Analysis

If We Get the Financial Crisis We’ve Been Waiting For, Israel Isn’t Ready

If the country suddenly finds itself in a fix and tax revenues plummet, it will be much less prepared than it was in 2008

Finance Minister Moshe Kahlon and Prime Minister Benjamin Netanyahu, 2012.
REUTERS

The warning lights have been going off at the Finance Ministry, and it’s not due to the sharply falling share prices around the world. The treasury is worried about the budget deficit – instead of the 2.9% target, Israel is on track to finish 2018 at 3% or even 3.2%. This would be the first time since 2012 that the country overshoots the target. And there’s no comparing it to last year’s – 1.9% of gross domestic fproduct.

On Thursday evening, the Finance Ministry and the Tax Authority announced that the deficit for the preceding 12 months had shot up to 3.35% of GDP as of September, the highest figure since 2013. Tax receipts, which had climbed at a steady 6% between 2013 and 2017, stopped growing at the beginning of the year, and Israel is likely to finish the year with 2.3 billion shekels ($633 million) less than forecast, which works out to 1% of the forecast total.

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Meanwhile, government spending was 7% higher between January and September than during the same period in 2017, instead of the 4% that had been budgeted. The defense budget increased 5.6%, instead of a 0.4% cut as had been planned.

This unhappy surprise is worrying for two main reasons. First, it signals the end of the era of happy surprises that the politicians were getting used to. For the past four years the deficit came in under the target despite constantly growing government spending.

In previous years, this was because tax revenues were higher than expected. Not this year: Revenues are on track to hit the forecast, if not 2 billion to 3 billion shekels less. There won’t be a Mobileye sale to save our budget, so the politicians can’t go on being as generous as they were at the beginning of the year.

This is particularly worrying given that an election is approaching. The combination of politicians opting for excessive spending right before a vote, alongside slowing tax revenues, could be dangerous. Politicians, particularly Finance Minister Moshe Kahlon and Prime Minister Benjamin Netanyahu, tend to pay little attention to the deficit.

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The second reason is obviously the growing instability in the international financial system. The sharp declines in share prices over the past two weeks are causing concern among decision-makers, particularly due to fears that this is the moment everyone has been waiting for a decade now – that central banks will be ending the era of interest rates hovering around zero, and that the cheap money that flooded economies following the 2008 financial crisis will be disappearing.

If we’re indeed at the start of this painful shift, we’ll soon see that the Bank of Israel too will have to start raising interest rates. Then we can also expect the markets to reel – even if this isn’t a crisis on par with the 2008 crash.

Given that a downturn is expected, we could also expect that countries around the world, including Israel, would be well prepared. But that’s not the case. Most countries face the prospect of a crash foretold while they’re overburdened by debt, both national and private, a factor very likely to make any crisis worse. Israel may have the lowest national debt level in its history – 60% of GDP – but the increasing deficit means things could take a bad turn.

Looking back, Israel weathered the 2008 financial crisis rather well due to the relative strength of our banking system – something that’s still true. Also, our decision-makers avoided dramatic interventions that would weigh the country down with debt. But the main factor was Israel’s low deficit and debt. The country entered the crisis with a budget surplus – a rare advantage that let the government weather a fall in tax revenues while the deficit expanded to between 4% and 5%.

We no longer have such an advantage. Given that our deficit is already 3% or higher, we only have wiggle room of between 1% and 2% if tax revenues plummet, not the 4% to 5% we had a decade ago. We wasted most of the firepower that could have served us during a crisis.

And this came at a time when tax revenues kept overshooting forecasts; we could have easily maintained a reasonable budget. There was no reason for a 3% deficit while the economy was in good shape. The politicians weren’t concerned by a 3% deficit because we have yet to pay a price for it. But if we suddenly find ourselves in an economic crisis and tax revenues plummet, Israel will be much less prepared to withstand the crisis than it was in 2008.

This failure stems from irresponsible economic management that only takes into account short-term considerations. This is largely the fruit of our economic success of the past 15 years, particularly following the 2008 crisis. We fell in love with our success story, and we thought we could allow ourselves everything. During the next crisis we’ll learn – the hard way – what our real economic limits are.

The disappointing part is that this policy failure has been foretold, yet our politicians still couldn’t avoid it. The lack of an institution to warn of the implications of such a policy, and take preventive measures, is apparently a factor. This role is supposed to be filled by a committee for financial stability, a joint panel of the Bank of Israel and the Finance Ministry.

Stanley Fischer, the Bank of Israel’s governor during the 2008 crisis, said that launching such a panel should be one of the most important lessons of the crisis. Yet it has been delayed all these years due to power struggles between the ministry and the central bank, and now the Knesset Finance Committee. The committee’s head, Moshe Gafni, demands that the committee give full reports of its meetings, which the ministry and Bank of Israel oppose. Full transparency, in this case, could harm disaster preparedness.

In any event, this unnecessary fight could cost us dearly because we still don’t have an entity for preparing for and handling economic crises. And that’s yet another failure by our politicians.

Avi Waksman contributed to this article.