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DE RUEHTV #0194/01 0271158
ZNR UUUUU ZZH
R 271158Z JAN 10
FM AMEMBASSY TEL AVIV
TO RUEHC/SECSTATE WASHDC 5191
INFO RUEHXK/ARAB ISRAELI COLLECTIVE
RHEHNSC/NSC WASHDC
RUEATRS/DEPT OF TREASURY WASHDC

UNCLAS SECTION 01 OF 06 TEL AVIV 000194 
 
SIPDIS 
 
SENSITIVE 
 
NEA/IPA FOR GOLDBERGER,FRELICH; EEB/IFD FOR PERDUE; EEB/OMA FOR 
ENGLE;  TREASURY FOR BALIN 
 
E.O. 12958: N/A 
TAGS: ECON EFIN PGOV ELAB IS
SUBJECT: JEDG MIDTERM REVEIW - ISRAEL ON TARGET FOR FY2010 LOAN 
GUARANTEES AND EAGER FOR HIGH-TECH COLLABORATION 
 
REFS:  A) 09 STATE 76107; B) 09 TEL AVIV 653 
 
------- 
Summary 
------- 
 
¶1.  (SBU)  At the December 15 mid-term review of the U.S.-Israel 
Joint Economic Development Group (JEDG) held in Jerusalem, the GoI 
clearly demonstrated that it is meeting, and may well surpass, the 
calendar year 2009 conditionality required to release the FY2010 
tranche of loan guarantees.  The GoI focused JEDG discussions on its 
positive economic performance, despite the global financial crisis, 
and on its desire to engage the U.S. in a high-tech dialogue.  The 
U.S. delegation, led by Treasury Acting Assistant Secretary for 
International Affairs Andy Baukol, presented the outlook for the 
U.S. economy, and offered its views on a future Israeli fiscal rule. 
 While expressing willingness to explore avenues of high-tech 
cooperation, the U.S. delegation remained non-committal citing 
funding constraints and consideration of the proper government role. 
 The Director General of the Ministry of Finance, Haim Shani, led 
the Israeli delegation, with Governor Fischer presenting Bank of 
Israel's monetary outlook.  Shani spearheaded the push for robust 
USG involvement in promoting the high-tech dialogue and a variety of 
Israeli officials underscored the call, including the head of the 
Economic Council, Dr. Eugene Kandel and the Chief Scientist of the 
Ministry of Industry, Trade and Labor, Dr. Eli Opper. End Summary. 
 
----------------------- 
A Tale of Two Economies 
----------------------- 
 
¶2.  (SBU)  At the JEDG mid-term review held on December 15, 2009 in 
Jerusalem, Acting Treasury Assistant Secretary for International 
Affairs Andy Baukol began the meeting by providing a sobering update 
on the U.S. economy.  From negative GDP growth until the third 
quarter of 2009 and an unemployment rate at a 26-year high, Baukol 
looked to the positives of improving financial conditions and a 
stabilization of the housing market.  He shared Treasury Secretary 
Geithner's goals for financial sector reform:  1) avoiding 
regulatory arbitrage 2) increasing accountability by regulators, 3) 
increasing the resilience of the financial sector and 4) avoiding 
the "too-big-to-fail" enterprises. 
 
¶3.  (SBU)  The outlook of a return to growth in 2010 and solid 
growth thereafter was moderated by the assessment that unemployment 
will remain high through 2010 and the federal budget deficit will 
remain at roughly 10 percent of GDP.  Fiscal projections from the 
Office of Management and Budget (OMB) show publically held 
debt-to-GDP rising through 2019 and mandatory spending on Social 
Security, Medicaid and Medicare increasing to 60 percent of the 
federal budget by 2080 on the current trajectory.  Baukol 
underscored the current administration's belief that spending on 
entitlement programs and healthcare will be the biggest economic 
problems the U.S. must address in the next four years.  Baukol also 
stressed the danger of snowballing interest payments on debt if the 
U.S. does not return to deficits under 3 percent of GDP (the 
long-term average U.S. growth rate) once private sector growth 
returns. 
 
¶4.  (SBU)  Ministry of Finance Director General Haim Shani offered a 
largely positive macroeconomic overview of the Israeli economy, 
spotlighting the role of the high-tech industrial sector as a key 
engine of Israeli economic growth.  Shani commented that Israel 
suffered less in the global crisis due to the financial nature of 
the fully external shock.  Exporters of financial goods and 
sophisticated markets such as derivatives experienced the worst of 
the crisis.  However, the relative lack of sophistication in 
Israel's banking sector and its status as a high-tech goods 
exporter, a sector which saw only moderate decline following the 
crisis, allowed its economy to rebound quickly.  The MoF estimated 
that Israeli GDP grew by a conservative 0.3 percent in 2009 and 
forecasts 1.5 percent growth in 2010.  The second quarter of 2009 
showed the first evidence of recovery in Israel, and DG Shani 
emphasized Israel's improved position relative to other countries. 
Focusing on exports, Shani cited a small increase in exports to the 
U.S. in 2009 (whereas exports to all other markets decreased), and 
credited the resilience of Israel's exports in part due to the 
opening of a major Intel fabrication plant in Kiryat Gat, north of 
Beersheba.  From 2002 to 2008, high-tech exports doubled, and now 
comprise 12 percent of GDP and over 30 percent of total exports. 
Shani did note, however, that Israel is still vulnerable to a 
high-tech downturn similar to the one experienced in 2001-2003, a 
period of slow growth and increasing fiscal deficits. 
 
¶5.  (SBU)  Shani also highlighted labor market statistics, noting 
 
TEL AVIV 00000194  002 OF 006 
 
 
the downturn in unemployment in the 3rd quarter (7.8 percent down 
from 8 percent in the 2nd quarter), the nominal freeze in wages, and 
signaling the government's interest in reversing the trend of 
decreasing labor participation among the ultra orthodox and the Arab 
minorities.  Capital markets and credit conditions improved 
dramatically from December 2008 to November 2009.  Corporate bond 
issuances and prices have shown significant improvement since April 
2009 after a period of stasis during the financial crisis.  Shuki 
Oren, the Accountant General at the MoF, noted his concern that the 
mood may be too exuberant and cautioned that Israel and the global 
economy are still in crisis. 
 
¶6.  (SBU)  On fiscal matters, Shani again emphasized Israel's 
progress relative to other OECD countries.  Stronger spending 
controls in Israel's budget since 2002, supported by conditions on 
U.S. loan guarantees, brought Israel's public expenditures down to 
42.9 percent of GDP in 2008, lower than the OECD average.  With 
Israel's high military expenditures and high interest payments, 
civilian expenditures rank among the lowest of industrialized 
countries, a matter of concern for some at the Bank of Israel and 
elsewhere in the GoI.  Shani expected the actual budget deficits for 
2009 and 2010 to be one percentage point less than the 6 percent and 
5.5 percent of GDP deficit ceilings agreed to at the June JEDG 
meeting -- about 4 percent in 2009 and 4.5 percent in 2010.  He 
added that Israel's increase in public debt due to the economic 
crisis is one of the lowest among advanced economies, estimated at 
80 percent of GDP in 2010. 
 
¶7.  (SBU)  Shani shared the IMF's advice from its recent mission to 
Israel that the increase in global debt-to-GDP ratios relative to 
that of Israel may not be beneficial to Israel's cost of funding. 
An increased supply of high-grade American and European debt may 
crowd out Israeli international debt and raise its cost of 
financing.  As such, Shani reiterated Israel's commitment to further 
lowering its debt-to-GDP ratio in the near term.  He cautioned, 
however, that current projections do not anticipate Israel's debt 
load decreasing until 2012. 
 
¶8.  (SBU)  When asked about 2010 debt management plans, MoF 
Accountant General Shuki Oren stated that Israel plans to issue $1.5 
billion in international bonds in the first quarter of 2010 and is 
contemplating at least one other large external offering in 2010 to 
finance Israel's budget deficit and reduce crowding-out pressures on 
Israel's domestic corporate debt market.  At least one offering will 
be Euro-denominated while the others will likely be 
dollar-denominated.  Oren added that Israel expects to raise a 
maximum of $1 billion from the Diaspora community in 2010, and said 
that U.S. guarantees remain a "backstop" that Israel will not likely 
utilize unless the Ministry deemed other sources of financing too 
costly.  He did, however, note the importance of the guarantees to 
investor confidence in Israeli debt. 
 
--------------------------------- 
Bank of Israel on Monetary Policy 
--------------------------------- 
 
¶9.  (SBU)  Bank of Israel Governor Stanley Fischer gave JEDG 
participants an overview of BOI growth forecasts, monetary policy, 
and assessment of health of the banking system. He noted that the 
Bank would likely revise 2010 growth rates upwards, but currently 
forecasts 2.5 percent.  He underscored the openness of the Israeli 
economy and the current account surplus of 3.6 percent of GDP in 
2009, expected to decline slightly in 2010 to 2.3 percent of GDP. 
 
¶10.  (SBU)  Fischer explained the BoI's recent monetary policy 
measures, including interventions in the foreign currency markets, 
as the need to increase reserves and improve currency dynamics in 
the face of a looming recession and a 20 percent appreciation of the 
shekel.  While noting that the exporter's ideal shekel/dollar 
exchange rate would be around 4, he said the Bank started 
intervening with U.S. Treasury bill purchases when the shekel was at 
3.3 to the dollar.  Daily purchases of $25 million per day started 
in March 2008 and increased to $100 million per day in July 2008. 
In August 2009 the BoI enacted an exit strategy that called for an 
end to daily purchases and continue to use ad-hoc interventions to 
guide exchange rate expectations and guard against movements deemed 
to be out of synch with Israel's economic fundamentals.  Fischer 
noted that he did not want to spur excessive currency market 
volatility and an unchecked appreciation of the shekel and therefore 
is pursuing a slow exit from daily interventions. 
 
¶11.  (SBU) By November 2009, foreign exchange reserves amounted to 
$61.5 billion, up $32.9 billion from March 2008.  Fischer noted that 
since 70 percent of Israel's exports are listed in U.S. dollars, and 
an even larger amount are incorporated into final goods sold in the 
 
TEL AVIV 00000194  003 OF 006 
 
 
U.S. markets, the BoI concentrates largely on the shekel-dollar 
exchange rate in its evaluation of Israel's real effective exchange 
rate.  The BoI also began purchasing government bonds through open 
market operations in February 2009, stopping in July 2009 as it 
became clear that Israel was coming out of a short recession. In 
all, the BoI purchased 3 percent of GDP in bonds, markedly less as a 
percentage of GDP than the Bank of England or the U.S. Federal 
Reserve. 
 
¶12.  (SBU)  When asked about the outlook of Israel's foreign 
exchange intervention policy, Fischer explained that he disagreed 
with the IMF recommendation to publically announce an end to 
interventions as he believes reserving the right to intervene will 
help guide market expectations to avoid excessive appreciation 
speculation.  He said that most private trading on the currency 
market does not follow long-erm trends and most actors do not 
employ sophistcated hedging techniques.  As such, he sees a 
cotinued, but gradually diminishing, role for the Ban in managing 
Israel's currency market. 
 
¶13.  (BU)  Fischer presented interest rate policy by firt noting 
Israel's history of high inflation and the Bank's focus on 
controlling inflation expectations. To counter rising 12-month 
inflation expectations above the Bank's 3 percent upper target, the 
BoI raised Israel's benchmark rate from 0.5 percent to 1 percent 
between September and the time of the December 15 JEDG midterm 
review. (Note: An additional increase at the end of December brings 
the current rate to 1.25 percent.)  Governor Fischer explained that 
inflation expectations remain at the upper end of the BoI's 1-3 
percent price stability range, and inflation momentum from the rise 
in Israel's value-added tax along with anticipated growth will 
likely precipitate further rate hikes.  Fischer commented that his 
ability to raise rates is somewhat constrained by interest 
differentials with the U.S. and European Central Bank, which may 
increase if developed market central banks do not raise rates while 
the BoI feels compelled to do so.  Regarding the banking system, 
Fischer noted that Israeli banks were able to raise funds on the 
capital markets and did not require government assistance.  The 
Supervisor of Banks exerted consistent pressure on banks to maintain 
capital requirements.  Although Israel has seen a contraction in 
credit growth in 2009, Fischer said, it need not return to 2006-09 
levels, which he deemed "overly aggressive." 
 
¶14.  (SBU)  When asked about the applicability of Israeli-style 
currency intervention policy to other countries, he stressed that 
few other countries could successfully mimic Israel's actions.  A 
small open economy, Israel enjoys a broad base of domestic investors 
with a strong home bias (creating inflows during the most recent 
crisis)as well as an open currency market that is small enough not 
to attract overly excessive speculative trades by large hedge funds. 
This combination, along with a well-respected and credible Central 
Bank, is not easy to duplicate, said Fischer.  He did note, however, 
that BoI policies during the crisis may have also spurred the 
beginning of bubbles in Israel's housing, equity and bond markets. 
He will be paying close attention to these markets in the coming 
months, he said. 
 
¶15.  (SBU)  Fischer also emphasized that the GoI must continue to 
focus on boosting economic growth.  The 3-3.5 percent growth 
predicted by the IMF for 2010 is too low to sustain current military 
spending levels, maintain social equity, and continue to raise the 
standard of living for most Israelis, he said.  He argued that 
Israel must concentrate on three main issues: 1) increasing the size 
of the workforce, especially among religious and Arab communities, 
2) boost competitiveness of the high-tech sector and its links to 
minority communities and 3) enact real estate market reform to make 
land ownership and transfer easier.  He also noted that Israel could 
see a large influx of foreign direct investment if a peace 
settlement were enacted. (Note: Treasury reports that most major 
rating agencies cite conflict/political risk as a primary constraint 
to Israel's credit rating and investment climate.) 
 
-------------------- 
The Fiscal Framework 
-------------------- 
 
¶16.  (SBU)  Eyal Epstein, Deputy Budget Director at the Ministry of 
Finance, described the history of Israel's fiscal framework from no 
fiscal rules prior to 1992 to 2005 when pro and a-cyclical 
limitations were introduced - a deficit ceiling and an expenditure 
limitation.  (See ref A for current targets agreed to in June 2009 
JEDG meeting in Washington).  Epstein argued that decreases in 
expenditures and debt (as a percentage of GDP) since 2003 
demonstrate the ability of the current arrangement to restrain 
spending.  (Note: Although spending controls aided fiscal 
 
TEL AVIV 00000194  004 OF 006 
 
 
retrenchment, a large increase in tax revenues from high economic 
growth during 2003-2007 served as the primary reason behind Israel's 
declining debt levels.)  The ceilings have contributed to 
conservative budgeting practices by the Ministry of Finance, which 
Epstein believes have now been internalized throughout the Israeli 
government. 
 
¶17.  (SBU)  Epstein cited three risks to the current framework: 1) 
the lack of sustainability of current expenditure ceilings given an 
anticipated rise in mandatory spending along with social spending 
that is already quite low compared to most OECD countries; 2) 
planned tax cuts; and 3) military and other spending commitments 
already  written into the budget that are not obliged to conform to 
Israel's future fiscal targets.  Epstein noted that the GoI will 
face difficulty in reaching the targets in 2011, when many budgetary 
obligations will be coming due.  He also said that the GoI is 
considering another two-year budget, in the hopes of retaining 
political stability and locking in multi-year budget commitments. 
 
¶18.  (SBU)  A new fiscal rule is under discussion among the Bank of 
Israel, the National Economic Council and the Ministry of Finance, 
but discussions are not likely to yield a unified proposal until the 
end of the first quarter of 2010, as the new rule will be the basis 
for structuring the next budget.  While there was no firm decision 
that the next budget would be another two-year budget, Eugene Kandel 
of the NEC noted that a two-year budget lessens political bickering 
and assists with long-term planning.  Epstein demurred on specifics 
of the fiscal rule options under discussion, but noted that the 
challenge for the future is to further reduce the debt-to-GDP ratio 
over the medium term under the appropriate size of the public sector 
and the tax level. 
 
¶19.  (SBU)  Acting A/S Baukol inquired about whether escape clauses 
would figure into the new framework, and if there would be 
sufficient accountability or enforcement mechanisms.  Previous 
fiscal rules, he said, had often proved ineffective in preventing 
creative accounting that led to overspending in strong economic 
times, and in allowing additional spending in sharp downturns. 
Baukol also asked, per the IMF's recommendation, if Israel is 
looking to change from real to nominal figures for its budget 
ceiling, to increase transparency and the budget's anti-cyclicality. 
 He queried as to whether the new fiscal rule might force 
medium-term spending plans to follow the rule's expenditure caps, 
noting that the current rule fails to guide medium-term spending, 
causing rapid increases in planned expenditures each year.  While 
non-committal on the new rule's escape clauses and enforcement 
mechanisms, Epstein explained that the MoF had recently consulted 
with Sweden and the Netherlands on the nature of their fiscal rules 
and policymaking.  He also confirmed that Israel is investigating 
the use of nominal budget figures and the creation of long-term 
budget projections that would allow spending plans to fit into the 
fiscal framework. 
 
------------------------------------------- 
GoI Prioritizes Expanded High Tech Dialogue 
------------------------------------------- 
 
¶20.  (SBU)  DG Shani introduced the discussion of the proposed high 
tech dialogue by providing an overview of the sector's significance 
to the Israeli economy.  In addition to the exports the sector 
generates, the Information, Communication and Technology (ICT) 
industry employs 14 percent of Israelis, according to Shani.  He 
pointed to the ICT sector's roots in the Israeli military and 
emphasized the heavy state involvement in its development, 
especially the strong government science policy.  Eli Opper, the 
Chief Scientist housed in the Ministry of Industry, Trade and Labor, 
participated in the JEDG discussion.  (See Ref B for description of 
the technology sector's history and challenges.) 
 
¶21.  (SBU)  Citing the many U.S. technology companies with 
facilities or other ties to Israel, including Intel, Microsoft, IBM, 
Motorola, and Cisco Systems, Shani brought the focus to areas of 
strategic cooperation that would address national priorities of both 
Israel and the U.S.  He introduced short presentations by two 
Israeli software companies that had recently participated in a high 
tech conference in New York organized by the Israel-America Chamber 
of Commerce.  The first, dbMotion, specializes in healthcare 
software which aggregates health information and creates virtual 
patient records.  The second, Time to Know, creates integrated 
educational software.  Both companies are actively engaged in both 
the Israeli and U.S. markets. 
 
¶22.  (SBU) Chemi Peres, a well-known Israeli venture capitalist and 
President of the Chamber, told participants that Israel and the U.S. 
are missing major opportunities to address problems on a national 
 
TEL AVIV 00000194  005 OF 006 
 
 
level with advanced technological solutions.  He called for a 
"binational stimulus package" in which the two countries would act 
like venture capitalists by elevating 2-3 projects to address 
national priorities such as healthcare, education, alternative 
energy and homeland security.  Israel, he proposed, could act as a 
test bed for implementation of high-tech solutions in the U.S. 
 
¶23.  (SBU) Following the private sector presentations, DG Shani 
asked what government could bring to the table to promote this 
binational alignment.  He argued that the U.S. and Israel are not 
competitors but natural partners with complementary business 
cultures, and that both countries seek to maintain a slipping edge 
in the face of growing competition from China, India, etc.  The GoI 
participants urged the establishment of a bilateral government 
structure to manage expanded high-tech cooperation that could 
prioritize projects with critical, strategic potential and help 
generate more resources for them.  The form such an organ would take 
was open for discussion, but generating new funding was essential, 
said Shani.  He also noted the potential to target the involvement 
of Israel's Arab minority and create linkages to Palestinian 
entities. 
 
¶24.  (SBU)  Providing preliminary feedback, the U.S. delegation 
questioned the proper role of government in this sphere, and 
emphasized a reticence to "pick winners" among private sector 
participants.  Addressing areas of policy coordination, resource 
allocation, and best practices discussions were all potential foci 
but required the involvement of varied government agencies and the 
private sectors on both sides.  U.S. delegates noted the possibility 
of wider forums, such as the OECD, to initiate discussions that 
might lead to a more considered binational objective.  U.S. 
delegates also raised the success of established binational 
foundations such as BIRD, BARD, and BSF and expressed a desire, in 
principle, to expand funding for the foundations.  However, they 
reported, initial attempts to identify funds had not yielded any 
positive results. 
 
¶25.  (SBU)  Acting A/S Baukol stressed that the Commerce Department 
has the lead in the USG on high-tech issues, and noted the 
importance of linking the private sector into any future dialogue. 
He amplified DG Shani's message regarding the inclusion of Israel's 
Arab minority by noting the possibility of high-tech cooperation 
with the PA and Israel's other Arab neighbors.  He stated his desire 
to continue dialogue on macroeconomic, fiscal and monetary issues as 
the main focus of the JEDG, regardless of where any future high-tech 
collaboration may be discussed. 
 
¶26.  (SBU)  Chief Scientist Eli Opper agreed that existing 
mechanisms could be utilized to address the areas of strategic 
bilateral concern, citing BIRD Energy as a successful example.  In 
May 2009, BIRD Energy garnered $2 million in funding from both the 
U.S. Department of Energy and the Israeli Ministry of National 
Infrastructures to pursue renewable and energy efficiency projects. 
He urged increased funding for the foundations along with continued 
discussion of focus areas to be recommended to the foundations. 
 
¶27.  (SBU)  Director of the National Economic Council, Eugene 
Kandel, argued that governments can act as facilitators of 
"equilibrium-changing" solutions and hasten progress by providing 
evaluations of strategic proposals by drawing on a range of 
subject-matter expertise.  This, he noted, would require 
collaboration from many governmental bodies as well as a managing 
mechanism to ensuring success.  DG Shani noted the possibility of 
harnessing the academic and research capabilities of the two 
countries as well.  However, he agreed that the matter required 
further deliberation.  Again, he emphasized the importance of 
funding, noting that the GoI was ready to commit resources, and 
encouraged the U.S. delegation to identify a counterpart to further 
develop the proposal.  (Note: Post will report septel on prospects 
for furthering the high-tech dialogue proposed by the GoI.) 
 
------------------------------------- 
Progress on Loan Guarantee Conditions 
------------------------------------- 
 
¶28.  (SBU)  Both Israel and the U.S. expect the calendar year 2009 
conditions for release of the FY 2010 tranche of the loan guarantees 
 agreed at the June 2009 JEDG (see ref A) to be met.  The Israeli 
delegation confirmed that final statistics for 2009 would be 
compiled and reported by March 2010 to allow for the USG's written 
determination and subsequent formal release of the FY2010 tranche of 
guarantees.  GoI delegates briefly described Israel's progress 
toward structural reforms in the 2010 conditions, including 
privatization in electricity, ports and land reform.  They stated 
that reform was proceeding, albeit with certain snags including IEC 
 
TEL AVIV 00000194  006 OF 006 
 
 
pensions and certain legal requirements of reorganizing the land 
administration and zoning systems.  Baukol noted that the spending 
targets agreed for 2010 differ from those specified in the 2009-2010 
budget.  GoI officials, however, reported that lower than expected 
social and other spending combined with higher than expected 
inflation will likely allow the GoI to meet 2010 fiscal 
conditionality. 
 
¶29.  (SBU) While IPR negotiations continued in other fora and were 
not discussed in detail, the U.S. delegation requested the Ministry 
of Finance's flexibility regarding a bottleneck in the progress of 
negotiations:  MoF's concern that longer patent terms would 
negatively impact the GoI's finances.  The U.S. delegation also 
reiterated the appeal for application of international sanitary and 
phytosanitary standards, and promised to submit questions regarding 
the GoI's procedures regarding food safety by the end of 2009. 
(Note: Post subsequently relayed food safety questions to GoI and 
responses are expected by December 2010.) Regarding the GoI's 
evaluation of long term social expenditures, the Israeli delegation 
reported that development of an action plan is underway and recent 
discussions with Swedish and Dutch counterparts on forecasting had 
informed the process considerably.  The GoI is currently devising 
estimates of the demographic pressures the country will face over 
the medium term, and do not foresee difficulties in the next 20 
years. 
 
¶30. (SBU) Acting A/S Baukol stressed to the Israeli delegation the 
timelines for the required reports and action plans upon which 
release of the loan guarantees are contingent, including an action 
plan for a new fiscal rule due by the next JEDG meeting (tentatively 
scheduled for June 2010) and a long-term budget analysis of Israel's 
future social expenditures due by December 2010. 
 
¶31.  (U)  This message was cleared by Treasury. 
 
MORENO