Israeli Economic News: Klein Puts Cuts on Hold;

UNCLAS SECTION 01 OF 02 TEL AVIV 002384 SIPDIS SENSITIVE E.O. 12958: N/A TAGS: ECON EFIN IS ECONOMY AND FINANCE SUBJECT: Israeli Economic News: Klein Puts Cuts on Hold; Cabinet Oks Netanyahu Tax Reductions; BOI Upgrades Growth Estimates This cable is classified Sensitive but Unclassified. Please handle accordingly. -------------- Summary -------------- ¶1. (U) On Sunday, April 25, the Bank of Israel announced that there would be no change in interest rates in May, leaving the BOI rate unchanged at 4.1 percent. On the same day, the GOI approved Finance Minister Netanyahu's plan for reducing taxes announced earlier in the month. The cuts include reductions in income taxes as well as a gradual reduction in corporate taxes from 36 percent to 30 percent by 2007. Meanwhile, the BOI Research Department Chief, Karnit Flug, says Israeli growth will reach 3.4% in 2004. End Summary. -------------- Pause in Interest Rate Cuts -------------- ¶2. (U) After 13 consecutive monthly interest rate declines, the Bank of Israel announced on April 25 that interest rates will remain unchanged at 4.1 percent. In a very carefully crafted press release, the Central Bank listed a number of reasons for not continuing its program of interest rate reductions: - the shekel has experienced a 4 percent cumulative depreciation since the beginning of 2004; - the money supply has increased 8 percent in the first four months of this year, directly related to the decrease in interest rates; - Government bonds yields have slowly begun to rise. The BOI also stressed its adherence to price stability as a chief aim, and stated that, as there is now an increase in inflation expectations, it will review its monthly interest- rate policy in order to maintain price stability within the government's 1 - 3 percent framework. -------------- BOI May Cut Further If... -------------- ¶3. (U) The BOI in its press statement indicated that if inflation remains in the price stability range and the financial markets remain calm there could be a continuation of interest rate cuts dependent on certain conditions. This would depend on whether there would be an increase in capital inflows relative to outflows, thus strengthening the shekel. ¶4. (SBU) In a veiled slap at the Ministry of Finance, the Bank noted that more attention needed to be paid to reducing Israel's high debt burden, which reached 105 percent in ¶2003. As the BOI press release explained, reducing the debt burden would reduce long-term rates, which would in turn allow for short-term rates to be lowered. -------------- Government Goes for Bibi's Tax Cuts -------------- ¶5. (U) On Sunday, April 25, the Cabinet approved Finance Minister Netanyahu's proposed tax reductions for low and middle-income earners, as well as a gradual reduction in corporate taxes from 36 percent to 30 percent. Draft legislation will be presented to the Minister's Committee for legislation next week. These changes will require Knesset approval, and if all goes according to schedule, would go into effect on July 1. Finance Minister Netanyahu announced the proposed tax cuts originally on April 4, 2004 on the eve of the Passover holiday. The MOF stated in its press release that the reductions were intended to reduce income distribution gaps, encourage employment and investment, and assist acceleration of growth. -------------- BOI optimistic about 2004 economic prospects -------------- ¶6. (U) On April 22, Karnit Flug, Head of the Research Department of the Bank of Israel, expressed newfound optimism in a news conference about the Israeli economy, with forecasts exceeding those of the Ministry of Finance. Flug attributed the turnaround to the global recovery, to an improvement in the security situation, and to the GOI's fiscal and monetary policy. ¶7. (U) Flug presented the updated BOI 2004 forecasts as follows: Updated Previous GDP 3.4 2.4 Business GDP 5.2 3.7 Private Consumpt. 4.0 2.8 Public consumpt. -2.5 -2.5 Exports 7.8 5.5 Civilian imports 8.4 6.7 Investment in fixed 3.5 2.0 assets Kurtzer