Untimely Debt: Interest Costs Loom Ever Larger for Israel

Repaying government debt comes at the expense of defense, education, health and other crucial items, and its share of the budget is due to rise in the coming years.

The third-largest line item in the state budget − after defense and education − is interest payments on the national debt. All this spending on interest does nothing to enhance security, develop infrastructure or narrow socioeconomic gaps, yet it isn’t even on the radar of most cabinet members, Knesset members or the public.

Interest payments will account for NIS 39.5 billion of the NIS 395 billion state budget in 2013 − eating up some 10% of total spending and growing to NIS 41.7 billion of the NIS 406 billion budget for 2014. It will be surpassed only by the NIS 51.3 billion to be spent on defense and the NIS 44.1 billion on education, not counting NIS 9.1 billion for higher education.

This year’s Interest charges are 2.3% greater than last year’s and will mushroom by another 5.8% in 2014, mainly because of the budget deficit but also due to uncertainty prevailing in the financial markets.

Had Israel’s debt load been half what it is, it would be left with NIS 20 billion to alleviate crowdedness in classrooms, build new hospitals and upgrade the highway and rail networks. Had interest payments been lower, Prime Minister Benjamin Netanyahu and Finance Minister Yair Lapid wouldn’t have needed to impose such harsh decrees in the 2013 and 2014 budgets.

The problem is that interest payments are only likely to expand over the coming years, rather than shrink. More spent on interest means less for education, health care and infrastructure. These payments will weigh heavy on the 2015 and 2016 budgets, too, as well as the budgets for 2025 and 2026. They always existed and will always continue to exist. After all, Israel doesn’t intend to renege on its debts and as long as it hasn’t paid off all its debts there will be still be interest.

The overwhelming majority of countries have debt and have to deal with the interest problem. In the recent global economic crisis many countries took on heavier debts and, as a result, larger interest payments. Israel also took on a heavier debt burden during the crisis.

But in global terms Israel’s debt load isn’t particularly high, and over the years the country has remained its solid reputation in world markets by meticulously making payments on time.

One of the key macroeconomic indicators for how countries are faring is the ratio of debt to gross domestic product. The lower the ratio, the better a country’s position is considered to be and it will pay lower interest rates on credit granted in international markets. Another way to measure a country’s debt load is by comparing its interest payments to the overall national budget.

In 2012 Israel’s gross domestic product grew to NIS 928.7 billion and at the end of that year its national debt reached NIS 666.8 billion for a debt-to-GDP ratio of 71.8%. This was down from 72.6% in 2011 and 74.7% in 2010.

Since Israel’s GDP has risen faster in recent years than its debt, the ratio has declined despite an increase in borrowing. But viewed from another angle, total national debt at the end of 2012 was 1.7 times larger than the 2013 budget itself.

Over the years Israel’s relatively high debt ratio has kept it from improving its credit rating with international agencies S&P, Moody’s and Fitch. For example, one criterion for joining the Eurozone is reaching a debt to GDP ratio of 60% − termed the Maastricht target. Israel’s newest target is above 61%, and it will reach that only towards the end of the decade.

Israel’s debt figures aren’t encouraging and the public isn’t familiar with them. The 2013 budget includes payments on principal and interest amounting to NIS 135 billion, representing 34% of the overall budget. Of this, NIS 95.4 billion is earmarked for repayment of principal and NIS 39.5 billion for interest.

If the state were to repay all its debts, nothing would be left for defense. In any case, payment of principal isn’t included in calculating the deficit or permitted expenditures according to the Deficit Reduction Law of 1992.

Debt payments in the 2014 budget amount to NIS 139 billion, NIS 96.9 billion for principal and NIS 41.7 billion for interest. But overall government debt has increased very moderately over the past decade and the cost of putting out debt has declined. This has reduced debt-related expenditures as a percentage of the overall budgets for 2013 and 2014 compared to previous years.

Rolling over debt

Most of the repayment of internal debt goes directly to the public as government bonds reach maturity − NIS 74 billion in 2013 and NIS 75 in 2014 − while the repayment of debts overseas should total about NIS 18 billion in each of these years. Overseas payments including the repayment of loans from banks in Israel and abroad, intergovernmental loans, and bonds issued outside of Israel.

To repay the principal on its maturing loans the government recycles its debt by raising money from the public and abroad by issuing new bonds by the billions both in Israel and overseas. The sale of bonds is also meant to cover the budget deficit, which this year will reach 4.65% of GDP and next year is meant to drop to 3% of GDP. So increasing the budget deficit also inflates the debt.

Raising the deficit target might ease the immediate budgetary decrees, but it also means a higher debt load on future generations and higher debt repayments at the expense of other expenditure items.

A bitter quarrel erupted two months ago when Lapid wanted to increase the deficit target for 2013 to around 5% of GDP, to which Netanyahu and outgoing Bank of Israel Governor Stanley Fischer adamantly objected. Ultimately a compromise was reached to raise the target to 4.65%.

The accountant general’s department in the Finance Ministry contains a unit that manages government debt. The unit is responsible for recycling the debt, meaning the repayment of past debts and raising money by issuing new debt, as well as being responsible for interest payments.

Among its duties is keeping interest rates down and spread over a longer period of years. Interest payments declined 7% from 2005 to 2014, making this the largest item in the budget to have shrunk over the years. The decline was due to a relatively low increase in government debt and a drop in interest rates. The state intends to take NIS 113.7 billion in loans in 2013 and NIS 102 billion in 2014.

At the Finance Ministry they say the best way to deal with Israel’s budgetary needs, anticipated to grow in the future, is by freeing up internal budget resources and that the best way to do this is by reducing the public debt, both the principal and interest components. This would allow for greater funding of education, health care, infrastructure, where expenditures are likely to grow in the future, without increasing the tax burden.

They also say that maintaining a declining debt pattern over time will enhance stability and budgetary credibility, allowing the economy greater leeway to deal with future economic crises.  

Olivier Fitoussi