Israel's Central Bank Criticizes Netanyahu: Defense Spending Will Hurt Civilian Spending

Criticism of Netanyahu is rare for the central bank, which said raising the defense budget was liable to raise the budget deficit unless it was accompanied by other cuts and tax hikes

Governor of the Bank of Israel Karnit Flug, March 28, 2018.
Bloomberg

Israel's central bank on Wednesday criticized a government plan to sharply boost defense spending, saying it would come at the expense of civilian spending and probably increase the budget deficit and state's debt burden. 

Prime Minister Benjamin Netanyahu told ministers last week that to meet expected threats in the coming decade, he intends to increase defense spending by 0.2 to 0.3 percent of gross domestic product under the "2030 Security Concept." 

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He said his goal was for annual average economic growth of 3 to 4 percent and average spending of 6 percent of gross domestic product for all of Israel's security needs. 

"The proposal to increase the defense budget ... over the next decade is inconsistent with the declining deficit path established in law, government resolutions about the expansion of social services, social programs and infrastructure investments, and the government's aversion to raising tax rates," the Bank of Israel said in a report. 

Israeli Prime Minister Benjamin Netanyahu attends the weekly cabinet meeting at his office in Jerusalem on August 12, 2018.
AFP

"If such an outline for defense spending is adopted, it should specify stable and transparent sources of funding for the plan and should depict the adjustments that the other aggregates will have to undergo." 

The criticism of Netanyahu is rare for the central bank, which has mainly sparred with Finance Minister Moshe Kahlon during the past three years over his penchant for tax reductions and other fiscal policy issues. 

Israel is scheduled to hold elections in November 2019, but some politicians and commentators have speculated they may be brought forward to early next year. Polls show Netanyahu still leading all political opponents, and defense issues are always a prominent issue in Israeli election campaigns. 

The bank noted that raising the defense budget was liable to raise the budget deficit unless it was accompanied by other cuts and tax hikes. 

"Given its existing decisions on multi-year spending programs, its aversion to raising tax rates, and its interest in increasing the defense budget at a rate similar to that of GDP growth, the government will be rather strongly challenged to stay within the deficit-decline trajectory ... and to stabilize, or to continue to reduce, the debt-to-GDP ratio," it said. 

The budget deficit is expected to reach 2.9 percent of GDP in both 2018 and 2019, up from 1.9 percent last year, which was boosted by one-time factors and stronger-than-expected tax income. The solid fiscal performance led Standard& Poor's this month to raise Israel's credit rating to "AA-" from "A+". 

Still, the Bank of Israel remained concerned that keeping the budget deficit around 3 percent through higher spending would prevent a decline in debt burden, which was 59.4 percent of GDP in 2017, excluding municipalities' debt. 

It noted that the government's use of creative accounting methods such as temporary provisions, future across-the-board cuts and issuing bonds, would only create budget issues in coming years. 

"Other countries' experience, and Israel's experience in the past," the central bank said, "show that circumventing the budget limits, even if done with good intentions at first, may eventually end in loss of control of the budget framework and the need to make budget corrections at times that are less convenient for policymakers."