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The Finance Ministry finally admitted the obvious and said Israel is facing an economic slowdown. Treasury Director General Yarom Ariav told TheMarker in an exclusive interview that a reasonable forecast for Israeli economic growth in 2008 is 3.5%. This is 15% lower than the treasury's previous estimate of 4.2%, which was used as the basis for the 2008 state budget.

Nevertheless, Ariav emphasized that Israel's economic situation is still much better than that of all other Western countries, and this is only a slowdown - and not a recession.

"There is no doubt that recent events will have an effect on Israel's economy, both because of the drop in the exchange rate, and also because of the shrinking export markets," he explained. "In addition, there will be a negative effect on the economy because of the shrinkage of the public's asset portfolio as a result of the losses on the stock market, and the effect on the perception of wealth," said Ariav.

Ariav said his 3.5% estimate for growth is his own personal forecast, and not an official treasury figure. The ministry will not publish a new official forecast in the near future, since it creates these forecasts only for building the budget and estimating tax revenues, he said. So far this year, tax revenues are not below forecasts, said Ariav.

"Growth of only 3.5% does not need to affect government spending. The growth rate can only influence the budget deficit, but for now I do not see a negative influence on the deficit - and not on tax revenues either," said Ariav.

Even if it turns out that tax revenues fall, the treasury does not plan at this stage to cut the budget, above and beyond the across-the-board NIS 1.5 billion cut already planned. "The solution is not a cut now, since the Israeli economy is continuing according to its basic script, even if at lower rates than what we have become used to over the past four years," explained Ariav.

As to the credit crunch in Israel, after Bank Hapoalim's announcement last week that its subprime losses have reached half a billion dollars, Ariav said the Israeli financial system is stable. Apart from exports, the other major growth engines of the Israeli economy (private consumption, growth in disposable income and the drop in unemployment) are all positive trends and are continuing as in the past, he said.

Nevertheless, Ariav did not hide his worries about the losses on the stock exchange, Hapoalim's big losses and, in particular, the sharp fall of the dollar.

Ariav met with Stanley Fischer on the matter last week, and clearly hinted that interest rates should continue to drop. However, he refused to comment on the expected reduction in interest rates.

He also repeated the treasury's objection to intervening in foreign currency markets, since such intervention is doomed to failure, he said. The Bank of Israel is unable to hold its own against foreign currency speculators, said Ariav.

"It is impossible for a small country like ours to intervene in trading, since it is very easy to make a killing off of us," he said.

However, the interview was held just minutes before the central bank intervened in the dollar market last Thursday, which reinforces the opinion that senior treasury officials did not know of Fischer's moves in advance.

Nevertheless, Ariav had a surprise of his own. Despite his objections to intervening in foreign currency markets, he did say fiscal intervention was possible. He did not rule out an economic stimulus package, as in the U.S. For example, infrastructure investments, in cooperation with the private sector are a possible stimulus, he said. In addition, planned tax reductions and effects of the economic slowdown would also stimulate the economy, said Ariav.