Israel Approves Budget Cuts Amid Warnings on Deficit

Ministers approve measures as red ink swells to 3.8% of GDP. Bank of Israel chief says more painful steps lie ahead

Israel's central bank chief Amir Yaron.
Steven Scheer / Reuters

Israel’s cabinet on Monday approved a package of fiscal adjustments, including a 1.2 billion shekel ($333 million) spending cut for 2019-20, as Bank of Israel Governor Amir Yaron delivered unusually harsh words about the ballooning budget deficit.

The reductions will be imposed on all ministries, with some of the savings directed to fund what Prime Minister Benjamin Netanyahu called a “security project of unparalleled importance.”

“This is very hard for all of us, it is what is necessary. We have no choice,” Netanyahu said. “We must see to the priorities – security, the homes that went up in flames, the afternoon daycare – these are the needs which, as of now, we must put before others.”

But Yaron, who has only been in office for a few months, warned in his first cabinet meeting that much more painful measures were necessary to deal with the growing deficit. “The government will need to show determination and raise tax rates,” he said, urging more spending cuts and eliminating tax benefits.

The spending cuts come at an awkward time for the Netanyahu government, which will be going into elections in September after the prime minister failed to form a coalition after April elections. But ministers had no choice.

Israel’s budget deficit widened to 3.8% of gross domestic product in the 12 months through May, way over the 2.9% target for 2019. The treasury says the deficit will reach 3.8% of GDP both in 2020 and in 2021, way above the targets of 2.5% for 2020 and 2.25% for 2021.

“The fact that we are meeting here right now and are ready to take this step is testimony to the government’s fiscal and economic responsibility,” Netanyahu said at the opening of the meeting.

Although credit rating agencies have continued to express optimism about Israel’s eventually getting its fiscal house in order, the International Monetary Fund and the Bank of Israel have been urging fiscal cuts and tax hikes.

The urgency has grown since the April elections failed to produce a new government. Israel now has a caretaker government with limited authority that could remain in power for most of the remaining months of 2019. The next government may not win approval for a 2020 budget until as late as March of next year.

Nevertheless, the reductions and other measured voted on Monday are not nearly enough to cope with a forecast shortfall of revenues to expenditures of 20 billion shekels in the year 2020.

Moreover, the spending cuts approved by the cabinet won’t actually reduce the 2019 deficit – they are only enough to cover extra costs the Knesset saddled on the original 2019 after it was passed.

They include 800 million shekels to finance construction of the anti-tunnel barrier on the Gaza border and 350 million shekels to continue subsidized afternoon childcare programs in the next school year. Another 84 million is slated to help pay for fire damage to communities in the Mevo Modi’in area last month.

“The measures presented by the Finance Ministry are important even if they are modest in relation to the scope of the problem of the structural deficit,” Yaron told the cabinet.

He estimated that without Monday’s measures, Israel’s deficit would have surpassed 4.5% of GDP. If the path of the deficit is not corrected, Israel’s debt to GDP ratio will exceed 65% in 2022 from 61% in 2018, he said.

Yaron warned that Israel would suffer if the ratio shows a sustained rise. “The financial markets assign a lot of importance to changes in the debt trend. An increase in debt will have a painful impact on the government’s interest costs and investor confidence in the economy,” Yaron explained.

In addition to the spending cuts, the Finance Ministry also plans other steps to tackle the deficit.Finance Minister Moshe Kahlon, who critics charge allowed the deficit to get out of control on his watch, blamed the problem on external factors.

“Israel is part of the global economy and there is a slowdown in the global economy that has led to declining government revenue and requires us to make adjustments,” he said.