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UNCLAS SECTION 01 OF 04 TEL AVIV 006431 
 
SIPDIS 
 
SENSITIVE 
 
E.O. 12958: N/A 
TAGS: ECON EFIN IS ECONOMY AND FINANCE
SUBJECT: ISRAELI ECONOMIC GROWTH SLOWS IN THIRD QUARTER 
 
 
This cable is Sensitive but Unclassified.  Please treat 
accordingly.  Not for Internet distribution. 
 
¶1. (SBU) Summary.  Although the economy slowed in the third 
quarter, it will grow close to 4% for the year as a whole. 
The deficit is likely to come in under the targeted level of 
4% as a result of the GOI's lid on spending and a positive 
revenue picture.  The Bank of Israel (BOI) took advantage of 
a low-inflation environment to cut interest rates 0.2% in 
November, providing monetary policy support for continued 
economic expansion in 2005. 
 
¶2. (SBU) Growth has yet to result in a significant reduction 
in unemployment, which remains at 10.2% as of the third 
quarter.  The picture is unlikely to improve in  2005.  The 
poor unemployment numbers increased the political impact of 
the "poverty report," issued annually in November by the 
National Insurance Institute, which claimed that almost 30% 
of all Israeli children live under the poverty line. 
 
¶3. (SBU) Economic stability has not been affected by Likud's 
ongoing efforts to form a coalition with Labor as well as 
with at least one religious party.  Within the context of the 
coalition negotiations, economic commentators believe Labor 
will use the poverty report to push for changes to the GOI's 
economic program, including possible delays in implementing 
the Bachar Committee's capital market reforms, approved by 
the Government on November 14.  Finance Ministry officials 
claim Labor's participation will have only a minimal impact 
on the budget, which is likely to be submitted quickly to the 
Knesset once the new coalition is in place.  Although the GOI 
continues to move towards Gaza disengagement, it has yet to 
finalize budgetary numbers.  End Summary 
 
-------------------------- 
Third Quarter Growth Slows 
-------------------------- 
 
¶4. (U) Although the Israeli economy continued to expand in 
the third quarter, it did so at a significantly slower pace 
than earlier in the year.  This was due to a contraction in 
personal consumption, the port strike of July-August, which 
restricted both imports and exports; and a decline in 
international demand for Israeli exports. 
 
¶5. (U) According to initial Central Bureau of Statistics 
figures based on partial statistics, the economy grew by 3.7% 
on an annualized basis in the third quarter, following 
annualized growth of 4.3% in each of the first two quarters. 
Private consumption expenditure, which had been showing signs 
of improvement earlier in the year, also contracted; in 
particular, consumption of durable goods per capita declined 
by 20% in the third quarter, following growth of 10.5% in the 
second quarter of 2004.  Per capita private consumption 
declined by 1.8% in the third quarter, compared with an 
increase of 1.1% in the second quarter of 2004, and increases 
of 2.3% both in the first quarter of 2004 and the fourth 
quarter of 2003. 
 
¶6. (U) Business sector GDP growth moderated to 3% in the 
third quarter from 6% in the second quarter.  The third 
quarter was the first quarter since the third quarter of 2003 
in which business sector GDP was lower than GDP.   The slower 
growth in the business sector reflects the significant 
reduction in export growth from 23% in the first quarter, to 
13% in the second quarter, and 4.2% in the third quarter. 
The lower export figures are due in large part to the port 
strikes during July and August.  Imports of goods, also 
negatively affected by the port strike, grew by just 1.8% in 
the third quarter, compared with 12% in the second quarter 
and 24% in the first quarter.  The main indication of 
investment, fixed capital formation, declined by 14.3% in the 
third quarter, compared with a decline of 3.2% in the 
previous quarter. 
 
------------------------------------ 
CBS: Overall 2004 Growth Close to 4% 
------------------------------------ 
 
¶7. (SBU) On October 18, the Central Bureau of Statistics 
reported that their preliminary growth estimates indicated 
that growth would be 4% in 2004.   A CBS contact told us this 
view obtained in spite of the decline in most major 
components in the third quarter.   He cited positive trend 
data, which indicated an increase in imports of raw 
materials, durable goods and consumer durables in October. 
Industrial production also showed a positive trend in each of 
the last three months. 
 
------------------------- 
2004 Deficit Below Target 
------------------------- 
 
¶8. (U) GOI and other private forecasts indicate that the 2004 
deficit will be in the 3% to 3.5% range.  The cumulative 
deficit for the first eleven months of 2004 totaled NIS 11.4 
billion, which is only 55% of the NIS 20.6 billion deficit 
target for the entire year.  By comparison, the deficit for 
the first 11 months of 2003 stood at NIS 21.2 bio.  A Bank 
Leumi economist told us that in his estimation the deficit 
will be somewhere between 3% to 3.5% for the year, as the 
government is likely to increase expenditures in December. 
The reduction in the deficit to less than 3.5% from a deficit 
of 5.6% of GDP is primarily a result of the GOI,s success in 
curbing expenditures, as evidenced by cumulative expenditures 
for 11 months of NIS 175 bio, or NIS 46 billion less than the 
expenditure target of NIS 221 billion.  Although there has 
been a slowing down in tax revenues in recent months, the GOI 
is likely to meet the tax target of the 2004 budget. 
 
-------------------------------------- 
BOI Reduces Rates by  0.2% in November 
-------------------------------------- 
 
¶9. (U) On November 22, the Bank of Israel announced a 0.2% 
interest rate reduction to 3.9% from 4.1%.  This was the 
first change in interest in seven months, since the BOI 
reduced rates by 0.2% at the end of March.  In its press 
release, the BOI indicated that the reduction was based on 
the very low level of inflation in the past few months, as 
well as the assessment that inflation will be within the 
range of price stability (current inflation rate for the year 
is 1.2%).   The Central Bank also cites the slower economic 
recovery and weaker dollar as reasons for lowering interest 
rates without concern that it would cause economic or 
financial instability. 
 
------------------------------- 
Unemployment High but Declining 
------------------------------- 
 
¶10. (U) The Central Bureau of Statistics reported on November 
24 that unemployment declined to 10.2% in the third quarter 
of 2004, from 10.5% in the second quarter.  There was an 
increase of 3.3% in the number of employed persons in the 
first 9 months of 2004 compared with the comparable period in 
2003, representing an increase of 76,000 people.  After the 
release of the unemployment data, Finance Minister Netanyahu 
expressed satisfaction with the consistent and continuous 
decline in unemployment during the last year, and said that 
this supported the efficacy of the government,s economic 
policies. 
 
--------------------------------------------- - 
Poverty Report Sparks Discussion on Bibinomics 
--------------------------------------------- - 
 
¶11. (U) The publication of Bituach Leumi,s (National 
Insurance Institute) &poverty report8 in November led to an 
intensification of Israel,s debate over combating poverty. 
Finance Ministry officials believe in using a range of 
economic incentives, including the reduction of transfer 
payments, to induce more people to enter the workforce. 
Other observers, including the Bank of Israel and Bituach 
Leumi (BL), believe the GOI has reduced government support to 
the poor and unemployed too far too fast, thereby 
unnecessarily increasing poverty levels. 
 
¶12. (SBU) The report indicates that there was an 8% increase 
in the number of people living in poverty to more than 1.4 
million people in 2003, an increase of more than 100 thousand 
compared with 1.3 million in 2002.  The 2003 statistics 
indicated that 29.4% of children and 19% of families were 
living below the poverty level, even after receipt of 
transfer payments.  In view of the proposed inclusion of the 
Labor party in the Government, it is likely that the poverty 
report and its findings will remain an important part of the 
economic debate in 2005. 
 
------------------------------------------ 
Bachar Capital Market Reforms Move Forward 
------------------------------------------ 
 
¶13. (SBU) The Bachar capital market reform recommendations, 
which are intended to increase competition in the very 
centralized and concentrated banking sector, were approved by 
the Government on November 14.  The main aspects of the 
reforms include removing Provident funds (private retirement 
funds) and mutual funds from the banks, ownership and 
management over the next few years.  In return, the banks 
will be able to enter the insurance market, and sell life 
insurance.  The banking community has strong reservations 
about the reforms and is seeking to delay their 
implementation. 
 
¶14. (SBU) Debate over the Bachar reforms is taking place 
against the background of increased &bank bashing8 
resulting from perceptions these institutions have taken 
advantage of their strong position to leverage outsized 
customer fees.  The reforms have also become something of a 
bargaining chip in coalition talks between the various 
parties.  As one Central Bank official told us, it is 
impossible to predict whether the Bachar recommendations will 
have a fate any more successful than other (unimplemented) 
financial reform plans introduced over the past twenty years. 
 She nonetheless finds them appropriate and necessary for 
reforming a hidebound financial services sector. 
 
------------------ 
Gaza Disengagement 
------------------ 
 
¶15. (SBU) A range of GOI officials have told us that PM 
Sharon is committed to implementing his Gaza Disengagement 
plan on time ) at the latest.  Fast-paced legislative 
movement reflects this commitment.  On November 3, the 
Knesset approved the first reading of the Disengagement 
legislation.   On November 15 the Knesset Finance Committee 
approved the transfer of NIS 35 million for the Disengagement 
Plan:  NIS 30 million for prepayment of compensation to 
Settlers who agree to leave their homes, and NIS 5 million 
for the cost of the Justice Ministry to prepare Compensation 
) Evacuation legislation.   On November 16 the Disengagement 
Administration officially commenced its operations, with the 
inauguration of its website including information and forms 
regarding compensation calculations and maps showing 
re-settlement possibilities. 
 
¶16. (SBU) The Israeli media estimates disengagement will cost 
more than NIS 5 billion (USD 1.1 billion).  The Finance 
Ministry plans to apportion payment over two years in the 
2005/2006 Budgets.   For 2005, the MOF has proposed 
accommodating disengagement-related spending by raising the 
deficit target to 3.4% from the original 3%, as well as by 
increasing real expenditure growth above the 1% target.  As 
these targets form a core element of Loan Guarantee Agreement 
economic conditionality, the MOF has requested USG views on 
the changes.  Although the Israeli press has reported the GOI 
will request U.S. assistance to pay for at least a part of 
disengagement, no formal request has been made to date. 
 
------------------------------------ 
The 2005 Budget ) Temporarily Tabled 
------------------------------------ 
 
¶17. (U) The GOI will likely begin 2005 without a new budget. 
Although PM Sharon had waited a number of months to submit 
the budget in the hope of finding the necessary votes, he 
finally decided that the cost of losing was less than not 
forcing a decision.  In the end, only Sharon,s own Likud 
party and United Torah Judaism supported the NIS 264.5 
billion (approximately USD 60 billion) bill in its first 
reading on December 1.  Sharon fired ministers from the 
Shinui party who voted against the budget, an action which 
reduced his coalition to a party of one and set the stage for 
ongoing coalition negotiations with the opposition Labor 
party, United Torah Judaism and Shas.  Sharon has threatened 
to call early elections if he cannot build a coalition with 
Labor. 
 
¶18. (SBU) According to contacts at the Ministry of Finance, 
Labor will make a big show of obtaining changes to the 2005 
budget once it is in the coalition.  In reality, these 
changes will probably center on a fairly modest increase in 
transfer payments to the elderly, which can be accommodated 
within the budgetary framework.  Even if Labor achieves more 
significant budgetary changes, these will be paid for out of 
across-the-board reductions in ministerial budgets, not 
through additional spending, according to our Finance 
Ministry contacts.  The result: a 2005 deficit that should 
not exceed 3.4% of GDP (disengagement expenses included). 
 
¶19. (U) Assuming the budget does not pass before the end of 
the year, the Government will begin operating on a monthly 
appropriations based, per line item, on the lower of either 
the 2004 actual or 2005 proposed budgets.  In accordance with 
Israeli law, if the Budget is not passed by March 31, 2005, 
the Government would fall, and new elections would be called 
in 90 days. 
 
 
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