While Israel's Economy Grows, Unemployment Remains

UNCLAS SECTION 01 OF 03 TEL AVIV 002167

SIPDIS

SENSITIVE

E.O. 12958: N/A
TAGS: ECON EFIN IS ECONOMY AND FINANCE LABOR AND COMMERCE GOI INTERNAL
SUBJECT: While Israel's Economy Grows, Unemployment Remains
Stubbornly High

REF: Tel Aviv 2067

This cable is classified Sensitive but Unclassified. Please
handle accordingly.

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Summary
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1. (SBU) Finance Minister Netanyahu's declaration in late
2003 that the recession has ended appears to look more
realistic today than it did at the time. There is
increasing optimism in Israeli economic circles regarding a
return to growth in 2004. All indications currently point
to growth of more than 3 percent in 2004, a significant
improvement over the 2.5% figure that was used in the
preparation of the 2004 budget last fall. Increased
exports, particularly in the high-tech sector, private
consumption, and tax revenues are all headed in the right
direction. Unfortunately, it does not appear that all this
good news will affect Israel's high unemployment rate any
time soon. End Summary.

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Exports: Engine of Growth
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2. (SBU) The newfound Israeli economic optimism is based, in
large part, on continued improvement in Israel's strong
export sector, which grew 12 percent in the first two months
of this year. This sector is fueled by the recovery in
world demand, which is expected to strengthen further over
the coming year. Bank Leumi underscored hopes for the year
to come in its April macroeconomic survey by noting
January/February 2004 exports were only 6% less than at the
their highpoint in late 2000. Leumi believes this
impressive performance is destined to continue during the
year and forecasts export growth of 8 - 9% in 2004, compared
with 2.6% in 2003.


3. (SBU) High tech is also supplying a turbo boost to the
economic engine. The Central Bureau of Statistics (CBS)
reports that electronic component and computer exports
increased 48.8% from December 2003 to February 2004. In the
same three-month period, exports of control communication
and medical equipment increased by 17.7%.

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Netanyahu: Cutting Taxes to Boost Growth
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4. (SBU) The recent growth spurt is boosting GOI tax
revenues. These grew 12.4% to NIS 38.6 billion in the first
quarter of 2004 compared to a year earlier. Finance
Minister Netanyahu has capitalized on this windfall by
cutting taxes twice this year alone (reftel). In the first
round of cuts in mid-February, he reduced purchase taxes on
a number of consumer items as well as lowered customs and
VAT taxes from 18% to 17%, effective March 1. The cuts
immediately led to increased discretionary consumer
spending. Import figures from February to March show this
clearly: sales of imported refrigerators grew 193%, imported
DVD players 109%, and imported televisions 60%. Even the
dormant real estate market may be coming out of its long
sleep: land tax revenues improved by 15.2 percent in the
first quarter of 2004.


5. (SBU) Netanyahu introduced his second round of cuts on
April fifth when he announced the GOI was reducing income
taxes on low and mid-level wage earners, gradually reducing
corporate taxes between 2004 and 2007, as well as canceling
taxes on a number of raw materials in the building sector,
which could also provide a boost for the building and
construction sector.


6. (SBU) Netanyahu has made it clear that he prefers tax
cuts to increased GOI spending or to reduced GOI debt
levels. As of the beginning of April, 2004 tax revenues
were forecast to exceed the original forecast used in the
2004 Budget proposal of NIS 150 billion by between NIS 2
billion to 4 billion. There is agreement among many
economists that Netanyahu's tax cuts will have a positive
effect on spending habits, on business activity, and will
serve to boost economic activity.

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Tax Reductions Aside: GOI Will
Likely Meet 2004 4% Deficit Goal
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7. (SBU) In spite of Netanyahu's significant tax cuts, the
most recent economic predictions indicate he will probably
be able to meet the GOI's 2004 budget deficit target of 4%.
This also corresponds to the conditions preliminarily
specified in the 2003 Loan Guarantee Agreement. It would
also be an improvement over the 2003 deficit, which totaled
NIS 27.7 billion, or 5.6% of GDP. To put the improved
budgetary framework into perspective, the deficit for the
first three months of 2004 totaled just NIS 587 million,
compared with NIS 4.3 billion in the same period a year ago.

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David Klein: Tax Cuts Must Be Balanced by Debt Reduction
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8. (SBU) Netanyahu's philosophy has its critics, prominent
among them Bank of Israel Governor David Klein (reftel).
Philosophically, Klein believes that Israel's very high debt
to GDP ratio, which reached 105% in 2003, needs to be cut.
He argues that reducing public sector debt would be
beneficial both for Israel's reputation in international
financial circles, as well as for the domestic economy. He
also noted in a March thirtieth press release that reducing
debt would reduce the GOI's heavy debt-servicing load,
freeing up funds for pressing social-economic programs.

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Passover Joy in the Tourist Sector
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9. (SBU) Before the Intifada, tourism (counted
statistically as a service export) served as one of the key
components of Israeli growth. Since the violence began,
however, this sector collapsed almost entirely. Although
the jury is still out for tourism this year, there was a 44%
increase in tourist entries during the first two months of
2004 compared with a year earlier. (Note: Some of the
increase is a result of the significant impact of the Iraq
war on the corresponding period of 2003.) The feared
Palestinian reprisal over the Yassin killing, and its
predicted impact on tourism, highlights the fragility of
this sector, however.

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Venture Capitalists also Celebrating
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10. (SBU) Israeli venture capitalists have also been
celebrating recently. Zeev Holtzman, Chairman of IVC
Research and the Giza VC Fund, proclaimed in a March 17th
press release that "2003 marked the beginning of new fund
raising after a long, difficult dry spell in the industry."
Holtzman cited IVC forecasts that Israeli VCs will raise
between USD 1.5 billion and USD 2 billion between 2004 and

2005. Another sign of an improvement in the industry is the
success of Israeli venture capital conferences held in
Israel, London and New York in the last two months.
Although Ernst and Young (Israel) chairman Yitzchak Forer
predicted in an interview with Globes on March 22 that high-
tech activity will return to the level of 1999 this year,
his enthusiasm is not widely shared. Israeli fund managers
with whom we have spoken are generally cautious and say that
investors are subjecting Israeli firms to much more rigorous
examination than during the height of the tech boom.

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Unemployment remains high and entrenched
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11. (SBU) Unfortunately, the positive economic news has not
yet translated into a reduction in Israel's unemployment
rate. Average unemployment in 2003 was 10.7%, and rose to
10.9% in the fourth quarter of 2003. The Israel Discount
Bank reported in its April 5 economic summary that
unemployment in 2004 would rise to 11%. Bank Leumi's chief
economist, Gil Bufman, has repeatedly commented that he does
not expect unemployment to fall before 2005, when firms may
begin to think the recovery will last over the longer term.
Although the GOI is making a concerted effort to reduce the
number of foreign workers working in Israel, this has also
not had a significant effect on the unemployment rate.

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Monetary Policy: Negative Inflation
in 2003 Leads BOI to Continue Rate Reductions
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12. (SBU) For the first time in its history, Israel saw
prices fall in 2003, as high interest rates, declining
wages, and positive exchange rate trends all worked in the
same, unexpected direction. The Bank of Israel reacted by
setting out on an extended policy of interest rate
reductions, which continued for the thirteenth consecutive
month in March 2004. The question now is whether the BOI
will continue its policy of monthly interest rate cuts.
The BOI last reduced rates by 0.2 percent on March 29,
bringing interest rates to 4.1 percent. This is a reduction
of 5% since December 2002, a drop that has provided added
stimulus to economic growth and received praise from the
Ministry of Finance.

Kurtzer