Growth slowed from a 4.6% spurt in 2011, mainly due to recessions in Europe, Israel's largest trading partner, weak growth in the United States and slower growth in Asia.
Consumer spending and investments also grew more slowly in 2012 than a year ago, although public spending rose.
But while it lagged emerging economies such as China, which grew 7.5%, Israel strongly outpaced the 1.4% average growth rate for Western nations.
"Given the international situation, the Israeli economy is doing very well," Shlomo Yitzhaki, the government's statistician, told a news conference on Monday. He referred to the figures as "the best considering the current situation… Whether it's because of the government or despite the government, I can't say."
The Bank of Israel predicts even weaker growth in 2013. Last week, it lowered short-term interest rates for the second time in three months, taking the key rate to 1.75%, and also lowered its 2013 growth projection to 2.8% from 3%, excluding natural gas output.
Israel's growth was in line with central bank and Finance Ministry estimates but the weakest since 1.1% in 2009, falling short of the bureau's initial estimate of 3.5%.
Europe's troubles held back Israeli exports - more than 40% of economic activity – which grew 1% this year, largely due to a 22.1% drop in diamond exports, versus a 5.5% gain in 2011. Some 35% of exports go to recession-hit Europe.
Excluding diamonds, exports grew 4.2% this year.
Private spending growth slowed to 2.8%, while investment in fixed assets grew 3.7%, down from 16% in 2011. Government spending rose by 3.7%, faster than 2.9% last year.
For the third quarter, the economy grew an annualized 2.8%, below a previous estimate of 2.9% and the slowest pace since the second quarter of 2009.
Exports in the quarter slipped 5.6%, while imports slid 11.9%. Private spending edged up 0.5% and investment in fixed assets dipped 6% despite a rise in residential building investment.
Avital Lahav contributed to this report