Identifier
Created
Classification
Origin
06TELAVIV2679
2006-07-05 15:55:00
SECRET//NOFORN
Embassy Tel Aviv
Cable title:  

MOF OFFICIAL PRESENTS THE CASE FOR EXTENDING THE

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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
-------

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.

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