Identifier
Created
Classification
Origin
06TELAVIV3501
2006-09-01 11:58:00
CONFIDENTIAL
Embassy Tel Aviv
Cable title:
DANGERS LOOM AS GOI DEALS WITH ECONOMIC EFFECTS OF
how-tonull Leza L Olson 09/05/2006 01:06:05 PM From DB/Inbox: Leza L Olson Cable Text: C O N F I D E N T I A L TEL AVIV 03501 SIPDIS CXTelA: ACTION: ECON INFO: FCS IPSC SCI IMO CONS RES POL DCM AMB AID ADM PD DISSEMINATION: ECON CHARGE: PROG APPROVED: ECON:WEINSTEIN DRAFTED: ECON:JNWITOW CLEARED: ECON: WWEINSTEIN VZCZCTVI569 OO RUEHC RUEHXK RHEHNSC RUEATRS DE RUEHTV #3501/01 2441158 ZNY CCCCC ZZH O 011158Z SEP 06 FM AMEMBASSY TEL AVIV TO RUEHC/SECSTATE WASHDC IMMEDIATE 6095 INFO RUEHXK/ARAB ISRAELI COLLECTIVE IMMEDIATE RHEHNSC/NSC WASHDC IMMEDIATE RUEATRS/DEPT OF TREASURY WASHDC IMMEDIATE
C O N F I D E N T I A L SECTION 01 OF 03 TEL AVIV 003501
SIPDIS
NSC FOR WATERS; TREASURY FOR HIRSON
E.O. 12958: DECL: 08/31/2016
TAGS: ECON EFIN IS
SUBJECT: DANGERS LOOM AS GOI DEALS WITH ECONOMIC EFFECTS OF
WAR
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 003501
SIPDIS
NSC FOR WATERS; TREASURY FOR HIRSON
E.O. 12958: DECL: 08/31/2016
TAGS: ECON EFIN IS
SUBJECT: DANGERS LOOM AS GOI DEALS WITH ECONOMIC EFFECTS OF
WAR
Classified By: Economic Counselor William Weinstein for reasons 1.4 b a
nd d.
--------------
Summary
--------------
1. (C) The former Chief of Economic Research at the
Ministry of Finance (MOF),Michael Sarel, says that the
Lebanon War will have negative short-term consequences for
the Israeli economy, but that the economy will resume its
strong growth over the longer term. Despite his skepticism
that the GOI will be able to reverse a "temporary expenditure
shock," Sarel recognized that some additional spending is now
necessary. Expenditures through 2007 will rise, but the
deficit will stay close to the three percent range. Defense
spending will increase significantly, but not by nearly as
much as the defense establishment is requesting. Social
spending will be sidetracked as will spending on education
and major infrastructure projects, and "Negev development is
off the map." Taxes will not be raised, but the reductions
envisioned by the tax reform program which is now in progress
will be delayed by a year or two. However, Sarel said that
if the cease fire in the north does not hold, the resulting
deterioration in the security situation will likely result in
significant negative changes in the reformist policies that
have helped the Israeli economy to prosper in recent years.
End Summary.
--------------
Economy Will Recover if Cease-fire Holds
--------------
2. (C) In an August 30 meeting, Michael Sarel, former Chief
of Economic Research at the MOF and now Chief of Economic
Research at Harel Investments - a top Israeli investment
firm, discussed two possible scenarios for the near-term
economic future with the Deputy Economic Counselor. In the
optimistic scenario, the cease fire in the north would hold
and the security situation would return to something
approximating what it was before the outbreak of the war. In
this case, Sarel said that the economy would recover very
quickly. There would still be a major impact on near-term
spending, and more spending on defense in the intermediate
and longer terms. The tourist sector will not recover
quickly, but the need to rebuild and rearm will spur growth
in construction, military industries, and other areas. In
such a case, 2007 would be a good year, and steady growth
would resume. Growth for 2007 will likely look even more
impressive when compared to 2006, with its artificially low
growth rate because of the war.
--------------
Deterioration in Security Spells Trouble
--------------
3. (C) In the negative scenario, Sarel described a situation
of continued low-level warfare in the north, with a rocket
being fired in from Lebanon once or twice a week, and people
unable to fully return to life as they had lived it before
the war. The long-term economic implications of this type of
situation are extremely negative. Tourism would not revive
at all in the north, and only slowly in the rest of the
country. More ominously, there may be some hesitation on the
part of foreign investors to continue to invest in the many
hi-tech companies that are located in that part of the
country. This would seriously affect the growth rate both in
the short-term and long-term.
4. (C) Sarel went on to say that there were two main
reasons for Israel's excellent economic performance in recent
years. The first was the dramatic improvement in the
security situation, and the second was the government's
decision to change its economic policies. Regarding
security, investors used to be jittery at the news of every
terrorist attack or military operation. In recent years,
they have come to believe that the country is essentially
stable and the economy solid. The number of terrorist
attacks and civilian casualties is still very important, and
Sarel stressed the need to maintaining vigilance. However,
since 2002, the sharp drop in the number of attacks and the
almost inconsequential impact of terrorism at the present
time has dramatically improved the economic climate. A
long-term deterioration in the security situation would be
severely negative for the economy.
--------------
Some Reforms May Be Rolled Back
--------------
5. (C) The other major factor which contributed to the
economy's dramatic improvement was the change in the
government's policies and the implementation of the economic
reform plan in 2003, which is still in progress. The "very
positive policies for growth and investment," such as the
reduction in expenditures as a percentage of GDP, and the
reduction in the deficit and taxes have all contributed to
the decrease in the risk premium for investing in Israel.
6. (C) Sarel noted that, in the post-Lebanon War situation,
both of these factors are at risk. There will likely be
economic policy changes as a result of the security
situation. Most important is the push to increase the
defense budget by NIS 30 billion (about USD 6.8 billion) over
the next three years. Sarel said that there was no chance
whatsoever that the Ministry of Defense would receive such an
increase. However, even a fraction of that amount - he
thought a figure in the NIS 5 billion range likely - would
have a big fiscal impact. On the need for additional defense
spending, Sarel noted that there is room for some savings in
the defense establishment. The army has an extremely
generous pension system, which was not reformed several years
ago when the GOI reformed the equally generous pension plans
enjoyed by most other government employees. Regardless of
the amount that defense spending is increased, this new
situation represents a drastic change from pre-war plans for
major defense cuts (about NIS 500 million per year for three
or four years) to finance social spending.
7. (C) In addition, some other reformist policies will be
"reversed a bit." The deficit ceiling will be raised, as
will expenditures and taxes. However, on taxes, Sarel said
that rates would not increase, but rather that the reform
under which corporate and personal income taxes have been
slowly declining would be postponed for a year or two,
bringing in an additional NIS 2 billion in revenue to the
government in 2007 and 3.5 billion in 2008. He also
expected that the government would not change the 15.5
percent VAT rate.
--------------
Temporary Expenditure Shock Needed
--------------
8. (C) Sarel said that the right thing to do in the present
situation was to allow for a "temporary expenditure shock,"
which would sharply increase expenditures and the budget
deficit now on the understanding that they would be brought
back into line in 2008 and 2009. However, he expressed
skepticism that these increases would be reversed later. He
said that the revenue side will not be much affected by the
war - the reduction in tax payment will only amount to about
NIS two or three billion. However, the compensation packages
for businesses and individuals who suffered damage during the
war and the increase in defense spending will have a big
effect on the expenditure side. Sarel noted that by law, the
budget deficit is set at three percent. The coalition
agreement calls for it to be reduced to one percent by 2009,
and the Prime Minister and Defense Ministers had agreed that
it should be set at two percent for 2007. Sarel suggested
that it would be prudent to allow for a reasonable three
percent deficit in 2007, and to plan to go back to reducing
it gradually after that.
-------------- --------------
Only Fiscal Tricks Can Maintain the Expenditure Target
-------------- --------------
9. (C) As for 2006, Sarel said that it will require some
"fiscal tricks" to keep expenditures from rising by only one
percent over those in 2005, as required by law. One
possibility is that additional expenditures be handled
"off-budget." He said that new legislation is needed to
raise the expenditure ceiling, adding that since the deficit
will likely stay in the three percent range, no new
legislation will be needed to raise that ceiling.
--------------
Negev Development Off the Map
--------------
10. (C) As for the impact of the new situation on social
spending, Sarel noted that much had already been done to undo
the damage caused by some of the more drastic cuts in
allowances over the past few years. He said that the
restoration of some cuts in the child and old age allowances
was done in a very modest and reasonable way that did not
threaten to explode the budget. Regarding the increase in
the minimum wage, he called it harmful to those it was
intended to help, but economically not significant. Planned
increases in education spending will likely be postponed, as
will work on major infrastructure projects such as the NIS
eight to ten billion allotted for road and railway projects
over the next five years. He added the "Negev development is
off the map," and that there will be another -- probably
failing -- effort to get rid of many of the "exemptions"
allowed in the tax system, such as the tax-free money in
funds allotted for training courses, and the exemption on
paying VAT in the southern port and resort city of Eilat.
--------------
Deficit Will Stay on Track
--------------
11. (C) When pressed, Sarel said he thought that while the
war has caused real - but temporary - economic damage, the
more optimistic scenario would ultimately play out. The
increase in the deficit and fiscal targets is a negative as
will be the change in the internal composition of the budget
towards more defense spending. However, he expressed
confidence that the deficit will remain in the three percent
range, noting that the Bank of Israel, the USG, and
international rating agencies will all be exerting a lot of
pressure to keep the deficit under control.
********************************************* ********************
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
SIPDIS
NSC FOR WATERS; TREASURY FOR HIRSON
E.O. 12958: DECL: 08/31/2016
TAGS: ECON EFIN IS
SUBJECT: DANGERS LOOM AS GOI DEALS WITH ECONOMIC EFFECTS OF
WAR
Classified By: Economic Counselor William Weinstein for reasons 1.4 b a
nd d.
--------------
Summary
--------------
1. (C) The former Chief of Economic Research at the
Ministry of Finance (MOF),Michael Sarel, says that the
Lebanon War will have negative short-term consequences for
the Israeli economy, but that the economy will resume its
strong growth over the longer term. Despite his skepticism
that the GOI will be able to reverse a "temporary expenditure
shock," Sarel recognized that some additional spending is now
necessary. Expenditures through 2007 will rise, but the
deficit will stay close to the three percent range. Defense
spending will increase significantly, but not by nearly as
much as the defense establishment is requesting. Social
spending will be sidetracked as will spending on education
and major infrastructure projects, and "Negev development is
off the map." Taxes will not be raised, but the reductions
envisioned by the tax reform program which is now in progress
will be delayed by a year or two. However, Sarel said that
if the cease fire in the north does not hold, the resulting
deterioration in the security situation will likely result in
significant negative changes in the reformist policies that
have helped the Israeli economy to prosper in recent years.
End Summary.
--------------
Economy Will Recover if Cease-fire Holds
--------------
2. (C) In an August 30 meeting, Michael Sarel, former Chief
of Economic Research at the MOF and now Chief of Economic
Research at Harel Investments - a top Israeli investment
firm, discussed two possible scenarios for the near-term
economic future with the Deputy Economic Counselor. In the
optimistic scenario, the cease fire in the north would hold
and the security situation would return to something
approximating what it was before the outbreak of the war. In
this case, Sarel said that the economy would recover very
quickly. There would still be a major impact on near-term
spending, and more spending on defense in the intermediate
and longer terms. The tourist sector will not recover
quickly, but the need to rebuild and rearm will spur growth
in construction, military industries, and other areas. In
such a case, 2007 would be a good year, and steady growth
would resume. Growth for 2007 will likely look even more
impressive when compared to 2006, with its artificially low
growth rate because of the war.
--------------
Deterioration in Security Spells Trouble
--------------
3. (C) In the negative scenario, Sarel described a situation
of continued low-level warfare in the north, with a rocket
being fired in from Lebanon once or twice a week, and people
unable to fully return to life as they had lived it before
the war. The long-term economic implications of this type of
situation are extremely negative. Tourism would not revive
at all in the north, and only slowly in the rest of the
country. More ominously, there may be some hesitation on the
part of foreign investors to continue to invest in the many
hi-tech companies that are located in that part of the
country. This would seriously affect the growth rate both in
the short-term and long-term.
4. (C) Sarel went on to say that there were two main
reasons for Israel's excellent economic performance in recent
years. The first was the dramatic improvement in the
security situation, and the second was the government's
decision to change its economic policies. Regarding
security, investors used to be jittery at the news of every
terrorist attack or military operation. In recent years,
they have come to believe that the country is essentially
stable and the economy solid. The number of terrorist
attacks and civilian casualties is still very important, and
Sarel stressed the need to maintaining vigilance. However,
since 2002, the sharp drop in the number of attacks and the
almost inconsequential impact of terrorism at the present
time has dramatically improved the economic climate. A
long-term deterioration in the security situation would be
severely negative for the economy.
--------------
Some Reforms May Be Rolled Back
--------------
5. (C) The other major factor which contributed to the
economy's dramatic improvement was the change in the
government's policies and the implementation of the economic
reform plan in 2003, which is still in progress. The "very
positive policies for growth and investment," such as the
reduction in expenditures as a percentage of GDP, and the
reduction in the deficit and taxes have all contributed to
the decrease in the risk premium for investing in Israel.
6. (C) Sarel noted that, in the post-Lebanon War situation,
both of these factors are at risk. There will likely be
economic policy changes as a result of the security
situation. Most important is the push to increase the
defense budget by NIS 30 billion (about USD 6.8 billion) over
the next three years. Sarel said that there was no chance
whatsoever that the Ministry of Defense would receive such an
increase. However, even a fraction of that amount - he
thought a figure in the NIS 5 billion range likely - would
have a big fiscal impact. On the need for additional defense
spending, Sarel noted that there is room for some savings in
the defense establishment. The army has an extremely
generous pension system, which was not reformed several years
ago when the GOI reformed the equally generous pension plans
enjoyed by most other government employees. Regardless of
the amount that defense spending is increased, this new
situation represents a drastic change from pre-war plans for
major defense cuts (about NIS 500 million per year for three
or four years) to finance social spending.
7. (C) In addition, some other reformist policies will be
"reversed a bit." The deficit ceiling will be raised, as
will expenditures and taxes. However, on taxes, Sarel said
that rates would not increase, but rather that the reform
under which corporate and personal income taxes have been
slowly declining would be postponed for a year or two,
bringing in an additional NIS 2 billion in revenue to the
government in 2007 and 3.5 billion in 2008. He also
expected that the government would not change the 15.5
percent VAT rate.
--------------
Temporary Expenditure Shock Needed
--------------
8. (C) Sarel said that the right thing to do in the present
situation was to allow for a "temporary expenditure shock,"
which would sharply increase expenditures and the budget
deficit now on the understanding that they would be brought
back into line in 2008 and 2009. However, he expressed
skepticism that these increases would be reversed later. He
said that the revenue side will not be much affected by the
war - the reduction in tax payment will only amount to about
NIS two or three billion. However, the compensation packages
for businesses and individuals who suffered damage during the
war and the increase in defense spending will have a big
effect on the expenditure side. Sarel noted that by law, the
budget deficit is set at three percent. The coalition
agreement calls for it to be reduced to one percent by 2009,
and the Prime Minister and Defense Ministers had agreed that
it should be set at two percent for 2007. Sarel suggested
that it would be prudent to allow for a reasonable three
percent deficit in 2007, and to plan to go back to reducing
it gradually after that.
-------------- --------------
Only Fiscal Tricks Can Maintain the Expenditure Target
-------------- --------------
9. (C) As for 2006, Sarel said that it will require some
"fiscal tricks" to keep expenditures from rising by only one
percent over those in 2005, as required by law. One
possibility is that additional expenditures be handled
"off-budget." He said that new legislation is needed to
raise the expenditure ceiling, adding that since the deficit
will likely stay in the three percent range, no new
legislation will be needed to raise that ceiling.
--------------
Negev Development Off the Map
--------------
10. (C) As for the impact of the new situation on social
spending, Sarel noted that much had already been done to undo
the damage caused by some of the more drastic cuts in
allowances over the past few years. He said that the
restoration of some cuts in the child and old age allowances
was done in a very modest and reasonable way that did not
threaten to explode the budget. Regarding the increase in
the minimum wage, he called it harmful to those it was
intended to help, but economically not significant. Planned
increases in education spending will likely be postponed, as
will work on major infrastructure projects such as the NIS
eight to ten billion allotted for road and railway projects
over the next five years. He added the "Negev development is
off the map," and that there will be another -- probably
failing -- effort to get rid of many of the "exemptions"
allowed in the tax system, such as the tax-free money in
funds allotted for training courses, and the exemption on
paying VAT in the southern port and resort city of Eilat.
--------------
Deficit Will Stay on Track
--------------
11. (C) When pressed, Sarel said he thought that while the
war has caused real - but temporary - economic damage, the
more optimistic scenario would ultimately play out. The
increase in the deficit and fiscal targets is a negative as
will be the change in the internal composition of the budget
towards more defense spending. However, he expressed
confidence that the deficit will remain in the three percent
range, noting that the Bank of Israel, the USG, and
international rating agencies will all be exerting a lot of
pressure to keep the deficit under control.
********************************************* ********************
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