Israelis love to tell foreigners--and reassure themselves--that their country has grown richer than some West European countries--Spain, for example--and, by some measures, is approaching the level of really wealthy ones, such as the Netherlands and Denmark.

So it was slightly jarring today when the government released figures showing that just over 1 million Israelis--1 in 6--were living below the poverty line in 1998 and that more than a third would have been had it not been for an array of welfare benefits that lifted them just above the bar.

The figures represented only a slight improvement over the previous two years and did not come as a complete shock to economists here. Israel has one of the widest income gaps between rich and poor among developed nations, a discrepancy accentuated by immigration and severe poverty among two groups that tend to have large families and paltry incomes--Arabs and ultra-Orthodox Jews.

Still, the release of the National Insurance Institute's annual report on poverty confronts the country with a reality sharply at odds with the dominant view of itself.

"It goes against the image of what the Jewish state should be like--an ideologically, socially oriented country--that so many people are living in poverty," said Jona Rosenfeld, an expert on poverty and a senior adviser at Jerusalem's JDC-Brookdale Institute--Israel's leading social welfare research organization.

Said Ran Cohen, Israel's minister for labor and industry: "This is social catastrophe; this is a black mark for us all."

The poverty figures were especially acute for Arabs and other non-Jews, who account for perhaps a fifth of Israel's population. Nearly 2 in 5 non-Jewish families live below the poverty line, which is defined as less than half the national median income--about $896 in monthly earnings for a family of four. By contrast, the U.S. poverty level for the same period was defined as an income of $16,530 annually for a family of two adults and two children.

The statistics in the Israeli report are drawn from 1998, and so do not reflect on the policies of Prime Minister Ehud Barak, who took office in mid-1999. Nonetheless, its publication hits the Barak government at an especially sensitive time.

With an end-of-year deadline looming for passage of the 2000 national budget, the government's tight-fisted, anti-inflationary fiscal policy is under fierce attack from a wide variety of political parties and interests demanding more than $250 million in additional funding. The report's disclosure that 1,020,000 people live below the poverty line--44 percent of them children or teenagers--will provide ammunition for those seeking extra funding for pet programs they insist will help the indigent.

The problem for Barak is not only allocating scarce resources. He also may find that his government's top priority, making peace with Israel's Arab neighbors, is threatened by the relatively high rate of poverty.

Barak has pledged that any peace deal he reaches with either Syria or the Palestinians will be submitted to the Israeli electorate in an unprecedented national referendum. On the Syrian track, public opinion is almost evenly divided. As things stand now, just under half of Israelis polled say they are willing to trade away the Golan Heights, the strategic plateau captured by Israel from Syria in 1967, in return for peace with Syria.

In the view of many analysts, Barak may be vulnerable if he is forced to fight for passage of a peace deal in a referendum while defending himself from partisan attacks on his economic policies. With an unemployment rate exceeding 9 percent, Barak--who promised in his election campaign to create 300,000 jobs--may be in a weak political position.

"It is not easy when so many people are under the poverty line" to win a referendum, said Mossi Raz, director general of the Israeli group Peace Now.

Barak acknowledged the grim poverty statistics--which he noted had done much to bring about the defeat of his predecessor, Binyamin Netanyahu--and said the trend would take time to reverse. He added that peace deals with the Arabs are precisely what is needed to lift the country's economy and aid the neediest Israelis.

"The peace arrangements will bring about a new reality," he told his allies in the Knesset, Israel's parliament. "They'll bring new investment, and inside six to eight months every citizen in Israel will feel the difference."

Many economists also embrace that view, contending that Israel's economy is poised to take off if peace accords can be reached with the Arabs. That would boost investor confidence and permit the country to redirect resources from defense to civilian areas.

In the meantime, though, Israelis are trying to digest figures that many of them find shocking. Nationwide, the richest 10 percent of Israelis earn about 28 percent of national income while the poorest 10 percent take in just 2.4 percent.

Not coincidentally, the two poorest cities are also those with the largest concentrations of ultra-Orthodox Jews, Jerusalem and Bnai Brak. Although they have very large families, ultra-Orthodox Jewish men often do not work, preferring to study the Torah in seminaries.