Identifier
Created
Classification
Origin
06TELAVIV2230
2006-06-09 13:25:00
CONFIDENTIAL
Embassy Tel Aviv
Cable title:  

PASSAGE OF 2006 BUDGET PRESAGES EXCEEDING LGA

Tags:  ECON EFIN PGOV PREL IS ECONOMY AND FINANCE 
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C O N F I D E N T I A L SECTION 01 OF 03 TEL AVIV 002230 

SIPDIS

NEA FOR FRONT OFFICE; NEA/IPA FOR WILLIAMS, GREENE,
WAECHTER; EB/IFD FOR DIBBLE, VON WANTOCH; NSC FOR ABRAMS,
LOGERFO; TREASURY FOR ADKINS

E.O. 12958: DECL: 06/08/2016
TAGS: ECON EFIN PGOV PREL IS ECONOMY AND FINANCE
SUBJECT: PASSAGE OF 2006 BUDGET PRESAGES EXCEEDING LGA
LIMITS IN 2007

Classified By: Economic Counselor William Weinstein for reasons 1.4 b a
nd d.

-------
Summary
-------

C O N F I D E N T I A L SECTION 01 OF 03 TEL AVIV 002230

SIPDIS

NEA FOR FRONT OFFICE; NEA/IPA FOR WILLIAMS, GREENE,
WAECHTER; EB/IFD FOR DIBBLE, VON WANTOCH; NSC FOR ABRAMS,
LOGERFO; TREASURY FOR ADKINS

E.O. 12958: DECL: 06/08/2016
TAGS: ECON EFIN PGOV PREL IS ECONOMY AND FINANCE
SUBJECT: PASSAGE OF 2006 BUDGET PRESAGES EXCEEDING LGA
LIMITS IN 2007

Classified By: Economic Counselor William Weinstein for reasons 1.4 b a
nd d.

--------------
Summary
--------------


1. (C) After a six month delay, the 2006 Israeli budget, the
largest ever at NIS 271 billion (USD 60 billion),passed the
Knesset on June 7 by a vote of 53 for, 25 against, and 45
abstaining. A considerable amount of expensive last- minute
financial maneuvering was needed to secure the abstention of
several opposition parties. Meanwhile, numerous Labor Party
MKs voted for the budget very reluctantly because they felt
it did not adequately address the social welfare issues that
were the centerpiece of Labor's election campaign. Many
Laborites felt that keeping the increase in expenditures over
those of 2005 to one percent was unnecessarily harsh in the
present positive economic climate, and were especially
perturbed that the budget was cut by about NIS 1.4 billion
(USD 311 million) to reach the one percent expenditure growth
objective . At a meeting on June 6 with the Deputy Economic
Counselor, Ministry of Finance (MoF) Deputy Budget Director
Yossi Gordon said that the price paid by PM Olmert to get
Labor Leader Peretz to agree to the one percent increase for
2006 was to raise the rate to 1.7 percent in 2007 and beyond
as promised in the coalition agreement, breaking the
framework of the one percent figure agreed to in the 2003
U.S.-Israel Loan Guarantee Agreement (LGA). Gordon explained
that Israel had proactively changed other aspects of the
agreement in the past, and said that the U.S. had always been
very understanding and flexible regarding such Israeli
actions. He painted a very rosy picture of Israel's economic
and budget situation and predicted that the budget deficit
for 2006 would be close to zero. Disengagement expenses are
lower than expected and financial support for PM Olmert's
unilateral "realignment" in the West Bank does not even
appear in the 2006 budget. End Summary.


--------------
Defense Budget Takes a Hit
--------------


2. (C) Gordon said that the process of arriving at a final
budget had been very difficult. It involved many bitter
disputes between the Finance Ministry, which wanted to
maintain fiscal restraint, and those in the GOI who cited
Israel's recent strong economy -- as evidenced by the
first-quarter 2006 growth rate of 6.6% -- to argue for large
increases in spending. The NIS 1.4 billion cut to the 2006
budget was an especially bitter blow to those who were
looking to take advantage of good economic times to increase
spending on social welfare programs. When asked why the
budget had to be cut during this period of growth, Gordon
said that many annoyed cabinet ministers had asked him the
same question. He said that the cut was needed to fulfill
Israel's commitment to the U.S. as part of the LGA to keep
its year-to-year expenditure increases down to one percent.
As a consequence, the Defense Ministry, which had escaped
previous budget reductions, was cut by NIS 500 million (USD
111 million),to an overall 2006 budget of about NIS 42
billion (USD 9.3 billion). Another NIS 500 million came from
cutting the "discretionary" budgets for the rest of the
ministries with the exception of health, education, and
welfare by another NIS 500 million, and NIS 400 million was
taken out of reserves. The NIS 1 billion spending reductions
at the ministries are permanent and will not be restored in
future years. Gordon added that there is still "a lot of
fat" in the Defense budget. He said that his ministry would
push for a NIS 2 billion defense cut in 2007, but would be
satisfied with another NIS 500 million reduction.

--------------
Busting the LGA Budget Framework in 2007
--------------


3. (C) The hit to the Defense Ministry budget was
particularly problematic for Labor Chairman Peretz. As the
new DefMin, he had pledged to safeguard his ministry's
budget. At the same time, however, as his Party's standard
bearer, his demand to reduce the defense budget in order to
finance increased social welfare spending had been the
centerpiece of his election campaign. To assuage Peretz, PM
Olmert agreed to discard the budget framework agreed to with
the U.S. and to increase year-on-year spending from 2007 to
2009 by 1.7 percent. With regard to this, Gordon noted that
Peretz had been insisting on a two percent figure for 2006,
and three or four percent for 2007 and beyond. However,
after it was explained to him that Israel was obligated to
the U.S. to maintain the one percent rate, he agreed to it
for 2006, but insisted on a 1.7 percent rate to at least
match Israel's population growth rate for 2007 and beyond, to
which Olmert agreed in the coalition guidelines. When
questioned as to why the LGA limit applies for 2006, but not
beyond, Gordon said that Israel, in the past, has proactively
changed or adjusted other aspects of the terms of the LGA,
and that the U.S. has always been flexible and shown
understanding regarding such Israeli actions. He said that
the prevailing Israeli presumption is that the U.S. will show
similar understanding in this case. He went on to note that
the LGA terms restricting Israel to a deficit of three
percent and an expenditure growth rate of one percent were
not originally suggested by the U.S., but were rather
requested by Israel's Ministry of Finance for use as a tool
to ensure a GOI policy of fiscal restraint. In light of that
and the economy's present strength, the GOI felt justified in
adjusting the expenditure figure upward. He noted, with
obvious satisfaction, that his ministry had indeed frequently
used the GOI's obligations to the U.S. in the context of the
LGA to keep ministers in line on spending questions since

2003.


4. (C) Gordon then added that 2006 was a special budget
year. Half the year went by without a budget because of
unique political circumstances. Despite the bitterness of
the budget fight, people expect the discussions over the 2007
budget to be even more acrimonious and were already
positioning themselves for the battles to come. In addition,
several more quarters of solid growth in the five percent
range are expected, and will make it more difficult than ever
to argue for continued adherence to a policy of extreme
fiscal restraint. Gordon indicated that while Peretz agreed
to the 1.7 percent figure for 2007, he and his party are not
happy with it, and will doubtless push for much more when the
budget negotiations begin later this year.

--------------
Goodies For The Opposition
--------------


5. (C) The passage of the budget -- Israel's largest ever at
NIS 271 billion -- was marked by a great deal of last-minute
maneuvering to ensure a comfortable margin of victory in the
Knesset vote. In the face of the unrest among Labor Knesset
members regarding the budget's treatment of social welfare
issues, PM Olmert reach a series of agreements with
opposition parties who agreed to abstain rather than vote
against in return for financial compensation. Yisrael
Beiteinu (YB),the largely Russian immigrant party headed by
Avigdor Lieberman, received about NIS 180 million (USD 40
million) for pet projects such as road safety. The National
Union-National Religious Party (NU-NRP) Alliance received NIS
122 million (USD 27 million) and United Torah Judaism (UTJ)
NIS 290 million (USD 64 million),to be used largely to
support religious institutions.


6. (C) Gordon commented that PM Olmert had made a "strategic
decision" to keep these parties from voting against the
budget. He said that the amounts involved are smaller than
they appear since some of the allotted money was slated to be
spent anyway. For instance, of the NIS 180 million for YB,
the PM had already decided to spend about NIS 100 million for
transportation and road safety projects championed by
Lieberman. Of the NIS 122 million allotted for spending on
NU-NRP projects, NIS 72 million had already been committed.
Therefore, only about NIS 152 million of the NIS 302 million
committed to projects supported by YB and NU-NRP actually
represented new monies.

--------------
UTJ Wants In - But At A Stiff Price
--------------


7. (C) Regarding the NIS 290 million for UTJ projects which
was announced several hours after the meeting, Gordon said
that UTJ Knesset Finance Committee Chairman Yehuda Litzman
was being extremely cooperative in helping the government
move the budget process forward, even though, as a member of
an opposition party, he would doubtless vote against the
budget. When asked why Litzman was being so cooperative,
Gordon responded that UTJ is still very interested in joining
the coalition, but that its entry price is quite high.
Cooperation on the budget was a way to keep the negotiating
process alive. On child allowances, he noted that the
coalition agreement with Shas had not reversed the reductions
instituted by the 2003 Netanyahu reforms, but had frozen them
at their present levels, instead of having them be reduced
even further over the next three years, as originally
planned. UTJ's price for joining the coalition was the
reintroduction of the "large family bonus," which would
reward families with more than four children and further
erode the impact of the Netanyahu reforms.
--------------
2006 Deficit Could Approach Zero
--------------


8. (C) Gordon said that lower-than-expected spending of NIS
4 billion and higher-than-expected revenues of NIS 5 billion
resulted in a NIS 9 billion surplus for the first five months
of 2006 (about two percent of GDP). He expected that by the
end of the year, about 97-99 percent of the budget allotted
for 2006 will have been spent. This is because until the
budget was passed, spending in 2006 was based on the lower
2005 budget figure, with a small adjustment for inflation.
Spending will rise in the coming months, but will not
completely make up for the lower spending from January
through May. It is still too early to know by how much the
budget will be underspent, but Gordon emphasized that the
deficit would be considerably smaller than the originally
anticipated NIS 16 billion, and might even approach zero. He
noted that this is another reflection of the excellent
economic situation in the country and thereby another factor
contributing to the argument for increasing year-over-year
spending by more than one percent.

--------------
Disengagement Cheaper Than Expected,
Realignment Not Yet On Budget Horizon
--------------


9. (C) Regarding disengagement expenses, Gordon said that
the GOI has so far spent about NIS 5 billion overall for
2005/2006. He said that he expects another billion to be
spent in 2007, and possibly another billion or so spread out
over the following years, for a total much smaller than many
of the original estimates. He illustrated the difficulty of
estimating the timing of the expenses associated with
withdrawal and compensation by noting that the GOI is still
spending money on the early 1980s withdrawal from Yamit in
the Sinai Peninsula, in the context of the peace agreement
with Egypt. Accordingly he expects disengagement expenses to
remain part of the budget picture for years to come.
Regarding "realignment," he said that it is not even on the
horizon from a budget standpoint, and the 2006 budget
contains no mention of it. He said that the 2007 budget
might contain a small sum for use towards the end of the
year.








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