Analysis

Despite Israel's Swelling Deficit, 2019 debt-to-GDP Ratio Looks Set to Fall

The key metric is likely to improve for 2019 due to the growing economy, low inflation and the strong shekel

Avi Waksman
Avi Waksman
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An electronic board displaying market data is seen at the entrance of the Tel Aviv Stock Exchange, in Tel Aviv, Israel January 29, 2017.
An electronic board displaying market data is seen at the entrance of the Tel Aviv Stock Exchange, in Tel Aviv, Israel January 29, 2017. Credit: \ BAZ RATNER/ REUTERS
Avi Waksman
Avi Waksman

Despite a much bigger than expected budget deficit for 2019, the government is expected to be spared the embarrassment of posting a second annual increase in its ratio of debt to gross domestic product.

The ratio, which is regarded by markets as a key metric of a government’s financial health, will be released later this month by the treasury’s accountant general, Rony Hizkiyahu.

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In 2018 the debt-to-GDP ratio rose to 61% from 60.5% the year before. In 2019 the deficit as a percentage of GDP rose sharply, but the debt-to-GDP ratio is expected to fall.

One reason is that GDP grew at a fast pace in nominal terms, so that even while the government’s debt grew the economy grew even more and reduced the ratio.

Preliminary figures show that GDP rose a nominal 5.7% in 2019, the Central Bureau of Statistics reported this week. That takes into account real GDP growth of 3.3% combined with the so-called GDP deflator of 2.4% – double the rate of 2018 and 12 times the 2017 rate. (The GDP deflator measures the price levels of all new domestically produced final goods and services in an economy.)

Meanwhile, the rise in Israel’s consumer price index was very low in 2019. The final figure won’t be released until the middle of this month but it’s expected to come in even below the 0.8% recorded in 2018. Since around half of Israeli government debt is linked to inflation, debt overall rose very little.

Another factor that reined in debt growth was the strong shekel. The dollar depreciated 7.8% against the Israeli currency over 2019 while the euro dropped 9.6% and the nominal exchange rate – based on a basket of currencies that represents Israel’s main trading partners – declined 8.3%.

The decline in the dollar and euro reduced the shekel value of Israel’s foreign debt, which comprises about 14% of the total. In 2018, the shekel had weakened.

At the end of the third quarter of 2019, Israeli government debt stood at 822.3 billion shekels ($238 billion at current exchange rates), up from 788.3 billion at the end of 2018. The 822.3 billion shekels includes interest, which has been very low, accumulated on the debt since the end of 2018, as well as principal.

Despite these favorable developments for Israel’s debt, the warnings by the Bank of Israel and many economists last year about the debt-to-GDP ratio were not entirely baseless. Many indicators showed that the ratio would worsen, not least the widening budget deficit and slower economic growth. In the end they didn’t have a major impact.

When Hizkiyahu spoke in November at the Knesset Finance Committee, the consensus was that the debt ratio would worsen in 2019 by as much as 0.5 percentage point, or in the best scenario would not widen. By December, when he appeared at the Eli Hurvitz Conference – the annual conclave of Israel’s top economic policy makers and businesspeople – Hizkiyahu was more optimistic and predicted no change or even a decline in the ratio.

When more data came in as December progressed, one senior treasury official dared to predict that the ratio would decline a few tenths of a percentage point. However, even the Finance Ministry admits that if the deficit continues to exceed 2.5% of GDP annually in the years ahead, the ratio will starting rising.

Before the debt-to-GDP figure is released later this month the treasury will release fiscal data for all of 2019. Officials expect a deficit of 3.7% of GDP, way over the 2.9% targeted in the budget.

The challenge is to keep to even the 3.7% figure because officials no longer have the unusually low December 2018 deficit to include in their calculations, which operate on a 12-month trailing basis.

In that context, they’ve had some help from an improvement in state revenues in recent months. While revenues haven’t grown as fast as the 2019 budget had assumed, they’ve at least stabilized at the lower level.

Since the deficit is measured relative to GDP, it may in fact end up lower than the initial figure released by the treasury. The statistics bureau’s preliminary estimate put Israeli GDP at a nominal 1.4 trillion shekels in 2019. But in all likelihood that figure will be revised as more figures come in, which means the deficit figure will ease.

For instance, nominal GDP in 2013, as published by the bureau this week, was 0.3%, or 3.3 billion shekels, higher than the preliminary figure that had been released on December 31, 2013. GDP for 2015 was revised 0.9% higher than the level published four years earlier, or about 10 billion shekels.

In any case, the start of the calendar year Wednesday was also the start of the fiscal year. But without a budget, the 2019 spending plan remains in effect to be implemented on a month-by-month basis and adjusted for inflation. That’s what the law requires in the absence of a budget for any given year.

Given that Israel won’t be choosing a new government until March, followed by coalition talks and then budget deliberations, there won’t be a 2020 budget until well into the year. This will create big problems for the government, but regarding the debt-to-GDP ratio it could be a positive development.

That’s because, assuming government revenues don’t fall, spending will be restrained by the treasury’s strict adherence to the 2019 budget. Whether revenues hold up depends in large part on economic growth. The Bank of Israel will publish its revised GDP forecast next week, which should provide a clue.

After the disappointing revenues of 2019, it’s fair to assume that the Finance Ministry’s accountant general will take a more conservative approach when predicting GDP growth for 2020. Officials are well aware that last year’s 3.3% growth, which was higher than originally expected, could be revised down.

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