ISRAEL: MODERATING FIRST QUARTER GROWTH POSES

C O N F I D E N T I A L SECTION 01 OF 03 TEL AVIV 003188

SIPDIS

E.O. 12958: DECL: 05/24/2015
TAGS: ECON PREL IS ECONOMY AND FINANCE
SUBJECT: ISRAEL: MODERATING FIRST QUARTER GROWTH POSES
SMALL RISK TO ANOTHER GOOD YEAR

Classified By: Economic Counselor William Weinstein for Reasons 1.4 (b,
d)


1. (U) Israeli growth moderated in the first quarter of 2005
to 2.9%, following four quarters of growth in 2004 between
3.5 to 4.4%. Business sector GDP grew by 3.4%, which was
also lower than any quarter in 2004. The overall
deceleration reflected moderating growth of both exports and
imports during the quarter. The slowdown did not come as a
surprise. The Bank of Israel (BOI) writes in its May
Economic Developments report that &signs of a slower pace
of expansion in the economy were apparent before the
beginning of 2005.8 This was reflected in moderating growth
since the second quarter of 2004 in both the BOI,s S-index
(composite state of the economy index); and in the exports of
goods and services, excluding high tech companies and
diamonds. The key question on economists, minds, which will
require more than one quarter of data, is whether the growth
slowdown is temporary or represents a fundamental change in
the growth trend.


2. (SBU) Israelis with whom we have spoken are unconcerned
about any significant, long-term slowdown, ascribing the
numbers either to technical factors or to a change in the
makeup of growth. Finance Ministry Director General Bachar
ascribed at least part of the moderation in a May 19 radio
interview to uncertainty relating to disengagement, as well
as to the last minute approval of the 2006 budget. Finance
Ministry staff continue to forecast 2005 growth at 3.8%.
Bank Leumi's Gil Bufman refers to the quarter as a "speed
bump" that hides a more fundamental shift in the economy from
export-led to domestic-led growth. He stands by an estimate
of 4% growth for the year, only slightly lower than his
previous forecasts.

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Trade: Moderating Growth
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3. (U) The Central Bureau of Statistics (CBS) reports that
Israeli exports of goods and services grew by 4.2% in the
first quarter of 2005 compared with a year before, a slight
deceleration from the 5.0% growth rate in the previous
quarter. First-quarter growth was led by an impressive
69.8% jump in tourism receipts, which are counted as a
services export. Agricultural exports also did well,
increasing by 35.6% in the quarter. Factoring in the first
quarter's figures, the Ministry of Finance forecasts overall
2005 export growth of 6%, following the very attractive
growth rate of 14.9% in exports in 2004.

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Tourism Gain Reflects Improved Palestinian-Israeli Relations
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4. (U) Improved relations between Israel and the Palestinian
authority, and decreasing terror attacks led tourism's star
to continue to shine. (Note: Tourism is counted as a
services export.) Arrivals in the first quarter of 2005
increased 25% compared with the same quarter one year before,
to 372,700 from 297,700. The GOI plans to capitalize on the
improvement through efforts to encourage more American
Christian tourists to visit Israel. It will set up a special
office in the U.S. dedicated to promoting religious tourism
linked with plans to set up a bible center near the Sea of
Galilee. In its efforts to cater to another group of
tourists, the GOI is also investigating the option of opening
a casino in the southern town of Eilat.

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Imports: Disappointing First Quarter
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5. (U) Imports declined by 1.4% in the first quarter of the
year compared with the previous quarter. Compared to the
same quarter one year before, however, first quarter 2005
imports showed growth of 11.8%. Furthermore, the import
slowdown is not centered in areas linked to future economic
growth: Statistics comparing the first four months of 2005
with the first four months of 2004 show that raw material
imports were 13.2% higher in 2005, durable goods imports
increased by 8.3%, and investment goods increased by 5.6%.
Another point to note is that as the Passover holiday came at
the end of April this year, imports may have been somewhat
lighter in the first three months than years when Passover
falls earlier.

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Israeli Consumption Moderates as Well...
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6. (U) Private consumption expenditure increased by 0.8% in
the first quarter of 2005, a fairly disappointing figure that
represented a drop in per capita consumption. This figure
was lower than in any quarter since the first quarter of

2003. The moderation may, however, be a reflection of the
unusually high growth rate of the fourth quarter of 2004. To
give just one example, after consumption of durable goods per
capita surged 49.6% in the fourth quarter of 2004, it fell
16.5% in the first quarter. Total expenditure for private
consumption declined by 1.6%, and indicates that the standard
of living did not increase. As Passover came late, it could
be that the second quarter will see a boost in private
consumption.


7. (U) The GOI,s efforts to rein in spending continues to
bear fruit, evidenced by a 7.2% decrease in general
government consumption the first quarter of the year.
Although this did not help short-term growth, continued GOI
rightsizing bodes well for the future (and conforms to USG
goals outlined in the bilateral Loan Guarantee Agreement).

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... as Unemployment Drops Significantly
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8. (C) According to the Finance Ministry's chief economist,
Michael Sarel, figures published May 25 show unemployment
fell from 9.8% - 9.1% during the first quarter. Employment
grew by 33,000 positions during the period. Even more
importantly, according to Sarel, the number of full-time jobs
increased during the quarter, significantly outpacing a drop
in part-time positions. Although this will not translate
directly into increased wages and consumption, these are
likely to come over time. Bufman was equally enthusiastic
about the news, but noted he expects unemployment to remain
at the new figure for quite some time.

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The Deficit: GOI Says Will Remain within Budget Framework
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9. (C) The GOI is on track to meet its 2005 deficit target,
which was increased to 3.4% of GDP (NIS 18.8 billion) from
3.0% to accommodate disengagement. According to Deputy
Budget Director Yossi Gordon, tax revenues are coming in at
levels which will result in a deficit below the target while
allowing for significant tax cuts desired by Minister
Netanyahu. According to GOI numbers, the State collected NIS
52.3 billion for the first four months of 2005, compared with
NIS 50.4 billion in 2004. Gordon notes the GOI is likely to
finish June with a small budget surplus for the year to date,
from which he draws the conclusion "There is no threat to
the 3.4% deficit target in 2005." Gordon's optimism does not
extend to 2006, however, as Finance still does not have a
comprehensive estimate of total disengagement costs. "2006
is made even more uncertain by the fact that it will most
probably be an election year," Gordon noted.

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Privatization News: Bezek
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10. (U) On May 9th the GOI sold 30% of the State's 46.4%
holdings in Bezek to the Apax-Saban group for USD 974 million
(NIS 4.3 billion). The sale was executed through a tender
process in which two groups competed. The Apax-Saban group
has the option of purchasing another 10.66% within four
years. Following the sale, the State of Israel holds 16.4%
of the shares. This marked a significant step forward in
Finance Minister Netanyahu,s privatization efforts, as the
GOI has been trying to sell Bezek for more than 15 years.
The Prime Minister said following the sale, &The fact that
groups with a global reputation like the Saban and Apax
groups have expressed interest in Bezek shows that the
Israeli economy is winning the confidence of world markets.8

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Bank of Israel: A New Era
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11. (U) Stanley Fischer assumed the Post of Governor of the
Bank of Israel on May 1, joining the Bank at a period of
historically low inflation and interest rates (currently
3.5%). The Fischer era may ring in significant change for
the Bank. He has come out in favor of replacing the Bank of
Israel law with a new law, which will maintain the Bank,s
independence while providing a sounder legal basis for the
Bank,s activities. He is also in favor of implementing the
Bachar banking and capital market reforms and reducing
Israel's large national debt burden. Initial reports
indicate that he supports the current tax plan being prepared
by the Ministry of Finance. The new Governor follows in the
footsteps of his predecessor on social issues, having
expressed a need for a policy that will better assist the
elderly, infirm, and disabled. Bufman expects Fischer to
become involved in a wider range of policy issues than his
predecessor, David Klein, "I expect Fischer to use his
official position as economic policy advisor to the Cabinet
to become involved in a wide range of issues, including the
economic aspects of peace negotiations between Israel and the
Palestinians." A prominent foreign banker noted that Fischer
has already brought "a new professionalism" to the bank's
activities.

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U.S. Economy a Concern
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12. (C) Both Sarel and Bufman said the course of the U.S.
economy remains their biggest current concern. Bufman
expressed particular concern about the possible advent of a
housing bubble in the U.S. A significant downturn in the
housing sector was likely seriously to impact overall U.S.
growth, leading directly to a reduction in demand for Israeli
exports. "I think risks coming from the U.S. economy now
outweigh regional geopolitical risks," Bufman noted. Sarel
echoed Bufman's concerns, noting Israel's vulnerability to
economic shifts in the U.S.

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