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Prime Minister Ehud Olmert said Tuesday that he would summon a special meeting with top financial officials immediately upon his return from Washington to discuss the government's plan to stimulate the ailing economy.

Olmert promised that a decision on the matter would be yielded by the end of the meeting, set for Wednesday.

"Economic decisions are made in the Prime Minister's office and by the Prime Minister," Olmert told U.S reporters, adding that he has an alternative plan of his own to solve the current crisis.

The awaited decision will be brought for the government's approval.

The finance ministry on Tuesday announced its intention to inject NIS 11 billion into Israel's economy as part of a bailout plan to combat havoc wrought by the global financial crisis.

The plan is comprised of two main components. The state is to pour money into funds devoted to investment in the corporate bond market, together with institutional investors. In addition, the state guarantees are to be provided to banks, enabling them to raise capital cheaply, which they will use to issue credit.

NIS 5 billion in state funding will be allocated to funds for investment in corporate bonds - NIS 3 immediately, and another NIS 2 in another five months or so. The government will invest, together with institutional investors - pension funds, provident funds and the like - in 5-7 year funds that will invest in the corporate bond market, both through buying of bonds, and providing financing to companies facing repayment of matured bonds (recycling of non-bank debt).

The rate of government to institutional investor participation in the funds has yet to be decided, as has the division of earnings, but Accountant General Shuki Oren said yesterday that he will be pleased with an investment ratio of NIS 1 of state funding for every NIS 3 of funding from institutional investors.

But the government will certainly take on most of the risks involved in the funds: participating institutional investors will be entitled to full repayment plus minimum interest before the state sees more than 10% of its investment.

No limitations will be placed on the choice of corporate bond the funds will invest in, other than that most of the company's activities are to be conducted in Israel. In other words, the funds will not invest in real estate companies that issued corporate bonds in Israel to raise financing for investments in Eastern Europe, for instance.

The funds are to be established and managed by independent entities, likely brokers or some other type of financial specialists. To avoid any conflict of interest, no institutional investor will be allowed to own more than a 15% share in any single fund. The funds investment committees will be operated by a body of members independent of the institutional investors.

The plan for the funds was already submitted for approval of the Knesset Finance Committee Tuesday to enable issue of the first tenders for establishing of the funds by the end of the year, ensuring that the necessary financing will be included in the 2008 budget. This will allow the government to continue uninterrupted investment in the plan during the first quarter of 2009, before next year's budget is approved.

Raising capital more easily

The government will also offer guarantees to banks totaling NIS 6 billion. But while the state will be investing NIS 5 billion in the funds, the guarantees will cost nothing, at least initially.

The government undertakes only to assure repayment of debt raised by the banks through the capital market - bonds that serve as the basis for increasing bank equity. As a result of this move, banks are expected to pay substantially lower interest rates on the bonds. For investors in the capital market, it means that the inherent risk in these bonds is about the same as that of standard government bonds, and banks will have an easier time raising necessary capital.

The government's aim is to make it easier for banks to raise capital, which in turn will be used by the banks for issuing of credit to businesses. To this end, the plan includes an incentive mechanism for issuing of credit: banks will be charged a fee for the guarantee, but entitled to a substantial discount of up to 60% with the increase of their credit portfolio.

The problem with the treasury's plan

There is one fundamental problem with the bank guarantees that the government is offering: the banks may not want them. Banks in Israel are in excellent shape compared to the rest of the world. They are not short on capital, and the sole reason that they are now limiting the issue of credit is that they don't want to do so in a period of economic crisis. And not only it is unclear whether the banks need government guarantees in order to raise capital, there is also a concern that doing so would signal weakness on their part.

Oren confirms that some of the banks have indeed told the treasury that they are not interested in government guarantees to raise capital, and others have said that 'it's not a bad idea'. "Clearly, as a government, I have no way to force banks into issuing credit. I can only make it easier, to create incentives, to try to persuade, and stand ready with tools - when the banks want to raise capital they will be able to, and reduce their costs of doing so. Naturally, if the banks manage to raise capital through the capital market without government assistance, it will be wonderful" Oren added.

Recycling debt

Two additional steps included in the plan are establishment of a mechanism, for assisting bondholders to reach debt recycling agreements with bond issuers. A representative body on behalf of bondholders will appoint credit officers specializing in creating solutions and reaching debt arrangements with corporate bond issuers. The credit officers, who will oversee the process on behalf of all bondholders, will coordinate with the corporate issuers, bond holders and other creditors to expeditiously reach arrangements that are beneficial to bondholders (and subject to their approval).

An additional step is a proposal for tax legislation that aims to encourage the flow of foreign capital into Israel and investment in the capital market. The legislation will reduced tax on dividends earned by foreign companies held by Israeli firms, from the current rate of 25% to just 5%. The legislation will also provide foreign residents tax exemptions on interest earnings on corporate bonds traded on the Tel Aviv Stock Exchange, and a sweeping tax exemption on the sale of shares in Israel by foreign investors.

The plan was consolidated by the treasury, the Bank of Israel and the Israel Securities Authority. The treasury estimates that the plan will supply tens of billions of shekels in credit leverage. The global credit crunch and its effect on the capital market, together with concerns of market failure, make the new plan essential, the treasury said Tuesday. But some of the banks have already rejected the offer of state guarantees in order to raise capital.