Israel Must Tackle ‘Stubbornly High’ Deficit, IMF Says

Bank of Israel warns that spending commitments to form the new coalition could make the budgetary shortfall bigger in 2016.

Finance Minister Moshe Kahlon, left, and Prime Minister Benjamin Netanyahu.
Reuters

REUTERS - Israel’s government needs to immediately address a high budget deficit which leaves the economy vulnerable to shocks, including a fall in house prices, the International Monetary Fund said yesterday. The IMF urged the government to bring the deficit down to 2.25% of its gross domestic product next year, from an expected 2.75% in 2015, and to target a deficit of 1.5% of GDP thereafter.

“The fiscal deficit remains stubbornly high,” the fund said at the end of a week-long visit to Israel. “Current levels leave few buffers to deal with shocks, such as a housing price correction, renewed conflicts or a sharp recession.”

It warned that if the deficit stays at around 3%, and assuming real GDP growth of around 3% and 2% inflation, the debt ratio will steadily rise to 80% of GDP from 67.1% in 2014. With last March’s election having delayed the approval of a 2015-2016 budget until later this year, the government is currently working off last year’s tax and spending plans.

Earlier, the Bank of Israel said it expected a deficit of 2.5% to 2.8% of GDP this year – in line with an initial target of 2.5%. But it warned that spending commitments to form a new coalition could make the shortfall bigger in 2016. Additional spending pledges of around 10 billion shekels ($2.65 billion) will push the deficit next year to around 3.3% of GDP, assuming no steps are taken to boost revenues, the bank said.

In its report, the IMF said no further interest rate cuts were needed in Israel, where inflation is expected to return to its targeted range of 1% to 3% in 2016, from an annual rate of -0.4% in May. The Bank of Israel held its key rate at 0.1% for a fourth straight month on Monday and Governor Karnit Flug all but ruled out another rate cut and use of unconventional tools.

The IMF is projecting economic growth of 3.0% in 2015, in line with the central bank’s forecast, but said labor productivity must rise or GDP will slow in the future.

It also said tightening labor markets were likely to exert upward pressure on wages, which along with moderating energy price falls and robust global growth should help lift inflation.

“Monetary tightening in the United States would likely help Israel, as it would exert downward pressure on the shekel, which would boost growth and inflation,” the IMF said. The Washington-based International agency added that Israel’s financial sector is stable, but that exposure to the real estate and construction sector has risen, and warned that efforts to boost banking sector competition must ensure that financial stability remains paramount. The fund said the government needs to raise the supply of housing to contain prices that have soared in recent years as supply has fallen behind demand. It also noted that income inequality in Israel is among the highest in advanced countries.