FISCHER GOVERNS A STABLE ISRAELI ECONOMY

C O N F I D E N T I A L SECTION 01 OF 02 TEL AVIV 000714 SIPDIS E.O. 12958: DECL: 02/15/2016 TAGS: ECON EFIN PGOV IS ECONOMY AND FINANCE GOI INTERNAL ISRAELI PALESTINIAN AFFAIRS SUBJECT: FISCHER GOVERNS A STABLE ISRAELI ECONOMY Classified By: Ambassador Richard H. Jones for reasons 1.4 b and d. -------------- Summary -------------- ¶1. (C) Bank of Israel (BOI) Governor Stanley Fischer told the Ambassador that the Israeli economy is in good shape, and that, contrary to statements by some politicians, the poverty situation was actually improving. He said that the political issue was really one of relative rather than absolute poverty, but that however one defines it, the new government formed after the elections would have to deal with it. He is not particularly concerned about election promises regarding the issue and was optimistic about the GOI's ability to deal with the issue. He said that it was necessary to raise interest rates to keep down inflationary expectations, and to preemptively deal with potential crises that may arise during the unstable period between the Hamas victory and the Israeli elections. Regarding the Palestinians, Fischer said that the Palestinian economy was too small to affect Israel's economic well-being, but that the Palestinians would be severely impacted by an economic downturn in Israel. End Summary. -------------- Palestinians Dependent on Israeli Economy -------------- ¶2. (C) A relaxed and confident BOI Governor Stanley Fischer spoke to the Ambassador, DCM, and Economic Counselor in his office at the BOI on February 13 about the economy, the role of the bank, bank reform, and poverty. He was satisfied that the Israeli financial markets displayed resilience in the wake of the PM's illness and the Hamas election victory, noting that Hamas represented not an economic problem, but a political one. He said that the USD ten billion Palestinian economy had very little impact on Israel's USD 125 billion economy, and likened the relationship between the two to that between the U.S. and Mexico. He said that the Palestinians were negatively impacted by the reduction in opportunities to work in Israel, and that it is unrealistic to think that Palestinian interactions with the USD 25 billion Jordanian economy and the relatively distant Egyptian economy would be able to take up the slack. He added that the Palestinians would face even more severe problems if the Israeli economy slipped into recession and further limited the number of Palestinians who can work in the country. Fischer said that he favored the transfer of PA customs revenue collected by Israel to the Palestinians, but would not predict further GOI actions on the issue. -------------- Interest Rate Hikes -------------- ¶3. (C) In response to the Ambassador's question about recent interest rate increases, Fischer cited the close link between the interest rate and the exchange rate, explaining that a rise in the shekel/dollar exchange rate - as has recently been happening in Israel - has a direct impact on inflation. Moreover, a gap between U.S. and Israeli interest rates would cause an outflow of needed capital from Israel. He also cited the need to deal with the political uncertainty brought on by the Hamas victory and the Israeli election campaign. Hiking rates now would help keep the financial system stable in the event of a crisis occurring between the period of the Hamas victory and the Israeli elections, and prevent future accusations that not enough had been done to prevent the crisis. He also complimented Ministry of Finance (MOF) handling of the economy, saying that their "reasonable" approach has been responsible for the economy's stability and ability to take shocks in stride. However, he later criticized the MOF for impinging on the BOI's independence by its attempts to control the salaries of the Bank's employees. Fischer added that there will likely be another rate hike shortly, but said that although the decision is fundamentally his alone to make, on two occasions his staff's presentations persuaded him to decide things differently than he had originally anticipated. As an aside, he noted that, as in the U.S., Israel's current inverted yield curve - where long term rates remain stable while short term rates rise - could be a harbinger of recession and should be watched. ¶4. (C) In response to another question, Fischer said that, although large, Israel's debt situation is not worrying. Most maturities are for seven years or longer and there is currently no danger of a liquidity problem. Only the fact that rating agencies pay close attention to it makes it a concern. Nonetheless, he acknowledged that interest on the debt represents the second largest budget expenditure, after defense. He said that tourism has been strong for the past two years and has contributed to the economic recovery. He also noted that foreign capital investment in the same period has been at least as important a factor in the recovery. -------------- Poverty Situation Improving -------------- ¶5. (C) Regarding poverty, which has become a major campaign issue, Fischer said that it has been improving, and that the issue is not poverty per se, but rather the growing social gap between the haves and the have-nots. He said that poverty in Israel today was actually at the same level as in 1997 - that it had been declining until the intifada and then rose again with the onset of the recession. He also said that income statistics are incomplete and present a more negative picture than actually exists. For example, they do not take into account the black economy and are adjusted for rents, which understates income for those who own their own homes, as is predominantly the case in the Arab sector. He added that the numbers used are pre-tax and do not count transfer payments, which are large relative to other countries and actually quite progressive. Fischer also noted a positive trend developing in the Haredi community, which is generally poor, but where more people have been tending to join the formal work force. -------------- Unconcerned about Election Promises -------------- ¶6. (C) Fischer said that he is not particularly troubled by the welfare programs proposed by the Labor and Likud parties as part of their election campaigns and is optimistic about the GOI's plans to deal with the poverty issue, even though it so politically difficult. He said that the NIS fourteen billion the GOI approved for spending over the next seven years to fight poverty during PM Sharon's last Cabinet meeting can easily be financed within the one percent cap on spending and the three percent budget deficit cap (note: as required by the terms of the Loan Guarantee Agreement. End Note). He added, however, that he did not think that caps are a good idea, since they will limit the flexibility of fiscal decision making as the economy grows. -------------- Comment -------------- ¶7. (C) Since Fischer's appointment as Governor of the BOI nine months ago, the Israeli markets have had to withstand several severe shocks, including the resignation of FM Netanyahu, the disengagement from Gaza, the illnesses of PM Sharon, and the Hamas election victory. In each case, there was a slightly negative market reaction to the event, but things quickly returned to normal. This was in no small part due to the experienced, highly respected, and reassuring presence of Fischer at the helm of the BOI. Beginning last summer, when the economic and financial leadership of the country first entered into a state of flux, Fischer has consistently stepped in to assume the economic leadership role, and acted to keep the markets calm and stable. In public fora, he has been very forward leaning in his policy prescriptions, pushing especially strongly for continued reform of the financial and banking system to allow for smoother integration with the global financial community. Until the next permanent Finance Minister is named upon formation of a government later this year, Fischer will continue to be Israel's de facto economic leader. 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