On the eve of another cabinet discussion on the 2004 state budget, Bank of Israel governor David Klein expressed support for the treasury's attempt to take a deeper cut out of the defense budget. Klein, who is currently attending the International Monetary Fund conference in Dubai, said in an interview with Haaretz, "The Finance Ministry is right. The defense budget should have been cut by NIS 3 billion, not just NIS 1 billion."

The result, he added, is that spending on social programs has been cut too severely. "It's a lopsided result," he said.

Why is it wrong to lower the welfare allowances, since some of them provide a disincentive to work?

"The problem is that the allowances were lowered without distinguishing between those who are of working age and those who are not. To reduce the allowances of everyone by such and such percentage is something that really hurts the weak. If the reduction could have been done on a selective basis, it would have been more fair. The allowances should only be reduced for those who are above a certain threshold, for example those who have additional income above the minimum wage. In addition, there are the criteria of age and ability to work. Someone who receives an allowance because he doesn't work, though he is able to work, should rightly have his allowance reduced more than someone who cannot work for legitimate reasons. This system of distinctions has not been implemented despite the fact that we have been saying it should be instituted for very many years."

That is, establish a unified-personal system of data?

"A unified database should be established that includes data about income tax, social security (bituah leumi), automobile ownership, employment. In addition, it would good to have the entire public file personal income statements, on the condition that this be kept simple. If, for example, someone has only one source of income, from wages, he should be able to sign a simple form once a year, and not have to fill in long and complicated forms."

It's easy to demand a reduction in the defense budget, but we're in a period that is not easy - intifada, terror and threats from Iran.

"The defense budget was not formulated as a function of the war on terror - this is only one of its components. There are two other big components: One is the threat from the east, and this threat has decreased considerably following the war in Iraq. The second component is the terms of service for career army personnel. Here a distinction should have been made long ago between combat and support functions. When you make this distinction, it is possible to reduce defense expenditures."

What is your view about the decision to award the Coca Cola plant a grant of NIS 70 million so it can move from Bnei Brak to Ashkelon?

"Dealing with the issue of grants should not have started with a particular factory. It should have started with question of what are the correct criteria for receiving government assistance, and what is the best way to award them. I think that grants are not the best way. It is preferable to offer tax breaks - this is more efficient, because then the investments are profitable ones."

What about the gap between the price of water for farmers (NIS 1 per cubic meter) and the price of water for industry and home use (NIS 2 per cubic meter), and the decision to raise the cost of water only for industry and home use, thus enlarging this gap?

"There is a government decision from 2002 to encourage agriculture via land not water, and this is a correct decision. We know that if you reduce the price of water to farmers, you're encouraging unprofitable crops and this is not the optimal use of public funds. We need to aim to make the price of water equal to the price of its production. This should be done in a multi-year process in order to give the farmers time to prepare. The price of water should be the same for all users - industry, homes and farming."

And what about the foreign workers in agriculture? The government decided not to reduce their number, unlike the reduction in industry and construction.

"The number of foreign workers in agriculture should also be gradually reduced. You need to give the farmers time to prepare, but they have to realize that this decision is final."

What is your opinion about not shutting down the Religious Affairs Ministry, not dismantling the religious councils and not reducing the number of local authorities?

"All these decision pertain to making the public sector more efficient, and they are certainly appropriate and should be implemented. We have a public sector that is too big and this is also reflected in the proliferation of local authorities and inefficient distribution of religious services. The government's part of the gross domestic product cannot be reduced without implementing these measures."

Do you agree to raise the deficit to 4 percent?

"I'd accept the 4 percent if I was sure that this year would really end at 4 percent, but I'm not at all certain of this. Previous governments have said, `This year we won't be able to reduce the deficit, but we'll close it next year.' And this doesn't work. Every year it's the same story. The problem also exists this year. We know what happened to the deficit this year [it will reach 6 percent instead of 3 percent, N.S.]. But they tell us that next year will be better, and then, in the following years, it will be like paradise. But how do we know that the deficit in 2004 will be 4 percent? They inflated the growth projection and as a result inflated the revenues projection a bit. So it's not likely that the deficit of 4 percent will hold. In any case, 4 percent is high - that increases the ratio between debt and GDP."

On the issue of interest, will you continue to lower the interest rate tomorrow?

"Yes. There is no reason for us now to stop the process of reducing interest."

So can we assume that tomorrow you'll lower interest by 0.5 percent again?

"You'll only know the answer to that tomorrow."

`Third banking group needed'

"A third banking group should be formed to compete with the two large banks. The group should be based on Israel Discount Bank and include the First International Bank of Israel, or Union Bank, or Jerusalem Bank - or all of them," Bank of Israel governor David Klein told Haaretz.

The governor's condition for this is to increase Discount's capital, which now stands at the minimum required. This additional capital must come from the market - from the sale of shares or bank assets - without any government involvement.

One of the central problems in the Israeli banking system is the lack of competition for individual (non-corporate) customers. "In the household banking sector, the margins are too high and the fees are crazy. Therefore, there is a need for a third retail bank."