Israel's Central Bank: Without Tax Hikes, Spending Cuts, Deficit May Hit 4.9%

Bank of Israel: 'Meeting fiscal targets in the 2013 budget will be a difficult challenge for the government.'

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Israel faces a whopping deficit equal to 4.9% of gross domestic product this year unless it cuts spending and increases taxes, the Bank of Israel warned in a bleak report on the government's finances on Wednesday.

"Meeting fiscal targets in the 2013 budget will be a difficult challenge for the government," the central bank said. "The difficulty has been created by the major, multiyear [spending] commitments the government adopted together with the low level of tax receipts. It will require significant effort and ... policy decisions to meet the targets."

The report comes amid a period of fiscal uncertainty. Prime Minister Benjamin Netanyahu's government never passed a 2013 budget, opting to go into an election and delay painful budget decisions until a new government is formed. That hasn't happened yet, leaving the budget operating on automatic pilot based on the 2012 spending package.

The treasury has been preparing a proposal to bring to the next government, but it lacks policy guidelines until the government is formed - and the budget division has been in turmoil over internal disputes.

The central bank said that to reach the targeted deficit level of 3% set by the cabinet last summer, the government will have to raise taxes or rescind exemptions by NIS 6 billion this year on top of slashed expenses.

And the fiscal crunch doesn't end this year, the central bank noted. For 2014 and 2015 there are wide gaps between projected income and spending commitments and the legally mandated ceiling on how much the budget can grow. That means the government will have to make further spending cuts and tax hikes in the next two years as well, the Bank of Israel said.

The bank examined how the treasury so badly miscalled the 2012 budget, which ended up with a deficit of 4.2% of GDP, more than twice the original target. Its economists say the main problem was that tax receipts came in well under the treasury's forecast - about NIS 14 billion less - because of "overly optimistic" expectations about growth in wages and new home sales.

For 2013, according to the central bank's forecast, spending will be 9% higher than last year because of extra allocations approved by the government. That amounts to NIS 13 billion more than the maximum spending growth allowed under rules established in 2010.

Even if the government takes steps to close that NIS 13 billon gap and align spending growth with the ceiling, it will still be saddled with a budget deficit of 3.6% of GDP, assuming that the economy grows 3.8% as the central bank is forecasting. That would be 0.6 percentage point more than the cabinet approved last summer.

The Bank of Israel also warned about the impact of wider deficits on Israel's debt-to-GDP ratio, a barometer of Israel's fiscal situation watched carefully by financial markets. If the government keeps to its spending and deficit targets, the debt-to-GDP ratio will fall to 60% in 2020. But the ratio could reach 100% if the government doesn't act to counter its spending commitments.

"Without a significant adjustment in the state budget, both in reducing the spending commitment undertaken by the government and in increasing tax receipts, the ratio of debt to GDP is unlikely to fall in the coming years unless the rate of economic growth is much higher - more than 5% on average annually," the central bank warned.

Stanley Fischer, former governor of the Bank of IsraelCredit: Tomer Appelbaum