Taking Stock / Klein's Sunny Mood

Unbelievable. After two years of prophesying gloom and doom, making frightening comments about the stability of the banks, and rebuking the government for its economic standards - Bank of Israel Governor David Klein came out of a meeting with foreign investors and released a concise announcement to the press, in which he was quoted as saying: "The conditions for economic improvement have been created."

When it comes to the Bank of Israel and its governor, words are chosen with extreme caution. Despite the usual reservations in the announcement, one cannot ignore the difference in its tone compared with releases in the last year.

So what has happened? Why this nascent optimism?

Let's look at the facts:

l The government's deficit is expected to balloon to 6 percent of GDP this year. Worse, the government refuses to declare any commitment to reducing it significantly next year.

l According to calculations of the Bank of Israel's macroeconomic research manager, Adi Brander, and Kobi Broida, incomplete execution of the treasury's budget cuts will increase the deficit to 6.3 percent of GDP. In an optimistic scenario, Brander and Broida see a high deficit next year too, of 5.4 percent. In a pessimistic scenario, they warn it could creep up to 8.1 percent in 2008.

l The consequence of the deficit is that government debt will continue to mushroom, reaching a 10-year high of 110 percent of GDP in 2004. Unless it is restrained, it could reach 118.5 percent within five years.

Killing the long-term reforms

Since its presentation, the treasury's economic program has been systematically plucked. Many of its long-term programs have been cut back. Most notable is the decision to restore public sector salaries to their original level after two years.

The main reform that managed to pass without being savaged was that of pensions, but Jerusalem knows perfectly well that the Bank of Israel deliberately avoided discussing it publicly, because its chiefs are dissatisfied.

But even if the central bank attributes the change in Israel's economic situation to the economic program, the real reason behind Klein's change in mood is probably the resumption of the diplomatic process.

It is apparently not coincidental that last week, the Bank of Israel published a study saying that without change in the diplomatic scene, Israel's economy could not realize its growth potential.

The mood has changed among foreign investors too, as was evident in the results of last night's treasury bond issue: The government raised $750 million by issuing non-guaranteed bonds on the international market. The offering was the first after two years in which the international marketplace was closed to Israel. Since its offering on the euro market in April 2001, the treasury did not try to raise even a single dollar abroad.

Why the sudden appetite for Israeli bonds?

It had good reason, too. Foreign investment banks had intimated that attempts to raise money would end in colossal failure or at prohibitive interest rates that would signal the entire world how risky a borrower the Israeli government was.

Sunday night, the treasury's accountant-general, Nir Gilad, and his deputy, Eldad Frecher, departed for New York after receiving clear indications from Citigroup and Lehman Brothers, the offering's designated underwriters, that they could market the bonds. And market the bonds they did. The change in mood among the underwriters and investors for Israeli government bonds was also due to the reignition of the peace process and its economic consequence - America's decision to extend $9 billion in loan guarantees to Israel.

The immediate contribution of the government's fundraising efforts abroad is clear. The government will be able to ease the pressure it had been imposing on the domestic capital market. Interest rates will fall and the credit crunch will ease.

But we cannot ignore the fact that a key component of the change in Israel's marketplace is America's involvement in the Israeli arena, from every way you look at it - imposing the "road map" on Ariel Sharon and in paying for it through loan guarantees.

Also, we cannot ignore the fact that American support relieves the huge pressure on the government to slash back the public sector and introduce structural reforms.

We received a dose of oxygen from the Americans and the international markets opened up to us. But one morning we will wake up, maybe in a year's time, or two, or five, and discover what we'd started to grasp last year. That anybody relying on unilateral transfers, contributions, gifts, and subsidized loans is doomed to weaken and wither up, and crawl back every few years to beg at the White House.