Netanyahu: Interest Rates Are Too High, Dollar Too Low

Finance Minister Benjamin Netanyahu isunder pressure. He may not admit it, nor does he show any outward signs of it, but he is.

To push his budget proposal for 2004 throgh parliament, Netanyahu lost battle after battle. He came out of the fray looking submissive, having capitulated to the demands of the coalition members, and having handed out money to bureaux affiliated with members of the Likud, the political party to which he belongs. He has used up all his budget reserves with the year not a month old, and he hasn't even gotten into the extra budgets defense demands, or the local authorities, which come to billions more.

Aware that his image of indomitability has been impaired, Netanyahu is now trying to defend himself, and mainly re-establish his good name through the battle that won the most media attention – the privatization of Israel's ports.

In a special interview with Haaretz, Netanyahu began by presenting the main points of his economic program. He flipped from slide to slide until reaching the one showing the performance of the Tel Aviv Stock Exchange's TA-100 index. The enthused finance minister knew his figure and related the upswing ("80 from the bottom") to his strategic economic program.

"We are in the second stage of the program, eradication of the monopolies," he explained, "the ports, Oil Refineries, water, milk and the post office. Some has already been carried out and some remain to be handled."

The following are translated excerpts from the interview, granted late last week.

What do you want to achieve vis a vis the monopolies?

Netanyahu: First of all, to dismantle the monopolization of the banking sector, to create a more competitive banking market. We shall try to consolidate a strong group with Israel Discount Bank (TASE: DSCT) at its center, and encourage competition in banking.

Secondly, we aim to reform regulation in the public sector. Israel has too much regulation and it does not always achieve its aim.

You are also targeting regulation? You're starting to sound like the Industry minister, Ehud Olmert.

If so, I’m in good company. Thirdly, I want to look at the construction industry, which is infected with dreadful bureaucracy and all sorts of obstacles. Aside from that, there are capital market reforms. We also want to create a secondary market for mortgages. The intention is to render Israel's capital market one of the most efficient in the world, from the perspective of standards, transparency and migration of money to and from Israel. The big question is whether we will achieve this before other countries going in the same direction.

How do you mean to eradicate monopolization in the banking industry?

Our policy is to destroy the monopolies and promote free market economics. If discussing monopolies, you can't ignore the especially powerful banking monopoly of Bank Hapoalim (TASE: POLI ) and Bank Leumi (TASE: LUMI ). It controls two thirds of the banking market and is the reason interest rates on overdrafts are so high, while interest on savings is so low.

That reality hinders investment and business traffic. We want to stimulate competition by privatizing the banks. Our desire and hope is to establish a third big, competitive banking group in Israel based on Bank Discount.

Do you mean to divorce the provident funds from the banks?

I mean to separate the management of the provident funds from the banks. Regarding control, we'll see later.

Do you have a schedule?

This year.

What about separating the mutual funds from the banks?

(Netanyahu laughs, and lets his spokesman answer:) "One thing at a time."

Would you support a merger between Bank Discount and other banks? You did suggest such a move to FIBI, for instance.

We did not contract First International Bank of Israel (TASE: FIBI). Foreign banks could come too.

They could, but they aren't.

Time will tell.

Are you hinting at something concrete?

No, no foreign bank is knocking at the door right now.

Well, if you didn't contact FIBI, and no foreign banks are packing up to come, what is happening to create this third banking group?

I am convinced that privatization will strengthen Bank Discount. We will find other ways to consolidate a third big bank. Finance Ministry director-general, Yossi Bachar, is handling the matter.

To regress, what do you have against regulation?

It is excessive.

Can you give examples?

Certainly. For instance, the regulation governing the banks. For instance, I don't understand why all the forty VPs at Bank Leumi have to be approved by the Supervisor of Banks. I think it is unwarranted. We shall act to reform the whole issue of regulation in Israel, using the regulatory reforms in Britain as an example.

There, regulation was strengthened by creating a central regulatory body.

I don't want to create a single super-regulator as Britain did. That may work for the British, but not for us. The problem with regulation is that you shift the decisions from the market to a single person. Our tendency has been for more regulation but the market is known to make better decisions. The reform I plan should abolish excessive regulation. The service regulators grant to consumers also needs improvement.

A regulator is supposed to allow the market to function. For example, when the banks supervisor intervenes regarding bank commissions, he is acting against the banks' monopoly.

Yes. But I prefer to let the market work when it can.

If so, what do you say about Industry minister Ehud Olmert's opinion, in protecting the incumbent carriers by refusing to open the long-distance communications market to competition?

Experience usually shows that where competition exists, if the incumbent carriers have difficulty competing, the entry of new players improves the market. The number of competitors, and their efficiency, depend on the type of market in question, whether it's a mature one or a young one. In any case I prefer competition, and letting the market decide.

Do you have any complaints against the Antitrust Commissioner?

To tell the truth, no.

Do you have any complaints against the Israel Securities Authority management?

No. Everybody has their own model.

So your complaints against regulation are essentially against the supervisor of the banks. Do you oppose his decision regarding single borrowers?

The issue of the single borrowers should be re-examined, because the supervisor is placing a very high obstacle before economic activity. But my impression is that the supervisor is receptive to the public's opinions, and fro my perspective it's best to talk with him directly.

Some believe the candidate to replace the central bank governor will be required to agree to fire the supervisor of banks.

I do not mean to discuss subjects relating appointments with you. You are neither denying nor confirming.

The supervisor of banks is not appointed by the finance minister, but by the (Bank of Israel) governor.

Yes, but the two appointments could be made contingent.

There is no such intention.

What does your agreement with the prime minister say about appointing a governor?

That the prime minister appoints in consultation with me.

It is not true that you have a veto right?

Nothing is written.

Is it coincidence that Aharon Fogel (of Migdal Insurance (TASE: MGDL )) and Victor Medina (of United Mizrahi Bank (TASE: MZRH)) were appointed to the central bank's advisory council?

It is not coincidence. I believe in fruitful debate, in differing opinions, that can create synthesis, or a choice between possibilities.

What is your opinion of the Bank of Israel governor, David Klein?

The governor is doing good work in consistently lowering interest rates, and is thus helping end the recession. But he has a long way to go.

How much further should be lower interest rates?

He already lowered them from 9.1% to 4.8%, in other words interest is 4.3% below its peak. He should continue to cut the rates, I can't say by how much. It depends on the world's financial markets, inflation and the exchange rate.

But roughly speaking?

There is more room for interest rate cuts.

Do you think the dollar's exchange rate today is problematic?

Yes, it's too low and is hampering acceleration of economic expansion. A higher rate would stimulate exports and growth.

Do you think the Bank of Israel should intervene in the foreign currency market?

Lowering interest rates naturally impacts the exchange rate. There is a correlation between interest and the exchange rate. I hope that by lowering interest rates, the exchange rate will increase.

Is that why you placed Fogel and Medina on the advisory board, given that they share that opinion?

I wanted debate, even confrontation, between opposing views, though the final decision belongs to the governor.

Are you satisfied with the governor's policy and leadership?

In conversations, we reach quite comprehensive consensus on the principles of economic policy. We had differences of opinion in the beginning over interest rates, and I urged him using all the means at my disposal.

What means?

Persuasion. I do not use torture.

The advisory board is a kind of torture.

I hoped that interest rates would be cut in smaller doses, more often, though in practice one can't deny that he lowered interest rates. Ultimately he did it without anything happening – the mountain of shekels is still there, nor did all the other horror scenarios pan out.

Does that mean he might win another term in office?

That means we aren't dealing with appointments.

The uppermost echelon of the treasury is constantly in motion. During your time as finance minister, none of the veterans have remained.

What's wrong with that?

We don't know. Klein himself took a swipe at the accountant-general, Yaron Zelekha, saying that at such a young age (33), he probably has his eye on his next jobs.

I was appointed economic attaché in Washington at age 32, and Zelekha isn't looking anywhere. He is doing a good job and shaking the tree, as he's supposed to. It's a good thing that he has different views.

Israel needs change in the structure of government, change in the structure of the economy, greater degrees of freedom in the marketplace. That's why it's important that the treasury have people like Yossi Bachar (the treasury director-general), Uri Yogev (the treasury's budget director) and Yaron Zelekha (the accountant-general), who were in the private sector and understand the downside of domination by certain groups, and the limitations of our kind of governance. I expect them to present solutions that supercede the routine and break through bureaucracy, not to mention break the monopolies.

Treasury people fret that it's all temporary, all the reforms and structural changes, since the finance minister's term in office isn't four years. They fear that you'll up and leave. Do you see yourself remaining at the ministry throughout this government's term?

It is a realistic possibility that does not deter me in the slightest.

Just a possibility?

I do not feel I’m wasting my time here, or as has been written, that I'm wearying. We stand before a realistic possibility of an Israeli breakthrough in the international markets. If we do things right, Israel's economic situation could change dramatically.

I hold talks with very creative people from the private sector and world, who are willing to contribute their genius to boosting the Israeli economy. Take the idea of the terrestrial bridge between Eilat and Ashdod, and if somebody makes a profit from it, so what? That would be a fundamental change that would contribute to Israel's economy. The inspiration for ideas like that I find only in the private sector, but implementation wouldn't take four years, it would take eight.

Which brings us back to our question.

I do not mean to remain finance minister for eight years. As long as this government is in power, I am glad to serve as finance minister. Yes, I will remain finance minister for four years.

One derivative assumption could be that Olmert could achieve an advantage in the race for the PM's seat thanks to his diplomatic program, while your job as finance minister doesn't help you.

When I took this job I assumed it wouldn't, and in the first months, my assumption was strengthened. All I had to do was open my office window and see the city of tents set up by various protesters below. Even now, when I ravel around the country among Likud party members, there's no shoulder clapping, none of the past closeness. People spell it out: times are hard for us and our families.

But lately, and this is a change, they're telling me: push on. People know that sometimes, just like in the family's budget, tough, painful steps have to be taken in order to improve the situation in the future. In practice, the answer to your question is no. Coming to the Finance Ministry has not hurt my chances of being prime minister.

When I came back to politics, and Arik (Sharon) made the offer, I was aware of the risks, and knew what happened to all the other finance ministers who wanted advancement. I knew the economy was in poor condition.

But I asked myself, why did I return to politics. The answer was, to change the economy and politics, to bolster Israel's strength in the 21st century. So the only question I asked Arik was if he'd give me the tools I needed. The moment he said yes, I took the job. I had no illusions that the expenditure would start to grow after only nine months.

The 2004 budget is very stretched. Might you have been misguided, strategically speaking, when you declared the recession to be over, a statement that reawakened demands for budgetary plums?

The Knesset members did not go wild with their demands, but the budget is stretched. Meeting the demands that you call "coalitionary" was the proper thing to do regarding education, health and other things.

In the last year we cut the budget by an unprecedented NIS 19.5 billion. All we handed out for coalition demands as it were, to get the 2004 budget approved was NIS 400 million.

You aren't sorry you declared the recession over?

The declaration did not affect the ministers' demands, partly because they contemptuously dismissed it, and partly because they don't control the figures. By the way, the economy isn't growing by 1%, that's the average growth throughout 2003. In the second half of 2003, the economy grew by 1.7%, which is the relevant figure.

What saved you, and the economy, were the loan guarantees. Otherwise Israel would have been in danger of bankruptcy, and you'd have had to cut back a lot more.

I disagree. The guarantees played an important part, but the key step was the tremendous budget cuts. You can't cut budget infinitely. There are boundaries you can't pass.

Without the guarantees we'd have been in danger of bankruptcy. Then you would have had to make the real budget cuts.

Or the budget cuts wouldn't have been made, then we'd have gone bankrupt. It's happened to other countries.

How will the additions the ministers are demanding be financed? By breaking the budget?

There is no possibility of breaking the budget. We are ambitiously cutting government expenditure. Meeting the demands of defense, the local authorities and others will have to be done through the budget.

That's billions. From where?

Yes. It means budgetary discipline. Defense wants NIS 3 billion, the local authorities want NIS 1.5 billion or NIS 2 billion, education wants NIS 2 billion. Everything that is approved will come from the budget.

How will the separation fence be financed?

I said in advance that I see the fence as investment in defense and the economy, and said its financing would not be a problem. The fence is ostensibly outside the books, but so far it's been accounted for.

Meaning the money will come from breaking the budget.

In extremity, we will finance the fence by breaking the budget. At the moment I do not see any need.

Ultimately you capitulated over the budget without a fight. You didn't even threaten to withdraw it if the coalition demands persisted.

When I threatened to withdraw it, the factional demands had mounted to NIS 1.5 billion beyond the reserve. Within a week, their demands plunged. I thought in advance that the reserve would have to be used, because we'd cut to the bone, and because the government would have to make decisions in two areas where we have historically not controlled the budget: defense and the local authorities.

What is your No. 1 challenge now?

Mainly reforming the ports, and not to break the budget. And to lower taxes. If tax collection increases, we will have two options: to reduce the deficit, or cut tax. My tendency would be to lower taxes, which would do most to stimulate demand among the weaker segments of society.

And if tax revenues do not increase?

We will not cut taxes. The IMF suggested we deviate from the deficit target if tax collection falls further, creating the absurd situation that the ones shifting uneasily in their seats were the treasury officials. We shall not deviate from our deficit target of 4% of GDP. Our agreement with the U.S. wasn't only to meet out deficit target, but to cap expenditure. If in February we see that tax collection is strong, we can lower tax on labor, and possibly other taxes too.

What's happening about the ports?

I don't do sprints, I do long-term programs. At the ports, our objective is to establish two separate corporations for the Haifa and Ashdod ports, that will compete with one another. They will have separate managements and maximal fees set by the Transport Ministry that they may levy for services. They will compete over prices below the threshold, and over services. The Ports Authority will be dismantled in the months to come, and the state will retain ownership of the ports' land. I do not conceal that our goal, not in the far future either, is privatization. We are willing to be generous with the workers, but not with their sons and grandchildren. That has to end.

The prime minister, his son – will they lend their support?

Yes, the prime minister is lending his support. His support has been consistent absolute, throughout the whole economic program. I have not spoken with his sons and grandchildren.