Analysis / Abnormal interest, abnormal economy
Why is this interest rate cut different from all other interest rate cuts? In previous rate cuts, when the governor of the Bank of Israel would cut the rate by only 0.2 percent, the finance minister would publicly reprimand him.
Why is this interest rate cut different from all other interest rate cuts? In previous rate cuts, when the governor of the Bank of Israel would cut the rate by only 0.2 percent, the finance minister would publicly reprimand him, treasury officials would whisper harsh words about him and the entire business sector would throw stones at him.
This time, everyone is silent - the finance minister, the treasury officials, even the criticism coming from the business sector is muted. Because everyone learned the lesson of December 2001, when David Klein gave into pressure and lowered the rate by 2 percent. Everyone remembers the dollar crisis of June 2002. Everyone ran to the dollar, which nearly crossed the NIS 5 mark, inflation intensified, interest rates skyrocketed and the economy barely escaped a financial crisis.
Now, after that costly lesson, everyone - particularly the finance minister - understands the importance of stability, so they are letting the symbolic rate cut pass without a ruckus. It's symbolic, especially in light of the enormous gap between U.S. rates and ours - 7.65 percent - and against the background of lowered expectations for inflation.
If this was a normal, stable economy, the monetary circumstances would have led to the governor to make a much deeper cut. Expectations for inflation are under 3 percent a year, private assessments and Bank of Israel models yield inflation rates of less than 3 percent as well, especially after the relative stability in inflation in the second half of 2002. A sharper rate cut would have been understandable. Clearly, the high rates dampen business sector activity and the public pays very high rates on its overdrafts.
But we are not a normal country and our economy is not as stable as a Western European economy. Clearly, the budget that pased last week is not the last budget for 2003. Immediately after the new government is formed, the finance minister will have to introduce new cutbacks, so the deficit for 2003 is still not certain.
According to the forecast for 2003, tax revenues are supposed to grow in the coming year, But that's a baseless assumption. The recession is only deepening, and dismissals and bankruptcies continue, so tax revenues will decline.
Expenditures are also not final. The Knesset voted for a defense budget last week, but the budget doesn't really exist. The prime minister imposed an NIS 3 billion cut in the defense budget and then immediately promised the defense establishment another NIS 5 billion, which, he said, would come from a special American grant. But who can guarantee the grant will be approved by Congress, or that it will even be approved in 2003.
Nor did the Knesset finish legislation on a series of bills that leave a hole in the budget. The cut in the Capital Investment Law wasn't passed, canceling benefits to plants in the center of the country - a NIS 500 million saving. The NIS 130 million change in the Caregiver's Bill wasn't made, nor was the change in the law denying extra pay for civil servants with academic degrees from institutions unapproved by the Higher Education Council. There's also no reserve in case of a war in Iraq, and what western economy needs to fortify itself against a missile attack from the East?
Therefore, Klein is afraid that if the deficit next year is bigger than planned, meaning over 3 percent, long-term interest rates will go up, the public will run back to the dollar, a devaluation will become necessary, prices will go up, and we'll be back in a financial crisis. Then he'd be forced to raise rates - if he were to cut the rate deeper right now. So, to avoid all that, and to make sure it doesn't happen, he's still not significantly lowering rates. For now, he's thrown us a 0.2 percent bone and he'll wait to see how the public - actually the government - chews on it.