Netanyahu, Finance Chief Agree to Wider Budget Deficit in 2016

Extra spending is needed to cover the costs of coalition handouts, but the treasury is determined to fight.

Next year the government’s budget deficit will widen to 2.9% of gross domestic product, or 33 billion shekels ($8.7 billion), under an agreement hammered out between Prime Minister Benjamin Netanyahu and Finance Minister Moshe Kahlon, sources have told TheMarker.

Netanyahu pushed for a higher deficit to be able to fund the programs he agreed to under the coalition agreement forming his government in May. Against that, the prime minister strove to keep spending under 3% of GDP, the ceiling set under the European Union’s Maastricht Treaty.

Economists from the International Monetary Fund told Israel last week that the deficit was already too high and must be reduced for the government to decrease the ratio of public debt to GDP.

The IMF said it expected a deficit of 2.75% in 2015 and urged the government to bring the number down to 2.25% next year. “The fiscal deficit remains stubbornly high,” the IMF said at the end of its week-long visit to Israel. “Current levels leave few buffers to deal with shocks, such as housing price correction, renewed conflicts, or a sharp recession.”

Kahlon agreed to the higher deficit target, but a treasury source said that according to the finance minister, if his Kulanu party had more seats in the Knesset he'd be able to go with a much smaller deficit. Economic growth of at least 3.4% next year would similarly ensure a drop in the debt-to-GDP ratio, the source added.

The treasury’s budget division is opposed to a 2.9% deficit, which would mark a rise over 2015 at a time when global credit markets are highly sensitive to countries’ fiscal health. Amir Levy, the budget division’s chief, would prefer a deficit of 2.5%, fearing that a deficit above that would whet the appetite of defense officials seeking higher defense spending.

The Finance Ministry’s accountant general, Michal Abadi-Boiangiu, is not opposed to the higher deficit, but Eugene Kandel, the chairman of Netanyahu’s National Economic Council and a close adviser to the prime minister, is lobbying for the 2.5% target.

Bank of Israel Governor Karnit Flug is urging higher taxes to allow for an increase in spending while containing the deficit rise, but she faces opposition from Kahlon about any tax hike, calling it “a lethal drug” stifling economic growth.

Meanwhile, at the end of last week, Netanyahu and Levy held a three-hour meeting on Netanyahu’s plan to pass a three-year budget that would cover the rest of this year and continue into 2016 and 2017. The prime minster sees a three-year document as an insurance policy against the government in case its thin parliamentary majority forces it to collapse over fiscal infighting.

Still, Netanyahu didn’t make public any decision on the matter. Kahlon is strongly opposed to a three-year budget, which would prevent him from undertaking major new budget initiatives or dealing with changing economic conditions. Sources said he still hopes to convince Netanyahu to go with a budget covering 2015 and 2016 only.