Bank of Israel Chief May Not Get Reappointed After Report Points to Worrying Trends

Annual report says Finance Minister Kahlon’s fiscal policies have left Israel vulnerable - and the head of the Bank of Israel may not get reappointed for damning report

FILE PHOTO: Israeli Finance Minister Moshe Kahlon gestures as he speaks at an event in Ofakim, southern Israel May 29, 2017. REUTERS/Amir Cohen/File Photo
\ AMIR COHEN/ REUTERS

Perhaps the nine most important words uttered during Bank of Israel Governor Karnit Flug’s news conference on Wednesday to release the bank’s annual report were: “We are at the peak of a business cycle.”

The report documented the economy’s sterling performance last year, with growing exports, rising wages and falling unemployment. It also noted the persistent ills of the economy, among them income inequality, low levels of investment in education, poor transportation infrastructure and a structural budget fiscal deficit.

Apart from these, there was a host of other disturbing trends that received less prominence in the 2017 annual report but have or will have a profound effect on ordinary Israelis.

The first is the cost of Finance Minister Moshe Kahlon’s various reform programs, like Family Net, increased nursing care coverage and enlarged allowances for the handicapped. Between all of them and the 3.4 billion shekels ($970 million) in tax cuts, Kahlon has added spending that will reach 12 billion shekels annually when all the programs are fully implemented, according to central bank projections.

The government’s fiscal policies increased civilian spending as a percentage of gross domestic product 1.2 percentage points last year, bringing them to their highest level in more than a decade, the Bank of Israel said.

The NIS 12 billion man
Annual costs of Kahlon's programs through 2022,
NIS billions

The spending increases and tax cuts were based on a large increase in tax revenues, much of it based on one-time windfalls from the sale of Mobileye to Intel and the sale of natural gas assets to Tamar Petroleum.

Discounting the one-off factors, Israel’s structural deficit grew 1.4 percentage points last year, rather than shrinking as the headline figure showed, the central bank said, and warned that the treasury can’t rely on similar windfall revenues going forward. With tax revenues plateauing or even falling in the face of a recession, the reverse is more likely to occur. The result would be a sudden turn upward is the country’s ratio of debt to GDP.

If that were to happen, the treasury could find itself with no choice but to cut spending at a time when it should be increasing it as a counter-cyclical strategy.

Moreover, Kahlon and Prime Minister Benjamin Netanyahu have signaled they want to cut taxes further, cutting, among other things, the U.S. tax reforms that have lowered America’s corporate tax rate.

The Bank of Israel said further tax cuts were not just imperiling Israel’s fiscal outlook but could also impede economic growth by undermining drivers like better schools and infrastructure, since Israel’s spending on health and education is low relative to most other developed economies.

Low-tech?
Output by Israeli startup companies

The Finance Ministry responded to the critique in a statement on Wednesday. “Regrettably, the Bank of Israel continues to conduct an economic policy that primarily serves ‘interests,’” it said. “Israel’s economy is in its best position in decades thanks to steps led by the Finance Ministry headed by Moshe Kahlon for Israeli citizens and despite the conduct of the Bank of Israel.”

Asked about the treasury’s comments, Flug told the news conference that she did not understand what the response was based on.

“When we submitted the report to the finance minister, we heard very positive things about the economy, and we think the economy is in good shape,” she said. “I have a feeling that the person who wrote the response did not read the report in detail and may have only responded to headlines,” Flug said.

However, sources who spoke with the media said that Kahlon may not ask Flug to renew her role as the head of Israel's central bank when she finishes her five-year term this November as a result of the report.

The Bank of Israel also expressed concern about the future of Israel’s high-tech sector. While exports of high-tech services, which include software and research producers at multinational R&D centers, more than doubled to $19 billion between 2011 and 2017, exports of high-tech products have slowed.

Part of the reason is a slowdown in global high-tech trade. But another factor is the loss of exclusivity by Teva Pharmaceuticals for its Copaxone multiple sclerosis treatment last year.

The high-tech sector is also being hurt by the strong shekel, which is making it less price competitive, and by a labor shortage.

The central bank noted that while the number of science and engineering graduates grew 2.8% a year from 2010 to 2016, the number of people working at technology-service companies grew 9.4% a year from 2012 to 16. Overall, Israel’s tech payroll grew 4.4% annually.

Turing to the housing market, the Bank of Israel warned that Kahlon’s Machir L’Mishtaken program of subsidized housing could cause free market prices to rise.

“The splitting of the market into two – a subsidized and a free market – is liable to raise the prices of homes in the free market because the supply is shrinking faster than demand,” it said.

With reporting by Elrian Rubin, Arik Mirovsky and Reuters