Taking Stock / It Must Be Making Silvan Crazy

Finance Minister Benjamin Netanyahu declared on Tuesday that the budget deficit for 2003 came in at 5.6 percent of gross domestic product, or NIS 28 billion. All of the pundits were quick to applaud, noting that the deficit was lower than "expectations" - and the capital market responded with another upswing, continuing its impressive gallop of recent weeks.

Silvan Shalom must be saying to himself: "If I had come with a deficit like this - 5.6 percent, one of the highest the Israeli economy has ever known - they would have killed me. They drank my blood after the 3.9 percent deficit last year and the 4.5 percent deficit in 2001. Just imagine what they would have done to me after a frightening deficit like this one.

"It would have started with the journalists, especially from one particular newspaper, which never left me alone during my entire term. They would have written about fiscal irresponsibility, about loss of control, about a lack of leadership and the dangers to Israel's credit rating.

"Next, the `Dr.' would come - the one in the building across from the government compound. I don't want to mention the name of that terrible man, who was on my back the entire time I was finance minister. He would have quickly proclaimed that a deficit of 5.6 percent represents a real threat to economic stability and that, consequently, he would be unable to lower interest rates.

"In response, bonds traders at the bourse would have dumped bonds; interest rates would have risen; and the entire capital market would have cried out that we have an irresponsible finance minister.

"I want to remind you of what Klein - oops, the Dr. said just nine months ago: His assessment then was that the government would exceed its deficit target of 3 percent for 2003 and that an anticipated 4 percent deficit would `make it difficult for him to lower interest rates.'

"And what happened? Not only did Bibi bring us a deficit almost twice as high, Klein has also slashed interest rates since then almost in half. And last month, he continued to say that he intended to continue lowering interest rates."

Okay, no need to exaggerate. Silvan Shalom's life is much happier these days, as he hops between the world's capitals. And perhaps he is not troubling himself at all with local economic matters. But the message is clear: If Silvan Shalom had come with a 5.6-percent deficit, it would have been received very differently by the capital markets, the rating companies, the Bank of Israel and the entire private sector. They would have made mincemeat of him.

So why is it going so well for Bibi?

First of all, Netanyahu is a champion of public relations and spin. During his first months as finance minister, Bibi learned what financial managers of companies traded on Wall Street usually learn after only five years - to "manage" the expectations of analysts.

When he assumed his post at the treasury, Bibi said that the deficit was an irrelevant number. Later, he said that a gigantic deficit was expected, but that this wasn't important. What was important, he said, was the government's economic program. Still later, he disseminated to the media projections of a deficit of 6-6.5 percent, despite the fact that treasury officials were telling him that the actual figure would be 5-5.5 percent.

Now, when the deficit comes in at 5.6 percent, Netanyahu happily announces that it is lower than expected. The media is paying scant attention to the figure; the analysts are applauding and the investors are saying that Bibi again delivered the goods.

Secondly, the market is still giving a lot of credit to Netanyahu: The capitulations on the budget and on Defense Ministry demands, the foot-dragging on reforms at the ports - these have not managed to taint his image. The market believes in his determination, his intentions, his measures - don't confuse them with the data.

The pension reform, cutting government spending in 2003 and Netanyahu's convincing media appearances are stronger at this stage than any recession or unemployment figures.

Thirdly, the governor of the Bank of Israel believes in the finance minister. Whereas during Silvan Shalom's term, the central bank and the treasury were publicly at odds on a daily basis, giving the financial markets a scare, the Bank of Israel is now usually cheering on the Finance Ministry. If the central bank is satisfied with a deficit of 5.6 percent, why should the analysts be worried?

Fourthly, we have $9 billion in loan guarantees. The fact that only $3 billion of this sum has been used so far makes no difference because the American guarantees reduced the risk premium for Israel, opening up world markets for us, solving the problem of debt servicing, lowering long-term interest and paving the way for the Bank of Israel to cut interest rates.

Until the era of the guarantees, any negative deficit number would immediately be translated into an urgent need for the treasury to raise funds on the local market, a wave of government bond issues and higher interest rates. Now, in the era of the guarantees, the deficit no longer frightens the markets.

Fifthly, everyone is sick and tired of being worried. No one wants another difficult year - 2001, 2002, and 2003 were enough. They want a turnabout, an upturn, a rollover of debt. People want to believe that the worst is behind us - so don't bother us about the deficit.

The good news is- that this momentum may continue for some time, especially in view of the cyclical nature of the economy and the global economic recovery. The bad news is that the deficit is a deficit. It is financed by debt and debts ultimately need to be repaid.