Bank of Israel: Government Must Cut Spending and Raise Taxes

Excluding the contribution of natural-gas production, economic growth slowed in 2013, the central bank warned.

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Karnit Flug, Bank of Israel governor.
Karnit Flug, Bank of Israel governor.Credit: Tomer Appelbaum

The Bank of Israel unveiled its 2013 annual report Monday, noting surging housing prices, a high poverty rate and the need to raise taxes and slash the 2015 state budget.

Central bank governor Karnit Flug said the government had to reduce spending by 12 billion shekels ($3.4 billion) and find another 8 billion shekels in tax revenue - either through tax hikes or improved collection - to reach its 2015 budget-deficit target of 2.5% of gross domestic product.

The bank said the economy grew by 3.3% in 2013, maintaining its better showing compared to many advanced economies. But growth was moderate considering the launch of natural-gas production off the country’s coast.

Excluding this contribution, growth was slower than in 2012. The slowdown in exports, the need to reduce the budget deficit and weaker growth in the construction industry contributed to lower economic growth overall.

“Certainly there will need to be ... an adjustment on the side of spending and an increase in tax revenue,” Flug told a news conference, noting that the government had pledged too much spending in recent years. But Israel is likely to meet its 2014 budget-deficit target of 3%, she added.

The slowdown in exports was the main reason for the slower growth. This stemmed largely from sagging world trade and “the cumulative negative effect of the appreciation of the shekel,” the central bank said.

Israel maintained a current-account surplus during the year, even excluding the contribution of natural gas. This was because imports dipped as well, mainly due to the slower increase in investments. The employment rate continued to improve.

Israel has the highest poverty rate in the Organization for Economic Cooperation and Development at 21%, and it's one of the five worst OECD nations in terms of inequality. But the central bank says the issue is more complicated. It says Israel’s tax regime is the main reason for the high poverty; the policy is not progressive enough.

But examining total income, both from employment and investments, poverty and inequality are not as bad as previously thought, the bank says. Still, the government must do more to alleviate poverty, it says.

Inflation in 2013 was 1.8%, near the midpoint of the target range of between 1% and 3%. Inflation was low during the first half of the year but worsened in the second half.

Three key developments contributed to 2013’s higher prices. Housing prices rose, electricity prices rose and food prices increased at a higher rate than in other countries.

Communications prices, however, continued to decline after the government took steps to increase competition in the cellular telephony industry. The central bank said the meeting of the inflation target reflected the credibility of its monetary policy.

Home prices climbed 6% in real terms in 2013, a slightly slower pace than in 2012. Since 2008 they have jumped by around 60% in real terms. Last year there was a further increase in new mortgage loans.

The Bank of Israel reduced the interest rate three times in 2013, reaching 1%, a number that his since been lowered to 0.75%.

The central bank resumed its purchases of foreign currency in 2013; one reason was the program for offsetting the impact of natural gas production. The other was the policy to intervene when exchange-rate fluctuations were not consistent with economic fundamentals. These measures were intended to slow the shekel’s appreciation and support exports.

Over the long term, Israel must ensure that economic growth is “sustainable and inclusive,” the central bank said.

“For this purpose, action must be taken to increase labor productivity in the economy, since it is low by international standards, and to enhance the integration of populations with low labor force participation. At the time same, action must be taken to ensure that the benefits of growth reach as many segments of the population as possible,” the annual report states.

“In order to achieve these two objectives, it is necessary to improve the level of education for all sectors of the population, broaden and deepen integration in the labor market, increase competition in the economy, thereby also facilitating a reduction in the cost of living, and maintain a reasonable level of public services.”

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