Taking Stock / Our Economy Is in Trouble. Shhh!

In the defense world, secret military missions are only disclosed years after the event. The all-too-human yearning to boast is tempered by the need to maintain confidentiality. The delay can even drag out for decades, in cases when the revelation of delicate intelligence issues could help the enemy.

But Nir Gilad, the accountant-general of Israel's Finance Ministry, cannot afford to wait that long. He will be leaving his job in a matter of weeks and is positioning himself for a plum seat in the private sector. That may explain why two weeks ago, he disclosed his covert, heroic mission last year to save the economy, in an interview to Yedioth Ahronoth.

"In June 2002, the state of Israel faced bankruptcy," Gilad divulged. "We all understood that the situation was starting to be reminiscent of what happened in South Korea and the Philippines - a dramatic drop in the value of the domestic currency. I feared we'd start to climb toward six, seven shekels to the dollar.

"That situation would affect more than the government's cost of raising capital, it would affect the nation's entire financial structure, the stability of the banking establishment, and the security of the people's deposits. The public knew nothing about it because it's still secret and the discussions between the prime minister, the finance minister and the Bank of Israel governor were secret. We didn't want anybody to know about it," Gilad described.

Leaving no room for doubt, he clarifies how disaster was averted: "We initiated an economic program in June 2002 to stabilize the economy and called it Defensive Shield, after the military operation. The program prevented a dangerous worsening of the deterioration, which the public wasn't even aware of, because the gravity of the situation was kept secret."

In case you haven't grasped Gilad's role in the secret mission to save the nation, check out his statement in answer to the final question of the interview: "What was the treasury's biggest achievement during your four-year stint?"

Gilad: "Something that I told you about in this interview. Not only hasn't the treasury failed in the last years, but in 10 years' time, people will look back and understand that one of its greatest achievements was maintaining stability in the very tough times we've gone through. There is very little understanding among the public regarding the magnitude of that achievement."

A few questions about the mission

Before we order him and the former finance minister, Silvan Shalom, commemorative medallions bearing their profiles and the words "Thank you", we need a few clarifications about their Defensive Shield mission, because the answers could be highly significant for future economic policy.

The funniest aspect of the covert mission Shalom and Gilad fought on the financial front is Gilad's statement that the public basked in its innocence and knew nothing of Israel's economic woes. Thing is, the papers had reported extensively on the horrible situation of the economy and the speed at which it was sliding toward financial crisis.

Gilad's "disclosures," that demand for government bonds had evaporated, that interest rates had soared to the skies, and that the stability of the banks had become questionable, were perfectly well known to each and every player in the capital market.

In fact, the prevailing opinion was that the only ones who didn't get it were the finance minister, Silvan Shalom, and his accountant-general, Nir Gilad. Now Gilad reveals that they had smelled the danger approaching.

Maybe they did, but their grasp of the gravity of the situation was certainly not evident in the way they managed Israel's economic policy. Or in the budgets they submitted for 2001 and 2002.

Some shield

Yet the real question is, what exactly was the Economic Defensive Shield which, according to Gilad, protected the marketplace from financial collapse?

Was he referring to that budget face-lift in mid-2002? It is hard to buy that the brew of tax hikes and a NIS 2 billion budget cut was what averted the financial crisis.

Could he be referring to the government's managing to meet its deficit target of 3.9 percent of GDP? Again, probably not. Remember that 2002 began with a deficit target of 3 percent, and that the treasury only managed to (almost) meet the amended ceiling of 3.9 percent after accounting acrobatics that would make a contortionist burst into tears of envy.

We shall not try to estimate the gap between Israel and South Korea, or Argentina, in June 2002, or now for that matter. But we can take note that the chief component of the heroic mission to save the economy was the Bank of Israel's 3 percent hike in interest rates.

Not that its step was that heroic. It is very easy to raise and lower interest rates. It is the only substantial economic move that can be carried out with no trouble at all, partly because it is the province of only one man, the Bank of Israel governor, and partly because all other economic decisions are subject to political pressures and approvals.

Lifting interest rates on the shekel sky-high imposed a heavy cost on betting against the Israeli currency. It also convinced the marketplace that the central bank was determined to fight inflation, it checked the shekel's slide, and it allayed fears of financial crisis.

We must note that the steep rate hike was a U-turn from the steep rate cut 18 months before, when the Bank of Israel departed from habit and slashed lending rates by 2 percent, which startled and frightened the market.

Little change

If the economy really had returned to a track of financial stability and responsible fiscal policy, this column about the bizarre interview Gilad granted to Yedioth wouldn't need to be written. We've read even more asinine claims before, we know it's just part of the PR game.

But it was an opportunity to remember that aside from lending rates, practically nothing has changed in the government's economic management. The budget for 2003, which was supposed to be based on the lessons learned from the 2002 budget fiascoes, will generate one of the highest deficits in a decade. Unless government spending is substantially reduced, we may end 2002 with a deficit of 6 percent, second only to Japan.

If the treasury fails to pass its budget-cut proposals, the fiscal picture of June 2003 will be evocative of that of June 2002, the date on which Gilad says we approached the situation of South Korea.

What has changed is the diplomatic horizon, after the fall of Saddam Hussein. The Americans are writing us checks again to cover the deficit.

This week Bank of Israel Governor David Klein announced a rate cut for May, of only 0.3 percent, even though the business sector had been begging for more because of the dire economic situation and the collapse of inflation expectations.

Indeed, the conditions on the market do beg a steeper rate cut. But when deciding on the level and speed of tweaks in the interest rate, one should remember why we reached such high interest rates in the first place, and what "achievements" we can chalk up on the economic policy management front.