VZCZCXRO2222
RR RUEHROV
DE RUEHTV #0725/01 0861324
ZNR UUUUU ZZH
R 271324Z MAR 09
FM AMEMBASSY TEL AVIV
TO RUEHC/SECSTATE WASHDC 1182
INFO RUEHXK/ARAB ISRAELI COLLECTIVE
RHEHNSC/NSC WASHDC
RUEATRS/DEPT OF TREASURY WASHDC

UNCLAS SECTION 01 OF 04 TEL AVIV 000725 
 
SIPDIS 
 
NEA/IPA FOR GOLDBERGER, SACHAR; EEB/IFD FOR JACOBY; TREASURY FOR 
BALIN 
 
E.O. 12958: N/A 
TAGS: ECON EFIN PGOV ELAB IS
SUBJECT: BOI PROPOSED SPENDING INCREASE TO COMBAT RECESSION 
 
------- 
Summary 
------- 
 
¶1.  The Bank of Israel (BOI) presented a plan of modest spending 
increases to combat Israel's economic downturn.  The cost is about 
NIS 4.4 billion (USD 1.1 billion), designed to offer incentives for 
the labor market, for infrastructure investment and for exporters. 
Implementation would raise the deficit, but the BOI says that, given 
Israel's excellent record of fiscal responsibility over the past 
five years, the markets should understand the need for these 
one-time spending measures.  If the downturn turns out to be harsher 
and longer than expected, the BOI said it might be necessary to 
implement a variety of spending cuts to maintain fiscal discipline, 
including delaying or canceling certain aspects of its plan.  It 
also strongly recommended that the new government come up with a 
comprehensive and credible economic program based on multi-year 
fiscal targets to enable it to focus on longer-range goals and 
priorities beyond the immediate necessity of dealing with the 
financial crisis.  Israel's unexpectedly successful bond offering on 
the international market last week is an indication that the Israeli 
economy is perceived as relatively strong compared to many others. 
 
 
----------------------------- 
NIS 4.4 billion Spending Plan 
----------------------------- 
 
¶2.  The Governor of the Bank of Israel (BOI) Stanley Fischer 
recently proposed modest increases in spending to combat Israel's 
economic downturn.  The BOI's latest 2009 growth forecast projects 
1.5 percent negative growth for the year, following growth of 4 
percent in 2008.  The cost of implementing the BOI's proposed steps 
is NIS 4.4 billion (USD 1.1 billion).  The plan offers incentives 
for the labor market, and for infrastructure investment and 
exporters. 
 
------------------------ 
Plan Would Raise Deficit 
------------------------ 
 
¶3.  Implementation of the proposal would raise the deficit in 2009 
to 5.8 percent, higher than the BOI's earlier deficit forecast of 
5.2 percent.  However, the BOI said that as long as it is understood 
that its proposal includes one-time, temporary measures to deal with 
an extreme situation -- a global crisis that could cause a sharp 
increase in unemployment and poverty -- the increased spending will 
likely not damage Israel's credit rating or raise the risk premium 
on its debt.  The BOI noted that this is due to the GOI's stringent 
policy of fiscal restraint since 2003, and its success in 
dramatically lowering Israel's debt to GDP ratio.  The "very 
moderate" expenditure increase the BOI is proposing will not have 
much impact on that ratio.  The BOI is recommending that the 
government prepare a comprehensive multi-year fiscal plan, similar 
to that presented by then Finance Minister Netanyahu in 2003.  It 
strongly emphasized the importance of credibly maintaining a 
declining debt to GDP path, despite the current difficulties. 
 
----------------------- 
Labor Market Incentives 
----------------------- 
 
¶4.  The BOI plan calls for a total of NIS 1,790 million (about USD 
450 million) for labor market relief.  NIS 750 million (USD 188 
million) would be used to implement a long-planned Earned Income Tax 
Credit nationally.  NIS 555 million (USD 140 million) would go 
towards increasing unemployment benefits, particularly extending the 
period of eligibility for receiving payments.  For example, those 45 
and older would be eligible to receive benefits for 200 days in 
place of the present 175.  Those aged 28 to 35 with fewer than three 
children would receive benefits for 138 days instead of the present 
¶100.  The number of months of work needed to be eligible for 
unemployment benefits would also be reduced from twelve months out 
of the last eighteen, to nine. 
 
¶5.  The BOI proposal also calls for spending NIS 200 million (USD 50 
million) to extend the "welfare to work" Wisconsin Training and 
Employment Plan beyond the current pilot areas nationwide.  It 
envisions spending NIS 185 million (USD 46 million) on a program to 
reduce the number of foreign workers in the country.  Finally in the 
area of labor market incentives, the plan would provide NIS 100 
million (USD 25 million) to finance temporary leave for employees at 
factories that are experiencing difficulties. 
 
------------------------- 
Infrastructure Investment 
------------------------- 
 
 
TEL AVIV 00000725  002 OF 004 
 
 
¶6.  The second tranche of the program allots NIS 1.5 billion (USD 
375 million) for infrastructure investment.  This includes NIS 500 
million (USD 125 million) for infrastructure projects, particularly 
public transportation.  It also includes a similar amount for 
projects such as rehabilitating city centers and neglected tourist 
areas, and for moving IDF bases to the Negev.  This part of the 
program also calls for moving forward on projects in the education 
sector, and for investment in other one-time projects such as new 
computer systems for the government. 
 
------------------------------ 
Industry and Export Incentives 
------------------------------ 
 
¶7.  The NIS 1.15 billion (USD 288 million) allotted for industry and 
export incentives includes NIS 750 million (USD 188 million) for 
increasing R & D budgets, NIS 600 million (USD 150 million) of which 
is targeted for the office of the Chief Scientist.  NIS 400 million 
(USD 100 million) would also be used to provide increased levels of 
risk insurance for companies involved in international trade. 
 
--------------------------- 
Quick and Easy to Implement 
--------------------------- 
 
¶8.  According to the BOI, the plan should be easy and quick to 
implement.  The bank stressed the importance of moving quickly to 
ensure that its impact be apparent in 2009.  It said that it is 
preferable to increase expenditures that do not require long-term 
planning - while infrastructure investment is always touted as a 
tool to stimulate economies, the benefit of such expenditure is 
often felt only over the long-term.  The BOI also suggested that the 
government attempt to reach agreement with the Histadrut Labor 
Federation to delay public sector wage increases scheduled to go 
into effect this year. 
 
-------------------------------- 
Soften the Blow of the Recession 
-------------------------------- 
 
¶9.  As the BOI's economic forecasts have become more pessimistic 
with time, the hope is that this relatively modest plan will 
slightly soften the blow of the recession in terms of growth, 
unemployment, and the number of people falling under the poverty 
line.  Following four years of greater than five percent growth, the 
Israeli economy grew by four percent in 2008, despite the onset of 
the worldwide financial crisis in the second half of the year.  This 
attests to the continued strong fundamentals of the economy.  The 
global slowdown took time to actually impact on Israel, which 
registered 0.9 percent growth in the third quarter of 2008, followed 
by a negative growth of 0.5 percent in the fourth quarter.  Exports 
alone declined by 43.6 percent in the fourth quarter, although the 
Central Bureau of Statistics notes that export figures are given to 
volatile swings from quarter to quarter 
 
--------------------------------------------- - 
2009 Negative Growth of 1.1 Percent with Plan 
--------------------------------------------- - 
 
¶10.  While explaining the BOI's economic proposal, Fischer also 
presented the bank's most updated forecasts for 2009 and 2010. 
These include negative growth of 1.5 percent in 2009, which would 
make this year even worse than the recession years of 2001 and 2002, 
when growth was negative 0.4 percent and negative 0.7 percent, 
respectively.  At that time, the recession was due to a combination 
of factors, including the Intifada, the bursting of the high-tech 
bubble and the NASDAQ downturn. The BOI says that the implementation 
of its proposed economic plan would marginally ease the present 
downturn by increasing growth 0.4 percent in 2009, bringing the 
overall negative growth for the year to 1.1 percent. 
 
----------------------- 
Unemployment Up Sharply 
----------------------- 
 
¶11.  The BOI forecast an unemployment rate of 7.8 percent by the end 
of 2009, but added that implementation of its plan could reduce this 
to 7.3 percent, resulting in 15,000 fewer unemployed and 4000 fewer 
people living in poverty.  These numbers stand in marked contrast to 
the 2008 unemployment figures of six percent in the second and third 
quarters and 6.3 percent in the fourth quarter.  The daily press is 
filled with reports about layoffs in all sectors of the economy, 
with growing numbers of people applying for unemployment benefits, 
20,000 in January alone. 
Labor Participation, which increased over the last few years to 52.9 
percent in 2008, was also forecast by the BOI to decline to 51.8 
percent in 2009.  The BOI claims that implementation of its plan 
would halt the decline at 52.1 percent. 
 
TEL AVIV 00000725  003 OF 004 
 
 
 
---------------------------------------- 
Increased Deficit and Debt to GDP Ratio 
---------------------------------------- 
 
¶12.  While preventing spiraling unemployment is viewed as one of the 
major goals that will face the new government, the BOI plan has a 
price. It will increase the deficit which is already expected to be 
high, and the debt to GDP ratio as well.  The general view among 
economists is that the deficit in 2009 will be over 5 percent as a 
result of the sharp decline in tax revenues.  The BOI 2009 deficit 
forecast is now 5.2 percent.  The BOI assesses that implementing its 
economic plan would raise it to 5.8 percent, if no cuts are made to 
offset the spending increases. 
 
¶13.  This contrasts starkly with 2007's almost-balanced budget and 
the 2008 deficit of 2.1 percent.  The 2008 figure was 0.5 percent 
higher than originally forecast due to the Ministry of Finance's 
(MOF) decision to stimulate the economy towards the end of 2008 by 
spending in advance NIS 4.4 billion that had originally been slated 
for spending in 2009. 
 
¶14.  The debt-to-GDP ratio has been on a steady and significant 
decline since the implementation of the 2003 Economic Recovery Plan 
under then-Finance Minister Netanyahu.  It declined from about 103 
percent at its height to 79.6 percent in 2007 and 78.1 percent in 
¶2008.  The BOI forecasts that it will increase to 85.7 percent in 
¶2009.  Implementation of the BOI's plan would increase it slightly 
more -- to 86.2 percent this year. 
 
-------------------------------------- 
BOI Favors Anti-cyclical Intervention 
-------------------------------------- 
 
¶15.  At the end of 2008, before the BOI had adopted its more 
pessimistic growth and deficit forecasts for 2009, Fischer publicly 
called for a very cautiously expansionary fiscal policy based on the 
"automatic stabilizer" of an increase in the deficit resulting from 
increased government expenditures - on unemployment payments, for 
example - at the same time that tax revenues are reduced by the 
slowdown.  Now, hit by the reality of a deeper-than-forecast 
downturn, the BOI thinks that the time has come to implement 
anti-cyclical intervention beyond the automatic stabilizers.  Their 
plan, which aims to increase demand, is much preferable, in the 
BOI's view, to raising taxes or significantly cutting the budget, as 
these measures would deepen the slowdown.  Forecasting a 0.5 percent 
reduction in private consumption in 2009, compared to a 3.9 percent 
increase in 2008, the BOI's assessment is that adoption of its plan 
would enable private consumption to grow by 0.1 percent in 2009.  In 
the central bank's view, an increase in the deficit is mitigated by 
the temporary nature of the plan and the extreme circumstances 
dictating its implementation.  The judgment is that this will not 
have a large influence on the cost of financing debt. 
 
---------------------------------- 
Low Debt-to-GDP Vital in Long Run 
---------------------------------- 
 
¶16.  The BOI replied to criticism that the plan's NIS 4.4 billion in 
expenditures is too little to have any real impact on the economy by 
saying that any spending increase needs to be moderate, in order to 
minimize the increase in the deficit and the cost of financing the 
growing debt.  In addition, the BOI stressed that the government 
must reaffirm its commitment to significantly reduce the debt-to-GDP 
ratio in the medium term.  Excessive expansion of expenditures 
without a credible plan that includes medium term fiscal targets and 
eventual budget cuts would harm the GOI's fiscal credibility and 
endanger its credit rating. 
 
---------------------------------------- 
Ideas on Offsetting the Cost of the Plan 
---------------------------------------- 
 
¶17.  Numerous commentators criticized the BOI for not suggesting 
enough offsets to pay for the costs of its plan.  Many note the need 
for expenditure cuts which would not affect domestic activity, 
implying a reduction in the defense budget. (Note: Dr. Karnit Flug, 
the Chief of Research at the BOI and one of the chief authors of its 
economic plan, was a member of the Brodet Committee, which decided 
in 2007 that the defense budget needed to be increased while at the 
same time calling for the military to implement efficiency measures 
to reduce its budget. End Note). 
 
-------------------------- 
Sharper Cuts May be Needed 
-------------------------- 
 
¶18.  The BOI notes that based on decisions made by the outgoing 
 
TEL AVIV 00000725  004 OF 004 
 
 
government on expenditures in the coming years, implementing these 
plans will require offsetting measures in order to maintain the 1.7 
percent annual expenditure ceiling, committed to by the GOI to the 
USG according to the 2003 Loan Guarantee Agreement.  The BOI's 
assessment is that if the government does not offset the increases 
in expenditures, some of which have been agreed to by the current 
government, and the economic situation is severe and continues for 
longer than anticipated, the deficit in 2010 could reach 7.4 percent 
and debt to GDP could increase to more than 90%. 
 
¶19.  The BOI suggests that in such a scenario, in which the 2010 
deficit will be even higher, the tax reductions planned for the last 
year of Netanyahu's five year tax reduction plan - presented when he 
was Finance Minister and estimated to cost about NIS 2.5 billion 
(USD 625 million) - should be delayed. In such a case, it also 
suggests cancelling certain tax exemptions, increasing the VAT, 
curbing the increase in other government expenditures, and even 
delaying or canceling certain aspects of its proposed plan.  The BOI 
noted that in any case, large cuts will be necessary in 2010 in 
order to meet the expenditure ceiling. 
 
--------------------- 
One-Time Increases OK 
--------------------- 
 
¶20.  The BOI noted that the fiscal consolidation that took place in 
the last five years reduced yields on government debt and improved 
Israel's credit rating.  Given the shakeup in the global economy, it 
thinks that it is worth risking a temporary increase in the deficit 
despite of the uncertainty regarding the markets' reaction.  The BOI 
also noted that similar policies have been undertaken in other 
countries.  As long as the new government presents a comprehensive 
and credible economic plan that will be based on multi-year fiscal 
targets, the risk of the BOI plan is minimal. 
 
---------------------------------- 
Most Successful Ever Bond Issuance 
---------------------------------- 
 
¶21.  With all of its problems, the Israeli economy is relatively 
healthy in comparison with many others around the world.  On March 
19, the GOI successfully floated Israel's largest-ever bond issuance 
on the international markets.  The MOF had originally intended to 
test the waters with a USD 500 million ten year-issuance, but 
tripled the amount to USD 1.5 billion after receiving indications 
that the market demand for the GOI bonds could reach as high as USD 
12 billion.  The rate of interest was 5.19 percent. 
 
------- 
Comment 
------- 
 
¶22.  It is not at all clear what impact the BOI's plan will have on 
whatever government is ultimately formed in Israel.  It is likely 
that, during this interim transaction period, the BOI wanted to 
reassure the public and the markets that someone was paying close 
attention to the country's economic problems and formulating 
practical plans to deal with them.  Fischer's moderate plan serves 
as a warning to the new government that, while action is called for, 
so is prudence and responsibility.  It remains to be seen what the 
final costs of the coalition agreements will be and how much money 
will be left for further discretionary spending to stimulate the 
economy.  In any case, the success-beyond-expectation of last week's 
bond offering indicates that, with all its problems, the Israeli 
economy is still perceived as among the healthiest in the world. 
 
 
 
CUNNINGHAM