Israel Could Face Austerity Under Next Government

But Finance Ministry officials downplay fiscal problems: ‘When you have 37.8 Celsius fever you don’t go to surgery’

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Finance Minister Moshe Kahlon at a campaign rally for his Kulanu party, Tel Aviv, April 3, 2019.
Finance Minister Moshe Kahlon at a campaign rally for his Kulanu party, Tel Aviv, April 3, 2019.Credit: Moti Milrod

Israel’s economy has barely featured in the run-up to next week’s general election, yet the central bank and many economists warn the new government will need to cut spending and raise taxes to rein in a growing budget deficit.

Netanyahu has long touted the economic successes of Israel, and growth is robust, unemployment is low, the Israeli high-tech sector is second only to Silicon Valley globally and foreign investment is strong. However he and his finance minister, Moshe Kahlon, have cut taxes while spending generously on policies like pay rises for police and subsidies for kindergartens, leading to a widening budget deficit.

Now the Bank of Israel and many economists warn that the economy is set to slow as a result of weaker global growth, which would hit Israeli exports. The central bank, which has started a gradual process of raising interest rates, said the next government would have to cut spending in coming months as well as raise some taxes.

>> Under a decade of Netanyahu rule the Israeli economy has gone backwards | Analysis

Analysts expect the spending reductions and tax hikes to reach up to 12 billion shekels ($2.8 billion-$3.3 billion) to narrow this year’s budget gap.

“The government that will be chosen will have to make fiscal adjustments,” said Bank of Israel Governor Amir Yaron. He added these steps should be taken when the economy was in good shape as they would be tougher to implement if conditions worsened.

A higher budget deficit and public debt reduce the ability of a country to withstand economic shocks, like another financial crisis, and can also threaten its credit rating and borrowing costs.

Ratings agencies Fitch and S&P said Israel was not at risk of a downgrade in the near term, but also stressed the next government would have to take steps to rein in the deficit.

The budget deficit is projected by analysts to rise to close to 4% of gross domestic product this year – above a target of 2.9%. The deficit was 2.9% of GDP in 2018, widening to 3.5% in the 12 months to February this year.

The central bank believes the state must stick to a deficit target of 2.5% of GDP. At 3%, the public debt burden would rise from a current level of 61% to 65% of GDP by 2025, or as much as 75% should the economy worsen, Yaron warned.

The finance ministry, which expects a budget deficit of at least 3.5% this year, says the situation is being blown out of proportion, noting Israel is one of the only Western countries to have reduced its debt ratio over the past decade.

“There is a gap of 6 billion shekels that we need to close in a budget of 400 billion shekels .... It’s not a big problem and certainly not a catastrophe,” Shai Babad, the ministry’s director general, told Reuters. “We are monitoring it. When you have 37.8 Celsius fever you don’t go to surgery.”

By comparison, the U.S. deficit is expected to be 5% of GDP in 2019, France’s deficit 2.8%, Spain’s 2.3%, Britain’s 1.7% and Germany’s 1.5%, according to International Monetary Fund estimates.

The next Israeli government is likely to be in place by late May.

Leader Capital Markets Chief Economist Jonathan Katz said the next government could implement so-called fiscal consolidation measures in two stages – in the middle of this year and then in early 2020.

“I don’t think they will necessarily have to cut immediately the budget by 12 billion shekels and raise taxes, to put the brakes on right away and sharply. I think they have the leeway to do it in two stages,” he said.

“The budget should have been balanced by 2017 when you are at full employment, and this would allow you fiscal tools to expand spending during a slowdown.”

Babad said updated forecasts for state income and expenses would be available in June, when the ministry would determine if action was needed. The 2020 state budget is expected to be ready for a cabinet vote by early August, he added.

He said if there was an issue with Israel’s fiscal policies, global rating agencies would be more concerned.

Last week, Fitch affirmed its sovereign debt rating of A-plus with a Stable outlook, but believes the new government must take steps to narrow the budget deficit.

Similarly, Standard & Poor’s last year raised its rating to AA-minus from A-plus, also with a Stable outlook. It affirmed the rating in February.

“If the fiscal slippage or relaxation of fiscal performance were to be repeated or happen consistently, we might conclude that there is a shift in the government’s fiscal stance,” said Karen Vartapetov, a sovereign ratings director at S&P.

“The next government, whatever it might be, will have to take some difficult decisions including potential tax hikes or cost controls. This is for sure,” she said.

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