Next Government Faces Economic Slowdown Without the Tools to Contend With It

A growing deficit will require the treasury to cut spending and/or raise taxes just as a global economic deceleration seems to be getting underway

Bank of Israel.
Emil Salman

Prime Minister Benjamin Netanyahu’s victory in Tuesday’s elections was made possible in part by years of uninterrupted economic growth, tax cuts and higher spending.

But as the Bank of Israel and many economists have warned, the future looks less bright, especially amid signs that the world economy is slowing. If Israel is swept up in a global slump, economist warn, it isn’t ready in terms of either fiscal or monetary policy to deal with the crisis.

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“We are in a critical period for the Israeli and world economies,” Ori Greenfield, chief economist at the investment house Psagot, told TheMarker in an interview a day before the election. “The problem is that policymakers don’t have the tools to help the Israeli economy if it enters into a slowdown.”

On Tuesday, the International Monetary Fund a reduced its growth forecast for the global economy against, this time to 3.3% for the year, after forecasting 3.5% in January. “This is a delicate moment for the global economy,” Chief Economist Gita Gopinath said.

Right now, the Israeli economy is tooling along at a good pace. Greenfield is relatively bearish, seeing gross domestic product growing at 2.9% this year, and a fifth of that arising from the natural gas industry and Intel’s Israel operations.

The IMF on Tuesday cut its forecast for Israeli growth this year by 0.2 percentage point but that still comes to a relatively healthy 3.3%. Israel’s Finance Ministry sees growth at about 3.1%, an estimate shared by many private forecasters.

The Bank of Israel predicts 2019 full-year growth at 3.2%, but reflecting concerns about the world economy slashed its forecast for export growth. Moreover of the central bank announced this week that its base interest rate would remain unchanged remarks by Governor Amir Yaron contained the word “uncertainty” no less than five times.

Three of the times they related to the policies of the next government and one to Britain’s exit from the European Union.

One expressed a general angst: “At this stage, there is uncertainty about several key factors that will affect policy in the near future - the development of the exchange rate, the picture of the global economy, and especially monetary policy abroad, developments in the real economy, the policy adopted by the new government, and more,” Yaron said.

The principal problem facing the new government is the budget deficit. Moshe Kahlon, who is likely to keep his job as finance minister in the next government, has repeated expressed confidence that Israel’s fiscal situation is under control. The credit ratings agencies Fitch and Standand & Poor’s have said Israel was not at risk of a downgrade in the near term.

But off the record Finance Ministry officials are concerned. Until recently they has been saying that unless the government took steps, the deficit this year would reach 3.6% of GDP, well above the 2.9% target. Now they are saying it is likely to be higher still after first-quarter tax revenues were disappointingly low.

The problem is only expected to grow worse going into 202 and beyond because the previous government undertook huge spending commitments that have yet to fully kick in.

Treasury officials are preparing the usual package of measures they offer ministers when the budget is under pressure -- across-the-board spending cuts, raising taxes (a traditional favorite is that value-added tax, which has gone up and down over the years as the budget requires) and eliminating tax breaks. There are also more creative measures they have employed in the recent past, such as raiding accumulated surpluses of the Israel Airport Authority or the Jewish National Fund.

Although new governments and new finance minister start their terms with a lot of political capital, it’s not yet clear that either will have the appetite to take unpopular measures. After the new government is in place, discussions on the 2020 and possibly a dual 2020-21 budget will begin.

“It will be very difficult to consolidate the budget,” said Leader Capital Markets chief economist Jonathan Katz, noting much depended on how much pressure Netanyahu will be able to withstand. “The big question is, ‘Will it be a macro story of billions of shekels, or hundreds of millions?’”

The timing for a fiscal austerity isn’t good. Governments ideally balance their budgets or run surpluses when the economy is growing and then let loose the fiscal purse strings when activity cools as a counterbalancing measure. The next government may be forced to exactly the opposite.

Meanwhile, interest rates are close to their record low. After one small hike last November, the rate has remained unchanged at 0.25%.