Budget Deficit Swelling as Israel Goes Into Election 2.0

Problem won’t be addressed until well into next year, but treasury officials are confident next government will act

Israeli Prime Minister Benjamin Netanyahu arrives to the weekly cabinet meeting in Jerusalem, Sunday, June 2, 2019.
RONEN ZVULUN,AP

Back-to-back elections in 2019 means nearly a year of neglect of Israel’s budget and economic policy by the country’s elected officials. The result is a ballooning fiscal deficit that won’t be addressed until 2020, analysts and treasury officials say.

Economic policy-making screeched to a halt in the final weeks of 2018 after the Knesset voted December 26 to dissolve itself for the April 9 election. The new Knesset was sworn in shortly afterward, but did little work during the period of failed attempts to form a new government.

Now the process is repeating itself with the September 17 election, followed by what will be another round of coalition talks and a new government by November.

About the only good news coming from the two elections is that the previous government’s coalition agreement, which saddled the government with added expenditures, has expired and a new one won’t go into effect until close to the end of the year.

Treasury officials said the savings from the absence of any agreement for most of 2019 will offset the added expenses of about 500 million shekels ($138 million) to cover the cost of the second round of voting and subsidize party election campaigning.

But the good news ends there, as far as the budget is concerned. As the politicians were campaigning this year, the government’s budget deficit swelled to 3.8% of gross domestic product in the 12 months through April, far above the 2.9% target for 2019.

While coalition talks were underway, the treasury budget division had been at work on a 2020 draft budget, which included spending cuts and tax hikes to cope with the growing deficit. Officials had expected the budget to go to the new cabinet during the summer and pass the last of three Knesset votes by the end of the year.

Officials told Reuters that they now expect the 2020 budget to be presented to the new cabinet in December, with a final vote slated for March 2020 – the latest possible date under the law.

In the meantime, the government will be operating with a big-deficit budget not only this year but into 2020 because last year’s budget remains in force on a month-to-month basis until a new one is passed in the current year.

“The summer traditionally is the time for budget negotiations, but this will not happen,” said Henry Rome, a global macro analyst at the Eurasia Group. “The current budget, with its widening deficit, will remain in place through at least the start of 2020.”

Leader Capital Markets Chief Economist Jonathan Katz believes the government will need to make budget adjustments of 12 billion to 15 billion shekels, mainly by raising taxes. “I don’t see it before January,” he said, projecting a deficit of 4% of GDP this year.

Postponing spending cuts and tax increases could boost GDP in 2019, but growth will suffer in 2020 as a result. Katz is now forecasting 3% growth next year but said he will probably cut his estimate to 2.8- 2.9%.

“Even before, I wasn’t expecting an [interest] rate hike this year but this strengthens that conviction ... unless for some reason the shekel begins to weaken significantly on the back of political uncertainty,” Katz said.

Other observers are more concerned. Last week, the International Monetary Fund called on Israel to reduce the 2020 deficit to 2.5% of GDP by cutting tax benefits and other measures.

“Leaving debt on a rising path will constrain Israel’s ability to use fiscal policy to cushion shocks to the economy,” it said in a report.

However, action on Israel’s rating is unlikely for now. Karen Vartapetov, a sovereign ratings director at Standard & Poor’s, said he expected deficits exceeding their targets in 2019 and 2020.

“A lot will depend on the composition of the coalition and the agreements they make,” he told Reuters. “But I don’t think this will blow up the fiscal story massively, even if they loosen fiscal expenditures.”

Treasury officials are optimistic that the next government, whatever its composition, will be able to get a grip on the deficit, if only because new governments tend to be more courageous on fiscal policy knowing the next election is far down the road.

“What is likely to happen now is that they will sacrifice 2019 for 2020,” IBI chief economist Rafi Gozlan told TheMarker.

If last year the Finance Ministry tried to defer 2018 spending to 2019, in an attempt to meet the deficit target for 2018, ahead of the elections, by the end of this year the treasury will try as much as possible to bring forward expenditures from 2020, so that it will be easier to balance the next budget.

“Despite the political mess, the economic environment is good now, with a growth rate of 3% or even more, said Gozlan. That relatively high rate of GDP growth hasn’t boosted tax revenues this year, but he said he expected it would as the year progressed.

Gozlan said that Israel’s strong financial position explains why the stock and bond markets didn’t react negatively the day after the Knesset vote.

“The debt-to-GDP ratio has declined in recent years, Israel enjoys a surplus in its current account and foreign exchange reserves are large.” Under the circumstances, he said, the economy can “manage” even for a year despite the government paralysis.

With reporting from Reuters