Israel's Central Bank Grows Bearish on the Economy

In its latest projection, the recovery will take longer due to lingering coronavirus restrictions

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A street in central Jerusalem revives a bit from the coronavirus crisis, May 2020.
A street in central Jerusalem revives a bit from the coronavirus crisis, May 2020.Credit: Emil Salman
Sami Peretz
Sami Peretz

In normal times, the economists at the Bank of Israel and the Finance Ministry are capable of doing battle over the difference of a tenth of a percentage point in their respective economic growth forecasts. It’s grounds for waging war about who's being unduly optimistic and who’s being unnecessarily gloomy.

The coronavirus has made these traditional disputes look like skirmishes being fought over two places to the right of a decimal point. After all, what's 0.01 of a percentage point compared with a few whole points in projections about where the economy is going?

The impact of the coronavirus on Israel’s national accounts is nothing less than an earthquake. It's shaking up all the predictions about future GDP, unemployment, the budget deficit and debt.

The first-quarter figures published Monday by the Central Bureau of Statistics only provide a partial picture of the state of the economy. They don’t include April, when activity was paralyzed to a far greater extent than in March, the final month of the first quarter. Even if lockdown measures were only introduced in the second half of the month, it was enough for gross domestic product to contract at a 7.1% annual rate in the quarter.

Serious? Certainly. Worrying? Of course. Catastrophic? It’s all relative if you take into consideration what happened in countries like France, where the economy shrank 23.3% in the first quarter, or Spain, where it contracted 20.9%.

Israel’s economy entered the first quarter in good condition and exited it in lockdown and paralysis. By contrast, the second quarter began with a near-complete lockdown, but already in May the economy began to reopen.

By next week, even restaurants, cafes and hotels will resume business. That won’t stop second-quarter figures from being bad, too. The second half of the year will supply a more complete answer (assuming there’s no second coronavirus wave) on whether the Israeli economy exited the crisis as quickly as it entered.

Anti-coronavirus measures among employees of an eyewear shop, spring 2020.Credit: Moti Milrod

'Soft' social distancing restrictions

The Bank of Israel issued an updated economic forecast Monday. The bank’s economists said that even if Israel is exiting the lockdown faster than they had expected, economic recovery will be slower than they had earlier predicted.

Israeli GDP will contract 4.5% for all of 2020, which is less than the 5.3% decline the bank had forecast in April. The worse news is a sharp drop in the bank's prediction for 2021, when economic growth is projected to reach 6.8%, down from a previous forecast of 8.7%.

The bank's expectations for a slower recovery is based on the assumption that the return to normal economic activity will be accompanied by “soft restrictions” regarding social distancing that will weigh on growth. Requirements that businesses limit the number of people on site at any one time, take the temperatures of people entering their establishments, and require them to wear masks will inevitably take its toll on economic activity, at least initially.

Under the circumstances, businesses will need to employ fewer people than they did before the crisis, and that will slow the return to normalcy. To fully appreciate what that means, remember how many times you haven’t been able to enter a store because of pandemic rules.

That will take a toll mainly on nonessential goods such as apparel and home furnishings. According to the statistics bureau, consumer spending plunged 20.3% in the first quarter on an annualized basis and 21.7% on a per capita basis. The only category that showed a rise, as might be expected, is food, beverages and tobacco, while others dropped by dozens of percentage points.

Last month, during the peak of the pandemic, the central bank issued a relatively optimistic forecast concerning unemployment, compared with what the treasury was expecting. But in the meantime, the bank has lowered its GDP forecast. It had once spoken of 8% unemployment in the second half of this year; now it's talking about 8.5%. At the end of 2021, the rate was previously forecast to fall to 4%; now it is forecast to fall to 5.5%.

Thus the Israeli economy will not be returning to its pre-crisis level of record-low joblessness even by the end of next year. Each percentage point of unemployment equals 40,000 jobless people.

The central bank stresses in its forecast how difficult it is to make predictions in a crisis environment like this. The level of uncertainty in Israel and the world remains very high, mainly due to big unknowns about whether there will be a second coronavirus wave this autumn. If that happens, the number the Bank of Israel is now forecasting will change considerably for the worse. Unemployment could reach 11% and the drop in GDP could widen to 8%.

Governor bashes the government

The central bank doesn’t discuss how fiscal policy could contribute to a recovery, but Governor Amir Yaron was sharply critical in an interview with TheMarker last week about the gap between when government-aid decisions were made and when they were implemented.

He repeated his criticism at this week’s cabinet meeting. “Even if there are problems about the details of the [aid] model of one kind or another, the most important thing right now is the speed at which it's put into effect and to reduce uncertainty. The program’s particulars must be announced immediately and be put to work as soon as possible even if its design isn’t perfect,” Yaron said.

He was talking about the 6 billion shekels ($1.7 billion) in grants the government will pay to employers to encourage them to bring back workers and loans of 4 billion shekels to businesses badly affected by the coronavirus crisis and that can’t get bank loans.

The aid programs and the lower tax revenues expected this year from the drop in economic activity will widen the budget deficit to 11.5% of GDP, according to the Bank of Israel. Public debt will grow to 74% of GDP from 60% at the end of 2019. The result will be a big increase in government financing costs. Israel has already raised $10 billion overseas to help cover the higher spending. More will be tapped from local markets in the coming months.

There remain a lot of question marks about the forecasts into the next two years. They depend on many variables including the pace of the world's economic recovery, the effectiveness of aid programs and whether there’s a second pandemic wave.

There’s also the question of whether the government will undertake economic reforms in 2021 and 2022 that give the economy a boost. But reforms usually take time to yield benefits, so that even those implemented at the start of next year won’t find their way into Israel’s national accounts for some time.

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