MOF OFFICIAL PRESENTS THE CASE FOR EXTENDING THE

S E C R E T SECTION 01 OF 03 TEL AVIV 002679 SIPDIS NOFORN NEA/IPA FOR WILLIAMS, GREENE, WAECHTER; EB/IFD FOR DIBBLE; NSC FOR ABRAMS, LOGERFO; TREASURY FOR ADKINS E.O. 12958: DECL: 07/04/2016 TAGS: ECON EFIN EAID PGOV PREL IS ECONOMY AND FINANCE ISRAEL RELATIONS SUBJECT: MOF OFFICIAL PRESENTS THE CASE FOR EXTENDING THE LGA Classified By: Economic Counselor William Weinstein for reasons 1.4 b a nd d. -------------- Summary -------------- ¶1. (C) Finance Ministry official Eyal Klein told Deputy Economic Counselor July 4 that the GOI decision to increase year-to-year spending from 2007 to 2009 by 1.7 percent, in violation of its commitment to the U.S. in the 2003 U.S. - Israel Loan Guarantee Agreement (LGA) to keep spending increases to one percent, was a political rather than economic decision. While saying that he personally prefers that spending increases remain at the one percent level, Klein justified the higher increase by citing the much improved condition of the Israeli economy. He added that the 2006 deficit would approach zero due to a confluence of favorable factors, and said that the GOI goal of having an ongoing one percent deficit by 2009 is on track. Klein also said the GOI very much wants to extend the LGA for four more years to provide a "rainy day umbrella" in case the good economic times do not last. He also noted that the LGA was useful in the past as a means of restraining the desire of politicians to spend too much, and thinks it will continue to be useful for the same reason in the future, especially as the temptation to spend will be ever greater in this more prosperous era. On "realignment," Klein said that there has been no MOF planning on the issue, and that the ultimate cost could reach anywhere from USD ten to 20 billion. End Summary. -------------- 1.7 Percent a Political Decision -------------- ¶2. (C) At the July 4 celebration at the Ambassador's residence, Eyal Klein, Director for Debt, Capital Markets, and Foreign Currency Transactions at the Ministry of Finance (MOF) told Deputy Economic Counselor that the decision to raise year-to-year expenditures by 1.7 percent instead of the one percent stipulated in the 2003 U.S. - Israel Loan Guarantee Agreement (LGA) was a political decision made for coalition-forming purposes. He noted that Amir Peretz, the Defense Minister and leader of the Labor Party, still is not pleased with the agreement on a 1.7 percent expenditure increase for the three years beginning in 2007, and will 
likely push for higher increases when budget talks actually begin. When asked to explain the rationale behind the 1.7 percent figure, Klein said that the Israeli population is growing at about that rate on an annual basis. The idea is that growing the budget at the same rate as the population keeps per capita spending the same, so that there is no cut in spending per citizen, as there is with a smaller one percent spending increase. -------------- Israel Should Have Consulted with the U.S. -------------- ¶3. (C) Klein acknowledged that the GOI has an obligation to the USG to maintain the one percent spending growth rate per the LGA and admitted that the GOI made a poor decision to increase it without consultations. He expressed the hope, however, that the USG would understand that the decision was made in the heat of difficult political maneuvering in Israel, during a period when poverty and social spending became burning election issues. He said that the lack of consultation with the U.S. was an oversight, and hoped that the recent phone conversation between MOF DG Yossi Bachar and officials from State and Treasury laid the groundwork to repair any damage. He noted that the Israeli side will come to the Joint Economic Development Group (JEDG) meeting in November prepared to explain and defend Israeli actions, and hoped for U.S. understanding. -------------- 2006 Deficit Approaching Zero -------------- ¶4. (C) Aside from the pressure to deal with social inequalities, Klein noted the recent outstanding performance of the Israeli economy, and the vast differences between the situation today and when the LGA was signed. In particular, he mentioned that both the deficit and the increase in expenditures were lower in 2005 (about a two percent deficit and about a one percent increase in spending) than normally permitted in the LGA, and much lower than the increased numbers of two percent expenditure growth and 3.4 percent deficit allowed in 2005 because of the disengagement. He said that the deficit for 2006 will likely approach zero due to unexpectedly high revenues resulting from one-time events such as sales of government companies and low spending due to the delayed passage of the budget, and that the GOI is on track overall towards fulfilling its goal of an ongoing one percent deficit by 2009. He also noted that Minister Hirchson has even expressed the desire to see the deficit hit zero by then. -------------- LGA Spending Limitation Very Useful -------------- ¶5. (S) When pressed, Klein admitted that he personally opposed the decision to increase spending, saying that it is very difficult for politicians to restrain themselves from spending when money is available. He noted that the one percent limitation had proven extremely useful, and that the MOF often used it during the last three years to prevent ministers from overspending. He gave a great deal of credit to former Finance Minister Netanyahu for getting the reform program off the ground, noting that by cutting spending and numerous allowances, Netanyahu sacrificed his personal political base among the less well off for the good of the country. He noted that the present Finance Minister, Avraham Hirchson, is not in a particularly strong political position and will likely have a hard time refusing other ministers' entreaties for more money. He hoped that the Prime Minister would be personally involved in pushing for fiscal restraint. -------------- Extend LGA for a "Rainy Day" -------------- ¶6. (C) When asked about the Israeli request to extend the LGA for four years, Klein said that such an extension would be extremely useful for the GOI, and would serve as a sort of "rainy day umbrella" should unforeseen economic problems arise. While individual military or terrorist events no longer rile the Israeli markets as in the past, nor do they drive away foreign investors, Klein worried that an accumulation of such events could have a negative overall impact over time and damage Israel's ability to borrow on the international markets. Continued access to long-term low-rate U.S.-backed loans would do much, in his opinion, to stem any such worries in the international financial community. He acknowledged that the original reason for the issuance of the guarantees has been accomplished, but hopes that, upon examination, the current situation would warrant serious U.S. consideration of the extension request. ¶7. (C) In addition, Klein stated that continued existence of the guarantees would provide the MOF a lever to restrain spending by the GOI. When asked why the terms in the LGA would have credibility with other ministries, given Israel's unilateral breach of the previous terms, Klein said that the existence of the LGA as an expression of continued USG interest in the need for GOI fiscal restraint is extremely useful, regardless of the specific numbers delineated in the agreement. Allowing the LGA to lapse would remove one additional -- and very important -- impediment to unrestrained spending. -------------- Loans Will Be Used up if LGA Not Extended -------------- ¶8. (C) When asked what the GOI would do regarding the unused portion of the guarantees, should the LGA not be extended, Klein said that the MOF would use them all prior to the 2008 LGA expiration. He noted, however, that this would not be his preference since doing so would increase the external component of Israel's debt structure to uncomfortable levels and would crowd out other types of borrowing. Despite these disadvantages, however, the MOF could not pass up the highly advantageous terms of the loans available through the LGA and will use them all before they expire. -------------- No Planning Yet for Realignment -------------- ¶9. (C) On "realignment," Klein said that there had been absolutely no MOF planning, or even discussion, of the possible costs involved. He said that about NIS six billion (about USD 1.35 billion) had been spent so far on the Gaza disengagement, and that the final cost will likely end up being in the NIS nine billion (USD two billion) range. He speculated that realignment could cost many times as much, from USD ten to 20 billion, or more. He also noted -- ruefully -- the possibility that the USG, if asked for assistance, may suggest using the remaining guarantees to finance realignment. ********************************************* ******************** Visit Embassy Tel Aviv's Classified Website: http://www.state.sgov.gov/p/nea/telaviv You can also access this site through the State Department's Classified SIPRNET website. ********************************************* ******************** JONES