This record is a partial extract of the original cable. The full text of the original cable is not available.

S E C R E T SECTION 01 OF 03 TEL AVIV 002679 
 
SIPDIS 
 
NOFORN 
 
NEA/IPA FOR WILLIAMS, GREENE, WAECHTER; EB/IFD FOR DIBBLE; 
NSC FOR ABRAMS, LOGERFO; TREASURY FOR ADKINS 
 
E.O. 12958: DECL: 07/04/2016 
TAGS: ECON EFIN EAID PGOV PREL IS ECONOMY AND FINANCE ISRAEL RELATIONS
SUBJECT: MOF OFFICIAL PRESENTS THE CASE FOR EXTENDING THE 
LGA 
 
Classified By: Economic Counselor William Weinstein for reasons 1.4 b a 
nd d. 
 
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Summary 
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¶1.  (C)  Finance Ministry official Eyal Klein told Deputy 
Economic Counselor July 4 that the GOI decision to increase 
year-to-year spending from 2007 to 2009 by 1.7 percent, in 
violation of its commitment to the U.S. in the 2003 U.S. - 
Israel Loan Guarantee Agreement (LGA) to keep spending 
increases to one percent, was a political rather than 
economic decision.  While saying that he personally prefers 
that spending increases remain at the one percent level, 
Klein justified the higher increase by citing the much 
improved condition of the Israeli economy.  He added that the 
2006 deficit would approach zero due to a confluence of 
favorable factors, and said that the GOI goal of having an 
ongoing one percent deficit by 2009 is on track.  Klein also 
said the GOI very much wants to extend the LGA for four more 
years to provide a "rainy day umbrella" in case the good 
economic times do not last.  He also noted that the LGA was 
useful in the past as a means of restraining the desire of 
politicians to spend too much, and thinks it will continue to 
be useful for the same reason in the future, especially as 
the temptation to spend will be ever greater in this more 
prosperous era.  On "realignment," Klein said that there has 
been no MOF planning on the issue, and that the ultimate cost 
could reach anywhere from USD ten to 20 billion.  End Summary. 
 
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1.7 Percent a Political Decision 
-------------------------------- 
 
¶2.  (C) At the July 4 celebration at the Ambassador's 
residence, Eyal Klein, Director for Debt, Capital Markets, 
and Foreign Currency Transactions at the Ministry of Finance 
(MOF) told Deputy Economic Counselor that the decision to 
raise year-to-year expenditures by 1.7 percent instead of the 
one percent stipulated in the 2003 U.S. - Israel Loan 
Guarantee Agreement (LGA) was a political decision made for 
coalition-forming purposes.  He noted that Amir Peretz, the 
Defense Minister and leader of the Labor Party, still is not 
pleased with the agreement on a 1.7 percent expenditure 
increase for the three years beginning in 2007, and will 
likely push for higher increases when budget talks actually 
begin.  When asked to explain the rationale behind the 1.7 
percent figure, Klein said that the Israeli population is 
growing at about that rate on an annual basis.  The idea is 
that growing the budget at the same rate as the population 
keeps per capita spending the same, so that there is no cut 
in spending per citizen, as there is with a smaller one 
percent spending increase. 
 
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Israel Should Have Consulted with the U.S. 
------------------------------------------ 
 
¶3.  (C) Klein acknowledged that the GOI has an obligation to 
the USG to maintain the one percent spending growth rate per 
the LGA and admitted that the GOI made a poor decision to 
increase it without consultations.  He expressed the hope, 
however, that the USG would understand that the decision was 
made in the heat of difficult political maneuvering in 
Israel, during a period when poverty and social spending 
became burning election issues.  He said that the lack of 
consultation with the U.S. was an oversight, and hoped that 
the recent phone conversation between MOF DG Yossi Bachar and 
officials from State and Treasury laid the groundwork to 
repair any damage.  He noted that the Israeli side will come 
to the Joint Economic Development Group (JEDG) meeting in 
November prepared to explain and defend Israeli actions, and 
hoped for U.S. understanding. 
 
----------------------------- 
2006 Deficit Approaching Zero 
----------------------------- 
 
¶4.  (C) Aside from the pressure to deal with social 
inequalities, Klein noted the recent outstanding performance 
of the Israeli economy, and the vast differences between the 
situation today and when the LGA was signed.  In particular, 
he mentioned that both the deficit and the increase in 
expenditures were lower in 2005 (about a two percent deficit 
and about a one percent increase in spending) than normally 
permitted in the LGA, and much lower than the increased 
numbers of two percent expenditure growth and 3.4 percent 
deficit allowed in 2005 because of the disengagement.  He 
said that the deficit for 2006 will likely approach zero due 
to unexpectedly high revenues resulting from one-time events 
such as sales of government companies and low spending due to 
the delayed passage of the budget, and that the GOI is on 
track overall towards fulfilling its goal of an ongoing one 
percent deficit by 2009.  He also noted that Minister 
Hirchson has even expressed the desire to see the deficit hit 
zero by then. 
 
----------------------------------- 
LGA Spending Limitation Very Useful 
----------------------------------- 
 
¶5.  (S) When pressed, Klein admitted that he personally 
opposed the decision to increase spending, saying that it is 
very difficult for politicians to restrain themselves from 
spending when money is available.  He noted that the one 
percent limitation had proven extremely useful, and that the 
MOF often used it during the last three years to prevent 
ministers from overspending.  He gave a great deal of credit 
to former Finance Minister Netanyahu for getting the reform 
program off the ground, noting that by cutting spending and 
numerous allowances, Netanyahu sacrificed his personal 
political base among the less well off for the good of the 
country.  He noted that the present Finance Minister, Avraham 
Hirchson, is not in a particularly strong political position 
and will likely have a hard time refusing other ministers' 
entreaties for more money.  He hoped that the Prime Minister 
would be personally involved in pushing for fiscal restraint. 
 
 
---------------------------- 
Extend LGA for a "Rainy Day" 
---------------------------- 
 
¶6.  (C) When asked about the Israeli request to extend the 
LGA for four years, Klein said that such an extension would 
be extremely useful for the GOI, and would serve as a sort of 
"rainy day umbrella" should unforeseen economic problems 
arise.  While individual military or terrorist events no 
longer rile the Israeli markets as in the past, nor do they 
drive away foreign investors, Klein worried that an 
accumulation of such events could have a negative overall 
impact over time and damage Israel's ability to borrow on the 
international markets.  Continued access to long-term 
low-rate U.S.-backed loans would do much, in his opinion, to 
stem any such worries in the international financial 
community.  He acknowledged that the original reason for the 
issuance of the guarantees has been accomplished, but hopes 
that, upon examination, the current situation would warrant 
serious U.S. consideration of the extension request. 
 
¶7.  (C) In addition, Klein stated that continued existence of 
the guarantees would provide the MOF a lever to restrain 
spending by the GOI.  When asked why the terms in the LGA 
would have credibility with other ministries, given Israel's 
unilateral breach of the previous terms, Klein said that the 
existence of the LGA as an expression of continued USG 
interest in the need for GOI fiscal restraint is extremely 
useful, regardless of the specific numbers delineated in the 
agreement.  Allowing the LGA to lapse would remove one 
additional -- and very important -- impediment to 
unrestrained spending. 
 
----------------------------------------- 
Loans Will Be Used up if LGA Not Extended 
----------------------------------------- 
 
¶8.  (C) When asked what the GOI would do regarding the unused 
portion of the guarantees, should the LGA not be extended, 
Klein said that the MOF would use them all prior to the 2008 
LGA expiration.  He noted, however, that this would not be 
his preference since doing so would increase the external 
component of Israel's debt structure to uncomfortable levels 
and would crowd out other types of borrowing.  Despite these 
disadvantages, however, the MOF could not pass up the highly 
advantageous terms of the loans available through the LGA and 
will use them all before they expire. 
 
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No Planning Yet for Realignment 
------------------------------- 
 
¶9.  (C) On "realignment," Klein said that there had been 
absolutely no MOF planning, or even discussion, of the 
possible costs involved.  He said that about NIS six billion 
(about USD 1.35 billion) had been spent so far on the Gaza 
disengagement, and that the final cost will likely end up 
being in the NIS nine billion (USD two billion) range.  He 
speculated that realignment could cost many times as much, 
from USD ten to 20 billion, or more.  He also noted -- 
ruefully -- the possibility that the USG, if asked for 
assistance, may suggest using the remaining guarantees to 
finance realignment. 
 
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