Identifier
Created
Classification
Origin
04TELAVIV1336
2004-03-04 09:11:00
CONFIDENTIAL
Embassy Tel Aviv
Cable title:  

ISRAEL'S ECONOMIC POLICIES GET HIGH MARKS AT THE

This record is a partial extract of the original cable. The full text of the original cable is not available.
C O N F I D E N T I A L SECTION 01 OF 07 TEL AVIV 001336 

SIPDIS

STATE FOR E, NEA/IPA AND EB/IFD/OMA;
TREASURY FOR U/S TAYLOR
PLEASE PASS USTR FOR SAUMS
NSC FOR EDSON
USDOC FOR 4520/CLOUSTANAU/TSAMS/NWEIGLER

E.O. 12958: DECL: 03/04/2014
TAGS: EFIN ECON ETRD BEXP IS ECONOMY AND FINANCE ISRAEL RELATIONS
SUBJECT: ISRAEL'S ECONOMIC POLICIES GET HIGH MARKS AT THE
2004 JEDG

REF: TEL AVIV 1033

Classified By: Ambassador Daniel C. Kurtzer for Reason 1.4 (B) and (D)



C O N F I D E N T I A L SECTION 01 OF 07 TEL AVIV 001336

SIPDIS

STATE FOR E, NEA/IPA AND EB/IFD/OMA;
TREASURY FOR U/S TAYLOR
PLEASE PASS USTR FOR SAUMS
NSC FOR EDSON
USDOC FOR 4520/CLOUSTANAU/TSAMS/NWEIGLER

E.O. 12958: DECL: 03/04/2014
TAGS: EFIN ECON ETRD BEXP IS ECONOMY AND FINANCE ISRAEL RELATIONS
SUBJECT: ISRAEL'S ECONOMIC POLICIES GET HIGH MARKS AT THE
2004 JEDG

REF: TEL AVIV 1033

Classified By: Ambassador Daniel C. Kurtzer for Reason 1.4 (B) and (D)




1. (C) Summary. The U.S. delegation to the 2004
U.S.-Israel Joint Economic Development Group meeting in
Jerusalem (JEDG),led by Under Secretary Larson and Treasury
Under Secretary Taylor, expressed satisfaction with the steps
the Government of Israel has taken to implement the
government's economic reform plan. The JEDG endorsed the
release of the 2004 tranche of loan guarantees (up to $3
billion),noting that the GOI had met its commitments under
the terms of the U.S.-Israel Loan Guarantee Agreement (LGA).
Although the U.S. team praised the GOI for meeting the 2003
expenditure targets outlined in the LGA 2003 terms sheet, it
urged heightened vigilance in meeting the GOI's expenditure
and deficit targets in 2004.


2. (C) The U.S. and Israeli JEDG delegations drafted a new
terms sheet detailing LGA commitments for 2005 (text in para.
19). This terms sheet will be annexed to the agreement
pending approval by Minister Netanyahu. Especially notable
is a commitment to meet expenditure targets in 2004 and to
limit real expenditure growth to 1% per year from 2005-2010.
Finance Minister Netanyahu said the only circumstances
wherein Israel might miss the spending commitments were
related to extraordinary costs associated with a Gaza
withdrawal or an emergency plan to revamp Israel's education
system. The draft LGA terms sheet outlines new planned
reforms, including restructuring Israel's financial sector,
ports and electricity markets, as well as continued
privatization efforts. It also stresses the importance of
intellectual property protection and notes the need to
resolve procurement problems affecting U.S. companies doing
business in Israel. Other issues discussed at the JEDG and
in related meetings with GOI officials included:
-- the "Land Bridge" between Eilat and the Mediterranean,

which Netanyahu said would cost $500 million and provide an
alternative to the Suez Canal for cargo shipping. (Note:
Netanyahu did not ask for U.S. financial support and none was
offered by the U.S. side);
-- an update on Israel's improved growth prospects and
pension reforms;
-- a U.S. call for heightened GOI steps to improve the
Palestinian economy;
-- Israel's request for U.S. support regarding OECD
accession, an issue which U/S Larson said involved reform of
the organization's organizational structure as a prerequisite;
-- a review of Bank of Israel (BOI) monetary policy by
Governor Klein;
-- a U.S. call for cooperation between the BOI and the
Palestinian Monetary Authority, which Klein said he welcomed.
End summary.

--------------
Meeting with Finance Minister
Netanyahu - Expenditures and Tax Cuts
--------------


3. (C) In a small-group meeting to kick-off the JEDG on
February 23, Netanyahu reviewed the main goals of Israel's
economic plan:

--freezing government expenditures;

--using excess revenues to lower taxes and the deficit;

--moving from welfare to work;

--stimulating exports;

--breaking monopolies; and

--building infrastructure.

The Minister said his recent decision to cut Israel's
value-added tax from 18% to 17% and reduce purchase taxes on
consumer durables was meant to help Israel's poor, since most
of the economic reform program was "skewed to the top" (i.e.,
tended to benefit middle and upper income Israelis). This
move, he said, was also consistent with his desire to cut
both taxes and government spending and was affordable in
light of expectations that 2004 revenues would come in above
previous estimates. Netanyahu said he hoped to devote about
half of any such excess revenue to deficit reduction and
about half to tax cuts. Netanyahu said Israel would
definitely keep to its 2004 expenditure commitment of NIS 226
billion, as it had in 2003, as well as to a budget deficit
target of 4%. Exceptions to this policy would be allowed
only if major, exceptional events forced the GOI's hands.
Such events might include withdrawal from Gaza, unforeseen
defense needs, and/or a major restructuring of Israel's
education system, an issue currently being discussed in the
government. This reform would result in lay-offs of many
under-performing teachers and would costs hundreds of
millions of shekels, he said. U/S Larson noted that, in view
of these potential expenditures, the GOI might be
well-advised to dedicate a higher portion of unforeseen tax
revenues to deficit reduction. Netanyahu took this
suggestion on board. Turning briefly to economic prospects,
the Minister noted that world growth was likely to boost
Israel's export-led recovery. He specifically mentioned the
BOI's interest rate reduction policy as likely to promote
economic growth.

--------------
Structural Reform Goals
--------------


4. (C) Netanyahu said the government would focus on four
structural reforms in the coming year:

--restructuring Israel's inefficient ports,

--increasing competition in the financial markets,

--real estate reform, and

--easing red-tape and regulations that impede economic
development.

The port reform, said Netanyahu, would almost certainly lead
to labor conflict - possibly as early as late February. But,
he continued, "reform has to be done, no matter what the
cost." He furthermore noted that "the measure of a minister
is his ability to fight the unions." He said the GOI would
sell the port of Eilat, and would allow the Haifa and Ashdod
ports to compete with each other on price and service. The
two latter ports, he explained, would each be a separate
company, with 51% government-ownership and the remainder sold
off to private investors. The Minister of Transportation,
Avigdor Lieberman, is fully supportive of the effort, he said.


5. (C) Netanyahu said that MOF Director General Yossi
Bachar would lead an effort to create more competition in the
financial markets by increasing transparency, adding new
financial instruments, and reducing the strangle hold on the
banking sector held by Israel's two largest banks - Hapoalim
and Leumi. He said the privatization of Discount Bank would
be a big part of that effort. He welcomed foreign banks into
Israel as a way to increase competition. Real estate reform
will be very difficult to implement, given the power held by
the Israel Lands Authority, but Netanyahu said he would try
to make changes. The Minister characterized the current land
system, wherein 93% of land is state-owned (long lease
contracts),as combining the worst elements of Ottoman,
British, and Israeli bureaucracies. He noted that there were
currently three overlapping land planning systems - the
local, regional and national planning boards. One of these
three planning boards, he said, must be eliminated to cut
back on red tape. In fact, unnecessary regulation in many
areas has held the economy back: "we need to move to a
culture of regulation by exception." To change the
regulatory culture, he said, was one of his largest and most
difficult challenges. The Minister said the GOI was looking
at Britain's regulatory reform as a possible model for GOI
action.

--------------
The Land Bridge
--------------


6. (C) Minister Netanyahu reviewed some of Israel's
transportation initiatives, but focused on the proposed rail
link between the Red Sea and the Mediterranean. He estimated
the total cost of this "Land Bridge" at USD 500 million. A
rail link between the center of the country and Eilat was
"definitely going to happen," he said. This link would set
the stage for creating a rail-based cargo link between Eilat
and Israel's Mediterranean ports that would provide shippers
an alternative (if much smaller capacity) route to that of
the Suez Canal. Preliminary studies by a consulting firm
looking into the project had determined, he said, that the
best port to serve as the Red Sea terminal would be Eilat,
not Aqaba. Despite this surprising finding, Netanyahu said
he continued to believe that Aqaba should be the terminus,
because it was important to bring Jordan into the project and
make it beneficial for the entire region. He mentioned
several other projects which could be combined with the
"land-bridge," including an amusement park and casinos on the
Jordan-Israel border. Netanyahu said that no final decision
had been made on the project, but that PM Sharon might
discuss it with President Bush in his upcoming trip to
Washington. (Note: As reftel notes, Embassy sources in the
PMO discount the likelihood of the PM raising this issue in
Washington.)

--------------
Business Issues
--------------


7. (C) Under Secretary Larson raised three business issues
with Netanyahu, noting that he and Under Secretary Taylor had
met with the representatives of U.S. firms just before their
meeting with the minister. U/S Larson expressed concern that
proprietary pharmaceutical data was not protected in Israel,
that the bilateral agricultural agreement remains unsigned,
and that U.S. firms often feel they are not given a fair shot
at government and parastatal procurement. In reaction to the
data issue, Netanyahu turned to his Director General and said
"This data isn't protected? That's a dirty trick! We need
to fix this." On agriculture, Larson stressed this issue had
come to the attention of the Chairman of the House Ways and
Means Committee, and that there was no reason it should take
so long to conclude a reasonable agreement. The Minister
promised to look into this and into procurement issues.

--------------
The JEDG
--------------


8. (C) The formal session of the JEDG covered Israel's
economic growth prospects, budgetary issues, Israel and the
OECD, and ways in which Israel could help the Palestinian
economy. On the economy, the MoF's Research Director said
that a number of factors are pointing in the direction of
strengthened Israeli growth. These include the global
economic recovery, which is absorbing increased quantities of
Israeli exports; decreasing Israeli interest rates; and
continued improvements in Israeli productivity. These
factors have led the MoF to increase its predicted 2004
growth figure from 2.5% to 3% or more. The GOI was also
taking steps to increase Israel's labor participation rate,
through measures aimed at making work more attractive. In
this regard, he expressed concern at suggestions aimed at
increasing Palestinian employment in the Israeli economy.
Although this was a laudable goal, employment in sectors such
as construction came directly at the cost of Israeli
employment. Rather, the GOI should focus its efforts on
increasing Palestinian employment in tradable goods sectors,
where the employment pie could grow and accommodate both
increased Israeli and Palestinian participation.


9. (C) The budget discussion focused on establishing a
mutually-acceptable definition of expenditures. Both Under
Secretaries said the USG required a detailed explanation of

SIPDIS
the NIS 228 billion expenditure figure for 2003 referred to
by Minister Netanyahu. MoF DG Bachar promised to provide
whatever information the USG required. He furthermore
confirmed that the GOI uses this number as the basis of its
new budgetary legislation limiting expenditure growth to 2010
to 1% a year in real terms. (Note: In subsequent,
staff-level meetings with GOI budget experts, the USG side
outlined exactly what information it required for reference
in the terms sheet and received a promise that this
information would be provided promptly. End Note.)


10. (C) The GOI officials also outlined pension reform and
privatization programs. On pension reform, the Commissioner
of Capital Markets, Insurance and Savings, Eyal Ben-Chlouch,
highlighted the increase in the retirement age,
contributions, and the amount of funds to be directed to the
capital markets. The Director of the Israel Government
Companies Authority, Eyal Gabbai, outlined achievements in
privatization including the successful El Al IPO, the sale of
majority ownership in Bezeq (telephones) and Zim (shipping),
and the plan to introduce more competition in the electricity
sector. There was also a brief discussion of monetary policy
by the Bank of Israel's Deputy Governor, in which the current
low-inflation environment and recent reductions in both short
and long-term interest rates were highlighted.


11. (C) During a JEDG lunch hosted by Finance Ministry
Minister without Portfolio Meir Sheetrit, Under Secretaries
Larson and Taylor noted GOI efforts to improve Palestinian
economic conditions and urged it to do more. Under Secretary
Larson noted the importance of the GOI continuing its
transfers of Palestinian tax revenues to the PA, as well as
addressing the issue of revenue attachments. Under Secretary
Taylor cited the importance of reducing impediments to the
free movement of goods and people within the West Bank and
Gaza. Both officials noted they had pushed PA officials hard
to improve performance in fighting terror, but also urged the
GOI to think about constructive ways it could respond to
positive PA moves should such occur. Sheetrit did not
respond directly to these concerns, but rather stressed ways
in which the Palestinians had undermined the peace process.
He expressed his strong personal opposition to PM Sharon's
ideas on unilateral disengagement, noting the issue could
break up the coalition while bringing little or no
improvement in security. In response to Sheetrit's statement
that the best solution would be to "kill Yassir Arafat,"
Under Secretary Larson pushed back strongly, noting there was
no way Israel could predict the consequences such an act
could have. Sheetrit said he recognized Israel could take no
steps against Arafat.


12. (C) Sheetrit urged the U.S. to support Israeli
accession to the OECD. Under Secretary Larson said the U.S.
wanted to enhance Israel's relationship with the OECD, but
noted the complicated state-of-play on OECD enlargement.
Before the organization increased its size, it was essential
it implement extensive institutional reform aimed at
streamlined decision making. He also noted that the
composition of the next enlargement required extensive
groundwork aimed at assuring regional balance in the
organization. In the meantime, he urged the GOI to continue
its efforts to work in whatever ways possible with OECD
bodies.


13. (U) JEDG Participants:

U.S.
Alan Larson, Under Secretary of State for Economic, Business
and Agricultural Affairs
John Taylor, Under Secretary of Treasury for International
Affairs
Daniel Kurtzer, Ambassador
Theodore Mann, Economic Counselor (Notetaker)
Adnan Kifayat, Director, National Security Council
Dayna Cade, Special Assistant to Alan Larson
Tom Engle, Deputy Director, EB Office of Monetary Affairs
David Greene, NEA Office of Israel and Palestinian Affairs
Catherine Downard, Office of Near Eastern Affairs, Department
of Treasury
Clark Price, Deputy Economic Counselor (Notetaker)

Israel
Benjamin Netanyahu, Minister of Finance
Meir Sheetrit, Minister in the Ministry of Finance
Joseph Bachar, Director General, MOF
Yaron Zelekha, Accountant General, MOF
Eyal Gabbai, Director Israel Government Companies Authority,
MOF
Eyal Ben-Chlouch, Commissioner, Capital Market, Insurance and
Saving, MOF
Michael Sarel, Head of Economics and Research Department, MOF
Dan Catarivas, Deputy Director General, International Affairs
Elded Fresher, Senior Deputy Accountant General, MOF
Boaz Raday, Economic Minister to Washington
Rani Loebenstein, Senior Advisor to the Director General, MOF
Yossi Gordon, Deputy Director, Budget Department, MOF
Meir Sokoler, Deputy Governor, Bank of Israel
Michel Strawczynski, Assistant Director, Research Department,
Bank of Israel

-------------- --------------
BOI Governor Klein Gives Netanyahu A Passing Grade
-------------- --------------

14. (C) In a meeting held after the conclusion of the JEDG,
Bank of Israel Governor Klein reviewed GOI fiscal and
monetary policy with U/S Larson and U/S Taylor. He said that
the Bank had been able to bring down short-term rates
relatively quickly - from 9.1% in the beginning of 2003 to
4.5% a year later - without igniting inflation. Markets had
responded very positively, he said, to the fiscal restraint
shown by the GOI, and long-term rates had also dropped.
Finance Minister Netanyahu, he said, had convinced the
markets that he is serious about economic reform, no small
achievement. Klein expressed skepticism, however, about the
government's ability to hold to a 1% per year expenditure
increase until 2010, as stated in the JEDG. Such a
commitment, which would require cuts in per capita spending
every year, will be very hard to keep, he said. Klein also
said that cutting taxes was no substitute for keeping
spending in check. It is sometimes stated that the best way
to control spending is to cut taxes (and so make less money
available to the government). That is not true in Israel, he
emphasized. Strict spending commitments are the only way to
keep budgets under control.


15. (C) The government's newfound fiscal responsibility,
continued Klein, remains constantly under pressure. He
recounted a recent conversation with the Minister of Health
(Danny Naveh),in which the minister asked him how could it
be that acceding to a NIS 500 million increase the ministry
was asking for would really threaten the Israeli economy.
Klein responded by saying that the notion that "small
deviations" were acceptable was precisely how Israel's public
sector grew to be "the largest in the world." Markets,
continued Klein, were a little nervous about the Bank of
Israel's willingness to continue reducing interest rates in
light of spending pressures. In fact, long-term rates had
risen in recent weeks, a sign that the markets are unsure the
Bank will keep reducing short-term rates. Klein made it
clear, however, that he believed there was still some room
for further rate cuts while keeping within the 1-3% inflation
target for 2004. He noted that rate would be cut later on
February 23 (BOI cut the interest rate by 0.2% to 4.3%).
Klein said that BOI's rates, after the pending cut, would be
very close to rates in some European countries and noted that
interest rates in the UK were at 4%.

--------------
Central Bank Regional Cooperation
--------------


16. (C) Klein said the recent meeting of central bankers
from the Mediterranean region in Naples was unprecedented. He
noted that he had talked to the central bank governors of
Morocco, Egypt, Libya and the PA, among others, during the
meetings. Klein said there was plenty of issues of common
interest to talk about in meetings like this, no matter what
the political differences between the countries represented.
Possible topics might include, he said, central bank
independence, and the various stages of capital market
development. In response to a question from U/S Taylor,
Klein said he would be happy to work with Amin Haddad,
Governor of the Palestinian Monetary Authority, to help
further cooperation on terrorist financing. This was an
issue, he said, that he and Haddad had discussed in Naples.

--------------
Comment and Next Steps
--------------


17. (C) This JEDG accomplished a number of important goals.
It recognized Minister Netanyahu's and the GOI's significant
progress on economic reform over the past year while urging
continued fiscal restraint, and did so both in private and in
a number of press appearances. The meeting also underlined
the close attention the USG is paying to the GOI's budget and
how it is calculated. The draft 2004 terms sheet
incorporates the issue of restraining GOI expenditures and
meeting its deficit target for 2004.


18. (C) According to our MoF contacts, Minister Netanyahu is
now reviewing the terms sheet draft and will respond to it as
soon as possible.

--------------
Draft 2004 Terms Sheet
--------------

19. (C) Modifications to and Determinations of Specific
Reforms Details in Annex II of the Loan Guarantee Commitment
Agreement
The Joint Economic Development Group (JEDG),as the joint
consultative mechanism referred to in Section 5.03 of the
Loan Guarantee Commitment Agreement, and proceeding under
Section 4.02 of the Loan Guarantee Commitment Agreement,
determines and modifies the &specific reforms8 referred to
in Section 4.02 by appending the following as Appendix 4 of
Annex II.

CONDITIONS FOR DISBURSEMENT OF THE SECOND TRANCHE OF
SUPPLEMENTAL ASSISTANCE

The second tranche of bond guarantees in the amount of up to
$3.0 billion will be released on determination of completion
of the following:


1. Progress on Reform Plan: Progress on the main measures of
the GOI economic reform plan. This plan includes, among
other things, reforms related to:
-- Acceleration of tax reform: Continued progress on final
implementation of tax reforms (legislated in the Knesset in
2002) by January, 2006;
-- Pension Reform: Continued long-term reduction in issuance
of special government bonds for pension funds;
-- Wage reforms: Continued reduction of public sector's
budgetary expense on the wage bill as a percentage of GDP, to
be achieved by cutting wages and/or benefits and/or reducing
public sector employees.


2. Meet Spending and Budget Deficit Targets
-- Commit to expenditures (defined in Appendix X) in 2004 of
no more than 226.1 billion New Israeli Shekels, with the firm
goal of keeping the budget deficit to 4.0 percent of GDP or
less.

-- Public dissemination and GOI commitment to a detailed,
multi-year fiscal plan, including a commitment to limit real
expenditure growth (defined in Appendix X) to 1 percent per
year from 2005 to 2010. Furthermore, commitment to maintain
budget deficits to a level of less than 3 percent of GDP and
aim to implement further reductions in the operational
deficit of at least 0.5 percent of GDP every year until the
deficit reaches 1 percent of GDP.

-- Any revenues in excess of those foreseen in the 2004
budget would be allocated to deficit and tax reduction. Due
emphasis should be given to deficit reduction.


3. Proceed with Privatization Plan
-- Further progress on the main measures of the Israeli
government's privatization plan. Future privatization steps
should focus on the twin goals of increasing competition as
well as reducing government involvement in the economy.


4. Implement Structural Reforms
-- Increase competition in the economy by:

A. Implementing liberalization of the domestic
telecommunications market through a regulatory environment
that facilitates the introduction of competitive local
landline services within the timeframe of this agreement;

B. Working to increase competition within the ports,
financial markets, and electricity sectors;

C. Reduce governmental regulation with the aim of promoting
economic growth.
-- Continue efforts to further strengthen IPR protection in
Israel.


5. Undertake Infrastructure Investments
-- Commitment to, and progress on $1 billion in
infrastructure spending as discussed in the GOI,s economic
reform plan.


6. Other
-- The amount of guarantees that may be issued shall be
reduced by an amount equal to the amount extended or
estimated to have been extended by the GOI during the period
from the last deduction to the date of issue of the 2004
guarantee, for activities which the President determines are
inconsistent with the objectives and understandings reached
between the United States and the Government of Israel
regarding implementation of the loan guarantee program.
-- Commit to working with the U.S. Government to resolve
outstanding procurement issues.
SUBSEQUENT DISBURSEMENTS

Subsequent disbursements of bond guarantees will be
conditioned upon determination and implementation of the
GOI,s macroeconomic, structural and other targets developed
through the USG-GOI joint consultative mechanism. Fiscal
deficit targets and implementation of the reform plan will be
the main foci. In particular, disbursements of the third
tranche of bond guarantees will be conditioned on achievement
of the spending and budget deficit targets for 2004 and 2005.
The extent to which other commitments made for the 2004
disbursement are met will also be an important consideration.


20. (U) This message was cleared by Under Secretaries Larson
and Taylor.

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