Top Israeli Officials Warn of Growing Budget Deficit Amid Political Standstill

Bank of Israel governor vows to use all tools at his disposal to head off a slowdown, while senior Finance Ministry official warns of bigger problems for 2020 when the deficit could reach 3.8% and even more after election

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Bank of Israel Governor Amir Yaron speaks at a press conference in Jerusalem, March 31, 2019.
Bank of Israel Governor Amir Yaron speaks at a press conference in Jerusalem, March 31, 2019.Credit: Emil Salman

Israel’s budget deficit, which has swelled to a worrying level in 2019, is on course to expand further as the country heads into its second election this year, two top economic officials said Monday. (For the latest election polls – click here)

After remaining below 3% of gross domestic product for five straight years, the government’s budget deficit is expected to widen to 3.6% this year, said Shaul Meridor, head of the Finance Ministry’s budget division. “It’s not a deficit we wanted to have,” he told an economic conference in Tel Aviv.

Haaretz Weekly Episode 38Credit: Haaretz

He warned of bigger problems for 2020 when the deficit could reach 3.8%. And that figure could rise further after the September 17 election, he said. The deficit was 3.8% of GDP in July over the prior 12 months.

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Forming a new government is a notoriously costly process, with coalition demands certain to strain the budget. Still, he offered words of reassurance.

“We have a clear position to rein it back in,” Meridor said. “We don’t need to panic. We’ve done it many times.”

The government lost its ability to take significant steps to control the deficit, such as enacting major cost cuts or tax hikes, when Prime Minister Benjamin Netanyahu failed to put together a coalition after an April election and the Knesset in turn voted to dissolve itself. Netanyahu has since been heading a caretaker government that has limited powers.

The economy is forecast to grow 3.1% in 2019 and 3.5% in 2020. An unchecked deficit would weigh on Israel’s debt-to-GDP ratio, which it had successfully lowered to 61% in 2018 from 74.6% in 2009.

At the same conference, Bank of Israel Governor Amir Yaron said that if action is not taken, the budget deficit would grow through 2021 and beyond. Yaron called for “diminishing the deficit to a level that would at least ensure a stable debt/GDP ratio, and keeping it that way for the next few years, along with the gradual implementation of growth-supporting moves.”

He said the cuts should be even in spending on investment that supports economic growth. Speaking in Tel Aviv at a conference sponsored by the Calcalist business daily, the central bank governor called on the next government not to delay in implementing recommendation by the Bank of Israel’s research department on increasing labor productivity. That should be done at the same time that spending cuts and higher taxes that will presumably be necessary are imposed, he added.

At a different conference Sunday, Yaron said the central bank will reexamine its monetary policy over the coming year and use all available tools to prevent an economic slowdown and to push inflation higher. The central bank would continue with expansionary policies since the inflation trend has changed, shifting to an annualized 0.5% in July from a peak rate of 1.5% in May, he said.

“[W]e intend to carry out a process of rethinking the monetary policy framework, and we have already invited senior officials from central banks around the world to come to Israel and participate in a conference we plan to hold on the issue,” the bank governor said at an event sponsored by the Globes business daily in Tel Aviv on Sunday. “It is certainly possible that at the end of the process we will reach the conclusion that the current regime is the correct one and there is no need to change it, but we must challenge that thinking from all sides before reaching that conclusion.”

Yaron’s remarks followed similar policy reexamination at central banks around the world, particularly by the U.S. Federal Reserve, regarding the tools available to address economic challenges in an era of low inflation and zero interest rates that the central banks are having difficulty increasing.

Housing costs

Addressing the perennial issue of housing costs, the Bank of Israel governor said officials at the central bank “are not blind” to the issue and its impact on the younger generation. “Therefore, I asked the Research Department to begin formulating operative recommendations in the housing area, in order to help the new [post-election] government identify the order of priorities and to act to remove obstacles that weigh on increasing the supply of homes.”

Regarding government spending, Yaron said that as long as the Israeli economy remains in good shape, the focus needs to be directed toward stabilizing the debt-to-GDP ratio at around 60%. That, he said, is necessary so that if and when a recession hits, the government will have room to increase the deficit.

Inflation policy

Yaron and policymakers have changed their tone since July, when they still held onto the prospect of a rate hike this year while markets had factored out any hikes well into 2020. “It is not clear to us at this point if it is noise in the data ... or a fundamental decline in inflation,” Yaron said. “However, it is clear to us that we have to continue to strive and raise the inflation rate toward the midpoint of the [1% to 3%] target range.”

Yaron said the risks to the economy had intensified and, if they are realized, “we will want to act in a timely manner, in order to prevent to the extent possible a slowdown in economic activity.”

Last week, the monetary policy committee held the benchmark interest rate at 0.25% and said that given the turnaround in the inflation environment, monetary policies of major central banks, the slowing in the global economy and continued appreciation of the shekel, the interest rate would not be increased for an extended period.

The statement was a reversal from remarks in previous rate decisions that said the path of interest hikes would be “gradual and cautious.”

“The message was changed because the data changed,” Yaron said Sunday. “Within a relatively short period of time, we saw a decline in inflation, a change in the direction of monetary policy worldwide, a worsening of the risks to the global economy, and a relatively sharp appreciation of the shekel.” The shekel has appreciated 5.5% against the dollar so far in 2019, helping to push down inflation.

Israel’s economy was growing at a good pace with a tight labor market, Yaron noted, and the global slowdown is not affecting it, “not even exports.”

The central bank will intervene in the foreign exchange market if it deems the shekel exchange rate has materially deviated from the window that we defined, the bank governor declared. “And no one will receive a warning letter from us beforehand.”

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