bn in 2000, but rose again in 2001-02, reaching US$3.9bn in 2002, as a 12.3% decline in export earnings outpaced a 8.3% fall in import costs of over these two years. However, in 2003 an export-led recovery of the economy began to emerge, while domestic demand remained weak. As a result, in 2003 exports rose by 10.4% while imports increased by 3.6% and the trade deficit narrowed to less than US$2.2bn, its lowest level since 1989.

Main exports, 2003 (US$ m; fob) Agricultural exports 715 Industrial exports incl. software 19,277 Diamonds (gross) 7,868 Worked diamonds 5,636 Total incl. others a 27,913 a National data vary for the trade account and the trade component of the current account that is used by the IMF's International Financial Statistics. Sources: Central Bureau of Statistics, Monthly Bulletin of Statistics; Foreign Trade Statistics Quarterly. Israel' s relative lack of natural resources means that the trade deficit is highly sensitive to price fluctuations of raw materials, fuel and commodities relative to industrial goods. In 2003 non- diamond industrial goods made up 69% of Israel's exports, diamonds about 28% and agricultural products only 2.6%. Thus, when the prices of manufactured goods fall relative to commodity prices, as they did in 1994-95 and once again in 1999-2003, Israel's terms of trade tend to deteriorate. Furthermore, a weaker US dollar, which reduces exports to the US, also pushes up the trade deficit because of the relative importance of the US as a market and the US dollar as a currency of trade with other countries. The value of European currencies is more important for import prices.

PE 351.340 EPADES\DELE\ISRAEL\NT\555430EN.doc 11 Main trading partners, 2003 (US$ m; unless otherwise indicated) Value % of total Exports to:

US 12,089 38.0 Belgium-Luxembourg 2,325 7.3 Hong Kong 1,495 4.7 UK 1,225 3.9 Germany 1,123 3.5 Netherlands 1,085 3.4 Italy 773 2.4 Japan 626 2.0 France 685 2.2 Spain 525 1.7

Imports from:

US 5,331 15.6 Belgium-Luxembourg 3,210 9.4 Germany 2,731 8.0 UK 2,283 6.7 Switzerland 2,062 6.0 Italy 1,398 4.1 Hong Kong 893 2.6 France 1,183 3.5 Netherlands 1,197 3.5 Japan 844 2.5

Source: Central Bureau of Statistics, Monthly Bulletin of Statistics.

Some EU countries have repeatedly threatened to boycott Israeli products as a result of Israel's de facto reoccupation of the Palestinian Territories. So far, this has had little impact on export growth, although some decline is visible in exports of agricultural produce to the EU as individual states or labour unions have taken various measures to that extent. Israel has also found it more difficult to gain licences for importing and exporting defence-related equipment. However, these measures appear to have been eased since 2003. In 2004 France announced that it would be purchasing military technology from Israel - the first defence contract between the two states since the 1967 war.

PE 351.340 EPADES\DELE\ISRAEL\NT\555430EN.doc 12 EU-ISRAEL RELATIONS

The EU-Israel Association Agreement is the main agreement governing relations between Israel and the EU. It is much more than just a free trade agreement and enables ongoing dialogue and cooperation between Israel and the EU in a wide variety of fields. The Association Agreement was signed in Brussels, on 20 November 1995, and entered into force on 1 June 2000, following ratification by the 15 Member States parliaments, the European Parliament and the Knesset. It replaces the earlier Co-operation Agreement of 1975.

In line with the new generation of Association Agreements between the EU and its Mediterranean partners, the preamble emphasises the importance of the principles of the United Nations Charter, in particular the observance of human rights, democratic principles and economic freedom. The respect for human rights and democratic principles guides the internal and international policy of both Israel and the Community and constitutes an essential and positive element of the Agreement. It also stresses the need to strengthen political stability and economic development of the region through the encouragement of regional co-operation; to open a regular political dialogue in bilateral and international contexts on issues of common interest; to maintain a dialogue on scientific, technological, cultural, audio-visual and social matters to the benefit of both parties.

The main text refers to regular political dialogue at ministerial and senior official levels, and at parliamentary level through contacts between the European Parliament and the Knesset. Emphasis is placed on peace, securityand regional co-operation and on the need to contribute to the stability and prosperity of the Mediterranean region, to promote understanding and tolerance. furthermore the agreement includes provisions on freedom of establishment and liberalisation of services, free movement of capital and competition rules, the strengthening of economic co-operation on the widest possible basis and the co-operation on social matters, supplemented by cultural co-operation. the agreement confirms the existence of free trade in manufactured goods and it reinforces the arrangements for free trade in industrial products, which have been in force since the late 1970s. arrangements for importing Israeli products are more flexible in the new agreement than there were under the 1975 co-operation agreement. it also calls for progressive and reciprocal liberalisation of trade for agricultural products and indeed a new agreement was reached in July 2003. a joint declaration attached to the agreement stresses the importance which both parties attach to the struggle against xenophobia, anti-semitism and racism.

The Association Agreement established two main bodies for the EU-Israel dialogue. The EU-Israel Association Council (held at ministerial level) and the EU-Israel Association Committee (held at the level of Senior officials) meet at regular intervals (see list below), to discuss political and economic issues as well as bilateral or regional co-operation. The fourth Association Council (17 and 18 November 2003, Brussels) was chaired by Israel. A frank and constructive discussion took place on a whole range of issues of common interest, including the Middle East Peace Process and the Road Map, the humanitarian situation in the Palestinian Territories, Iran, and Iraq. On Wider Europe, the Israeli side welcomed the EU initiative and indicated that a high level task force had been created by the Israeli authorities to work with the . The EU stressed that the initiative’s full potential would be achieved in a context of peace. Various economic and trade issues were discussed in the context of the EU-Israel Association Agreement. Among these were rules of origin where further talks between the European Commissionand the Israeli authorities are envisaged. Both sides mentioned the good participation of Israeli enterprises in the first call for proposals launched under the sixth EU Framework Programme for Research. The Israeli government expressed their interest in developing co-operation on Energy, Environment, Justice

PE 351.340 EPADES\DELE\ISRAEL\NT\555430EN.doc 13 and Home Affairs.

Trade Relations

Trade between the EU and Israel is conducted on the basis of the Association Agreement. It has flourished in the last decade. The EU is Israel's major trading partner. About 40% of Israeli imports come fromthe EU, and about 30% of Israeli exports are directed to the EU. It occupies rank number 1 in Israel's imports and rank number 2 in its exports. Israel is the EU's 21st largest export market, and occupies rank number 28 in the EU's imports.

EU imports from Israel have approximately tripled since 1990. Total trade between the EU and Israel decreased, by 7% in 2001 and 8.7% in 2002; in 2002 it reached a level of € 22 billion. The changes were due in large part to a restructuring in the diamond trade which represents around 20- 25% of EU-Israel trade and to a dramatic reduction in trade in high tech products. The downward trends continued during 2003.

Agricultural products account for a significant proportion (8.4%) of the community's total imports from Israel, and 2.4% of its total exports there. Under the Euro-Mediterranean Agreement, the two sides granted each other significant trade concessions for certain agricultural products, consisting of tariff reductions or elimination, either within quotas, or for unlimited quantities.

In accordance with Article 14 of the Agreement, which provides for the further reciprocal liberalisation of agricultural trade, negotiations for a package of new concessions have been concluded.

For details of recent trade flows please see annex 3.

Technical co-operation

Israel was the first non-European country to be associated with the EU’s Framework Programme for Research and Technical Development (RTD). Israel's special status is the result of its very high level of scientific competence and the dense network of longstanding relations in scientific and technical co-operation between Israel and the EU.

Israel first entered the Fourth Framework programme in August 1996. On 8 March 1999, the "Second Agreement for Scientific and Technical Co-operation between the European Community and Israel" came into force. This agreement fully associated Israel with the 5th Framework Programme for Community RTD (1999-2002). During this period, Israeli universities, research institutes and companies participated in over 600 research projects with EU partners, representing an estimated total funding of around €165 million.

The agreement associating Israel to the 6th Framework Programme (FP6 2003-2006) was signed in Brussels in June 2003. FP6 is a key part of the EU's strategy to create a true European Research Area, an Internal Market for science and knowledge in which Israel will play a full role. FP6 is set to play an instrumental part in the Barcelona 's target to raise average EU research spending to 3% of European GDP.

The EC and Israel were participants in the negotiations, which led to the WTO's new Government Procurement Agreement (GPA). As part of the negotiations toward an EU-Israel Association Agreement, both parties affirmed their commitment to mutually open their respective procurement

PE 351.340 EPADES\DELE\ISRAEL\NT\555430EN.doc 14 markets. It represents real progress in the EU's goal to continue to open up public procurement markets beyond what has already been achieved in the GPA and Israel will be committed to further market opening in urban transport, services, medical equipment and sub-central government procurement, such as municipal and state agencies.

Other agreements are those on Telecommunications Procurement and on Good LaboratoryPractice (concerning authorisation of cosmetics, industrial chemicals, pharmaceuticals, food additives, animal feed additives and pesticides). A Cooperation Agreement on Galileo (a Global Navigation Satellite System to be used in civil telecommunications) is being negotiated.

Israel can participate in Tempus projects, aimed at the development of Universities’ networks and restructuring of higher education; the new Erasmus Mundus programme (scholarships to third country students), which became operational in the course of 2004, will also involve Israel.

Regional Economic Cooperation

The EU’s relations withIsrael are also important in the context of the multilateral framework of the Euro-Mediterranean Partnership. The South and East Mediterranean and the Middle East are areas of vital strategic importance and a key external relations priority for the EU.

The EU’s proximity policy towards the Mediterranean region is governed by the comprehensive agreement launched at the 1995 Barcelona Conference between the European Union and its 12 Mediterranean Partners: Israel, Morocco, Algeria, Tunisia, Egypt, Jordan, the Palestinian Authority, Lebanon, Syria; Turkey, Cyprus and Malta. (Libya currently has observer status at certain meetings.)

The aim of the Euro-Mediterranean Partnership is to turn the Mediterranean basin into an area of dialogue, exchange and co-operation guaranteeing peace, stability and prosperity; to strengthen political dialogue, the development of economic and financial cooperation, the social, cultural and human dimension, and by 2010 establish a free-trade area. As such it provides a context for the involvement of both Israel and its Arab neighbours.

One of the primary goals of the Euro-Mediterranean Process is the establishment of a Euro-Med Free Trade Area (FTA) by the year 2010. Among the necessary pre-conditions for the establishment of an FTA is the granting of cumulation of rules of origin to Mediterranean partner countries. Cumulation could be particularly important in the context of the peace process, in that it facilitates economic cooperation between Israel and its neighbours by enabling export to the EU of goods jointly produced by Israel and its neighbours.

The EC-Israel Association Accord (Declaration by the EC on Cumulation of Origin) stipulates:

In line with political developments, if and when Israel and one or more other Mediterranean countries conclude Agreements to establish free trade among themselves, the European Community is prepared to implement cumulation of origin in its trade arrangements with those countries.

Pursuant to Israel's signing of free trade agreements with Jordan and with Turkey, joint requests were submitted to the Commission for cumulation of origin. The Commission has not, to date, responded positively to either request. The Commission has expressed its preference for granting cumulation to sub-regional blocks rather than to country pairs, in preparation for the eventual

PE 351.340 EPADES\DELE\ISRAEL\NT\555430EN.doc 15 establishment of a Free Trade Area.

In addition to requesting cumulation with its neighbours, Israel has also requested the right to pan-European cumulation. This is in recognition of the fact that Israel, while strongly committed to regional economic cooperation, considers that cooperation solely within the Mediterranean framework is limiting, due to the great economic disparities in the Middle East. In order to fully exploit the inherent potential in the Israeli-EU economic relationship, Israel considers that a two-track approach is necessary, including economic cooperation both on a regional and on a pan-European level.

PE 351.340 EPADES\DELE\ISRAEL\NT\555430EN.doc 16 Annex 1

Election results

(No. of seats in the Knesset)

1984 1988 1992 1996 1999 2003

Labour 44 39 44 34 26 a 19 a Likud b 41 40 32 32 19 38 Shas 4 6 6 10 17 11 Meretz c - - 12 9 10 6 - d - d - d - d 6 - d Shinui d 3 2 - - 6 15 National Union - - - - - 7 f Yisrael Ba'Aliya - d - d - d 7 6 2 g National Religious Party 4 5 6 9 5 6 2 5 4 4 5 5 United Arab List - d 1 2 4 5 2 Hadash h 4 4 3 5 3 3 Am Ehad a - d - d - d - d 2 3 Tsomet - d 2 8 - - - d Moledet - d 2 3 2 - - d CRM e 3 5 - - - - Others 15 9 - 4 10 3 Total 120 120 120 120 120 120

a One Israel alliance originally comprising Labour, Gesher and Meimad but only Labour and Meimad in 2003 election. Am Ehad scheduled to join One Israel alliance from October 2004. b Includes Tsomet and Gesher since the 1996 election. c Meretz merged with Shahar, a new left-wing party, to form Yahad in March 2004. d Did not contest election. Having joined with other parties to form the electoral bloc, Meretz, in 1992, Shinui left to stand alone in the 2003 Knesset elections. e The Civil Rights Movement (CRM) joined forces with , which had fought the 1981 and 1984 elections in conjunction with Labour, and with Shinui to form Meretz in 1992; Shinui subsequently left the federation in 1999. f Union of ultra right-wing parties including immigrant party Yisrael Beiteinu. g Merged with Likud after the 2003 general election. h The DFPE (Democratic Front for Peace and Equality) and the Israel (HADASH in Hebrew). HADASH has historically been a Jewish-Arab movement, although it is now a predominantly Arab party. i Tsomet fought 1996 election in alliance with Likud and Gesher.

PE 351.340 EPADES\DELE\ISRAEL\NT\555430EN.doc 17 Annex 2 : Map of Israel and the Occupied Territories (from EIU Country Report)

PE 351.340 EPADES\DELE\ISRAEL\NT\555430EN.doc 18 Annex 3 : EU-Israel trade flows

Table 1 Trade relations EU(15)-Israel, 2003 By products 1000 EUR

CN Chapters Imports (cif) Exports (fob) 1000 % of 1000 % of EUR total EUR total 01-99 Total 7.482.8 100, 11.413.1 100, 54 0 41 0 of which: 01-24 Agricultural products 790.635 10,6 546.557 4,8 of which: 06 LIVE TREES AND OTHER PLANTS; BULBS, ROOTS 143.735 1,9 5.659 0,0 AND THE LIKE; CUT FLOWERS AND ORNAMENTAL FOLIAGE 07 EDIBLE VEGETABLES AND CERTAIN ROOTS AND 150.604 2,0 18.404 0,2 TUBERS 08 EDIBLE FRUIT AND NUTS; PEEL OF CITRUS FRUITS 189.665 2,5 3.442 0,0 OR MELONS 17 SUGARS AND SUGAR CONFECTIONERY 43.298 0,6 112.580 1,0

28-38 Chemical or allied industries 1.248.6 16,7 1.397.72 12,2 61 3 of which: 28 INORGANIC CHEMICALS; ORGANIC OR INORGANIC 155.620 2,1 36.276 0,3 COMPOUNDS OF PRECIOUS METALS, OF RARE- EARTH METALS, OF RADIOACTIVE ELEMENTS OR OF ISOTOPES 29 ORGANIC CHEMICALS 351.262 4,7 384.403 3,4 30 PHARMACEUTICAL PRODUCTS 379.147 5,1 357.175 3,1 31 FERTILISERS 137.551 1,8 9.648 0,1 32 TANNING OR DYEING EXTRACTS; TANNINS AND 22.463 0,3 109.678 1,0 THEIR DERIVATIVES; DYES, PIGMENTS AND OTHER COLOURING MATTER; PAINTS AND VARNISHES; PUTTY AND OTHER MASTICS; INKS 33 ESSENTIAL OILS AND RESINOIDS; PERFUMERY, 39.416 0,5 171.568 1,5 COSMETIC OR TOILET PREPARATIONS

39-40 Plastics/rubber and articles thereof 580.540 7,8 529.101 4,6 of which: 39 PLASTICS AND ARTICLES THEREOF 525.614 7,0 479.954 4,2

50-63 Textiles and textile articles 327.308 4,4 293.843 2,6

PE 351.340 19 EPADES\DELE\ISRAEL\NT\555430EN.doc 71-83 Base metals and articles of base metals 1.716.1 22,9 3.283.49 28,8 19 4 of which: 71 NATURAL OR CULTURED PEARLS, PRECIOUS OR 1.352.9 18,1 2.767.03 24,2 SEMI-PRECIOUS STONES, PRECIOUS METALS, 89 0 METALS CLAD WITH PRECIOUS METAL, AND ARTICLES THEREOF; IMITATION JEWELLERY; COIN

84-85 Nuclear reactors etc 1.560.8 20,9 2.747.21 24,1 94 9 of which: 84 NUCLEAR REACTORS, BOILERS, MACHINERY AND 745.604 10,0 1.678.60 14,7 MECHANICAL APPLIANCES; PARTS THEREOF 2 85 ELECTRICAL MACHINERY AND EQUIPMENT AND 815.291 10,9 1.068.61 9,4 PARTS THEREOF; SOUND RECORDERS AND 7 REPRODUCERS, TELEVISION IMAGE AND SOUND RECORDERS AND REPRODUCERS, AND PARTS AND ACCESSORIES OF SUCH ARTICLES

86-89 Vehicles, aircrafts, vessels etc. 97.724 1,3 815.871 7,1 of which: 87 VEHICLES OTHER THAN RAILWAY OR TRAMWAY 32.073 0,4 673.224 5,9 ROLLING-STOCK, AND PARTS AND ACCESSORIES THEREOF

90-92 Optical, photographic, cimematographic instruments etc. 458.268 6,1 531.098 4,7 of which: 90 OPTICAL, PHOTOGRAPHIC, CINEMATOGRAPHIC, 455.500 6,1 517.978 4,5 MEASURING, CHECKING, PRECISION, MEDICAL OR SURGICAL INSTRUMENTS AND APPARATUS; PARTS AND ACCESSORIES THEREOF

Various ch. 555.872 7,4 979.568 8,6 Source: COMEXT database, EUROSTAT Production: JDa/DG4/European Parliament

PE 351.340 EPADES\DELE\ISRAEL\NT\555430EN.doc 20 Table 2 Trade of the EU(15) with Israel by Member States

EU-imports (cif)

2003 January-October: 1000 € - % - 2003 2004 Total 7.482.854 100,0 6.252.000 6.764.869 of which: France 647.804 8,7 530.513 557.499 Netherlands 1.023.786 13,7 857.598 838.128 Germany 1.052.800 14,1 879.058 886.386 Italy 806.746 10,8 680.490 761.051 United Kingdom 1.185.468 15,8 1.007.604 1.049.449 Ireland 76.774 1,0 64.958 91.012 Denmark 61.119 0,8 52.449 50.123 Greece 186.629 2,5 156.376 148.911 Portugal 42.240 0,6 35.670 53.867 Spain 510.579 6,8 433.425 435.338 Belgium 1.688.948 22,6 1.388.135 1.703.872 Luxembourg 3.497 0,0 3.003 5.211 73.293 1,0 62.078 66.342 59.592 0,8 49.231 60.853 Austria 63.579 0,8 51.411 56.829

EU-exports (fob)

Total 11.413.141 100,0 9.492.993 10.283.609 of which: France 1.026.118 9,0 856.334 823.802 Netherlands 967.317 8,5 794.532 851.767 Germany 2.351.015 20,6 1.989.425 2.030.805 Italy 1.212.555 10,6 1.009.018 1.088.155 United Kingdom 1.933.805 16,9 1.618.189 1.655.714 Ireland 200.569 1,8 171.009 265.397 Denmark 126.014 1,1 109.305 84.122 Greece 105.393 0,9 86.664 79.727 Portugal 67.180 0,6 53.466 45.008 Spain 561.402 4,9 477.362 418.531 Belgium 2.340.582 20,5 1.894.027 2.474.927 Luxembourg 13.566 0,1 11.539 8.378 Sweden 238.824 2,1 199.418 216.031 Finland 137.839 1,2 113.616 104.823 Austria 130.961 1,1 109.090 136.421 Source: COMEXT database, EUROSTAT Production: JDa/DG4/European Parliament

PE 351.340 EPADES\DELE\ISRAEL\NT\555430EN.doc 21 Table 3

Trade of the EU(15) with Israel: 1995-2003

MIO ECU/€ EU-imports (cif) EU-exports (fob) Balance 1995 4.658 9.661 5.003 1996 5.283 10.414 5.131 1997 6.269 11.505 5.236 1998 6.883 10.854 3.971 1999 7.648 12.866 5.218 2000 9.957 15.846 5.890 2001 9.571 14.464 4.893 2002 8.547 13.455 4.908 2003 7.483 11.413 3.930 Jan-Oct: 2003 6.252 9.493 3.241 Jan-Oct: 2004 6.765 10.284 3.519 Source: COMEXT database, EUROSTAT Production: JDa/DG4/European Parliament

Trade of the EU(15) with Israel: 1995-2003 16.000

14.000

12.000

10.000

8.000

MIO ECU/€ 6.000

4.000

2.000

0 1995 1996 1997 1998 1999 2000 2001 2002 2003 Jan- Jan- Oct: Oct: EU-imports (cif) EU-exports (fob) Balance 2003 2004

Production: JDa/DG4/EP

PE 351.340 EPADES\DELE\ISRAEL\NT\555430EN.doc 22