Is Israel sliding into a recession?
A mixed bag of economic data suggests a time of transition, with much dependent on financial recovery elsewhere in the world.
Macroeconomic data released in recent weeks show that Israel’s economy grew by just 3.4% on an annualized basis in the period from 2012 to 2013, prompting concerns over whether there’s real danger of the country sliding into a recession. According to the Finance Ministry, however, we are definitively not headed in that direction.
January’s consumer price index was released in mid-February, revealing that overall prices declined by twice the expected amount – to 0.6%. Two days afterward, the growth rate for the last quarter of 2013 was published, showing that the economy grew by just 2.3% on an annualized basis.
The following day, the International Monetary Fund released its report on Israel, in which it projected average annual growth in the next few years of 3.5% – but that includes the boost the economy will receive from natural gas production at the offshore Tamar drilling site.
It also compares poorly to the economy’s 4.5% average annual growth rate over the past 10 years.
On the other hand, there have also been more optimistic indicators recently.
Last Wednesday, the Central Bureau of Statistics reported that the Achilles’ heel of the economy over the past two years – industrial production – showed a handsome growth in the fourth quarter of 2013: an annualized 13%, following a 5.6% growth rate the previous quarter.
And high-tech production for the last quarter of 2013 surged by a whopping 32% following a 14% figure for the previous quarter. And then last Thursday, the Bank of Israel released the encouraging news that the Composite State of the Economy Index rose in January by 0.3%.
All told, it appears that the economy is in a transitional stage. The partial recovery of economies around the world from the financial crisis of the past few years has had a positive effect on the Israeli export sector – one of the major engines of economic growth here.
Lot of volatility
However, the projected annual growth rates of 3% to 3.5% in the coming years are substantially lower than the country’s economic potential, and that’s even without taking the expected major levels of natural gas production into account.
Based on the other data, the coming year is expected to bring less-than-stellar growth with a lot of volatility, dependent in part on world economic developments.
A return to the bright economic picture of the not-too-distant past will require Israel to undergo a real transformation when it comes to productivity, and a broadening of the workforce base through continued higher levels of workplace participation by ultra-Orthodox men and Arab women.
Economic growth through all four quarters of 2013 was relatively modest – between 2% and 2.5%, a senior Finance Ministry official noted – and that’s with the exception of the 4.6% annualized rate in the second quarter (which was influenced by the start of commercial gas production at the Tamar gas field).
For all of 2013, the official noted, per capital growth was just 0.5%, the lowest rate in recent years.
“There were several clear reasons for the low growth, and it’s almost certain that they would not reoccur in 2014,” the official said.
He noted specifically the major drop in global trade and the strong shekel, which hurt Israeli exports, as well as a drop in investment in the first half of the year after companies such as Intel and the Tamar partnership wrapped up a major injection of funds.
The thinking at the ministry, the official said, is that the factors that constituted a drag on the economy last year would abate this year, either in part or completely. An upturn is expected with Israel’s major trading partners – the European Union and the United States – and employment is keeping up with population growth.
And the ministry’s projected growth rate of 3% to 3.5% for 2014 is “not fantastic, but reasonable,” in the official’s words.
“You need to understand that we recorded high growth in the years coming out of the  recession, or from 2010 to 2012, when global trade grew tremendously and when employment grew.”
And, he added, although the ministry doesn’t anticipate Israel being in store for rapid growth this year, a slowdown or actual recession is not on the cards, either.
“The forecast the Finance Ministry released in December for 2014 is correct, and the tax collection figures for January are better than what we projected,” he revealed. “Despite the low [consumer price] index in January, Tax Authority revenues from value-added tax are very good, which shows that there was no decline in demand.”
And when it comes to the 2015 budget, no option is being excluded, including tax cuts. “If it happens, it will be in 2015.”
Not satisfied with 3% growth
Gal Hershkovitz, who headed the ministry’s budget division until last July, is also optimistic about the economy, but warns of potential risks.
“We can’t be satisfied by any means with growth of 2.8% to 3%,” he cautions. “The target needs to be higher to contribute to the ultimate goal, which is growth that narrows [socioeconomic] disparities.
“If there aren’t any surprises, we’ll finish 2014 in keeping with the forecasts – with a deficit of 3% of gross national product,” he adds. “That’s on the condition that the government keeps to its targets of increased growth and the narrowing of socioeconomic gaps.”
Referring to legislation that is expected to limit draft exemptions to ultra-Orthodox yeshiva students and encourage more of them to enter the workplace, Hershkovitz said that when the draft reform is approved, it won’t be possible to grow faster than a rate of 2.8% to 3% without narrowing disparities and inequality in society.
Hershkovitz underlined the importance of boosting growth through increased productivity, which he noted was relatively low here compared to other developed countries.
That, he said, can be accomplished by boosting competition and innovation, and by making the public sector more efficient through reduced bureaucracy and duplication, and more efficient regulation.
Looking at the bigger picture, however, he acknowledged that Israel is, to a large extent, dependent on what happens overseas, particularly in the United States, where the economy is picking up and Europe, where it is stalled.
“It doesn’t look like the world will come out of the crisis nicely and elegantly, as it did in 2008, and the global slowdown will substantially affect exports and the capital market,” says Hershkovitz. “It’s a sensitive situation that requires follow-up month after month. We can’t wait for quarterly statistics, because sometimes developments happen fast.”
And although on the fiscal level the government seems to be on track with projections, Hershkovitz says we must be prepared for surprises – on the political and military front, for example, or due to a real economic downturn abroad.
Hebrew University’s Prof. Michel Strawczynski, who also heads the economics and society program at the Van Leer Institute in Jerusalem, cautioned that the current rate of economic growth was not sufficient to consistently lower unemployment. Also, although the jobless rate had sunk below 6%, in recent months that drop had stalled.
Strengthening of the shekel
One of the main challenges on the macroeconomic policy front, he said, relates to the fact that an interest rate hike in the United States doesn’t seem to be in the offing in the near future. “And this could create conditions for a continued strengthening of the shekel,” says Strawczynski. “In that context, it’s very important that the burden not fall on just on the Bank of Israel, whose ability to influence the exchange rate by buying foreign currency is limited.”
A strong shekel makes Israeli exports less competitive because in foreign currency terms, they become more expensive.
Strawczynski had praise for the program to encourage exports, announced last week by the finance and economy ministries, as a “step in the right direction.” An additional step, he suggested, would be to reduce taxes on exports or encourage imports in certain sectors. The competition from imports, he explained, would lower prices here.
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