The Bank of Israel is worried about the global financial crisis and its effect on the Israeli economy while its governor expressed confidence in the Israeli banking system. Therefore, Stanley Fischer is considering reducing the central bank's key lending rate.
Fischer and his senior staff are evidently worried that a global economic slowdown, combined with a strong shekel, could together bring about a slowdown in the Israeli economy. However, such an occurrence would also probably bring down inflation, giving the central bank more room to maneuver.
The Bank of Israel is now forecasting economic growth of slightly less than 3% in 2009. That is still quite respectable, but less than originally estimated, and central bank officials believe this reduction, along with the global slowdown, will be enough to lower inflation in 2009. That in turn would allow Fischer to lower interest rates now.
However, the central bank's interest rate policy will be heavily influenced by what happens with the 2009 state budget. Calls by politicians to expand the budget ceiling and increase spending may tie Fischer's hands when it comes to rates - though neither the Bank of Israel nor the Finance Ministry object to a small increase in spending, such as raising the 1.7% increase already agreed upon for next year to about 2%.
The deficit is expected to increase in any case, as tax revenues will decline due to the economic slowdown. The prevailing estimate is that tax revenues will be NIS 3-6 billion lower than initially forecast, though some senior officials are even more pessimistic and talk about a NIS 9 billion drop. This, of course, would increase the deficit, meaning that the government's share of the economic pie in 2009 would grow.
Both the Bank of Israel and the treasury view this rise in the budget deficit as necessary: It is part of what is known as an automatic stabilizer mechanism, a natural occurrence in times of financial crisis. Thus they do not intend to ask for further budget cuts to counteract it.
However, speaking in an interview with Israel Radio yesterday, Fischer warned against reopening the budget framework already approved by the cabinet, saying this would be irresponsible. He was apparently referring to the demands made by Labor and Shas in the current coalition negotiations. Labor, for instance, is demanding that spending be increased by 2.5% next year.
Fischer also said the Israeli banking system is strong, and no Israeli bank is likely to fail. The Bank of Israel is keeping careful track of the condition of Israel's major borrowers, he added, but sees no cause for worry. One of the major questions still to be debated in light of the financial crisis is the structure of Israeli financial regulation, currently divided between the Bank of Israel, the Securities Authority and the treasury's commissioner of capital markets.
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