MOMENTUM BUILDS FOR HIGHER SPENDING

C O N F I D E N T I A L SECTION 01 OF 03 TEL AVIV 003336 SIPDIS SIPDIS NEA FOR PO, NEA/IP FOR GOLDBERGER, SHAMPAINE, ZIMMER, EEB/IPS FOR DIBBLE, GARRY NSC FOR WATERS TREASURY FOR HIRSON E.O. 12958: DECL: 11/20/2017 TAGS: ECON EFIN PGOV PREL IS SUBJECT: MOMENTUM BUILDS FOR HIGHER SPENDING CLASSIFIED BY: AMBASSADOR RICHARD H. JONES FOR REASONS 1.4(B) AND (D) -------------- Summary -------------- ¶1. (C) Playing to public concern about the large gap between Israel's rich and poor, Avishai Braverman, a Labor Party Knesset member, submitted a bill to the Knesset to significantly raise Israel's year-to-year budget expenditure increase ceiling from the present 1.7 percent, starting with the 2008 budget. While the GOI has been considering increasing spending from 2009 onwards as a way to deal with the perceived need for more defense and social welfare spending, it strongly opposes any move to change the 2008 budget, which is based on a 1.7 percent spending increase as agreed to with the U.S. in the framework of the Loan Guarantee Agreement, and which is well on its way to approval. Opposition Likud leader Benjamin Netanyahu told the Ambassador that he strongly opposes passage of the bill, even though his party has urged him to sign on as a way to embarrass the government and benefit himself politically. The Ministry of Finance (MoF) also strongly opposes the bill and is doing everything it can to prevent its passage. Many other key figures, such as Bank of Israel (BoI) Governor Stanley Fischer have also spoken out against raising the expenditure ceiling now. The discussion about increasing spending comes at a bad time. Many international credit rating agencies are now in the process of doing their annual assessments of Israel's credit rating. End Summary -------------- Braverman Surprises the GOI -------------- ¶2. (C) Avishai Braverman, Labor Party member of the Knesset Finance Committee, economist, and former President of Ben Gurion University of the Negev, proposed a private member's bill to the Knesset late on November 19 calling for an upward revision in the ceiling for year-to-year budget expenditure increase. This surprise move caught the government and the financial and business communities off-guard and put ex-Finance Minister and Likud opposition leader Benjamin Netanyahu into an awkward position. According to press reports, for 2008, the bill calls for an increase from the present 1.7 percent increase to a 2.5 percent increase. Starting in 2009, it calls for expenditures to rise by two thirds of the economic growth rate of the prior year or by the rate of growth of the population in the prior year, whichever is greater. In the wake of the greater attention being paid recently to social welfare issues - partly as a result of the 36-day-and-counting high school and middle school teachers strike, there appears to be widespread support in the Knesset for the legislation and in the Knesset Finance Committee as well, with one count showing a majority of the Finance Committee in support and at least 69 members of the entire Knesset indicating they would vote for the bill. -------------- Braverman Puts Bibi on the Spot -------------- ¶3. (C) In a November 20 conversation with the Ambassador, Netanyahu sounded very alarmed at the prospect that the bill could pass. He said that the call to raise the expenditure ceiling contravenes an explicit Israeli commitment to the U.S. made in the framework of the Loan Guarantee Agreement to limit the ceiling to 1.7 percent and urged the U.S. to indicate its opposition to the passage of such a measure. He also said that he personally strenuously opposes the measure - as it would threaten to undo the work he did as Finance Minister in the Sharon government instituting a new culture of fiscal restraint. "Once they go from 1.7 percent to 2.5 percent, it will be impossible for them to stop there. Every special interest in the country will join the campaign for more spending," he predicted. However, he is under heavy pressure from fellow Likud members not to oppose the bill, as it will be popular with the Party's rank-and-file and the embarrassment to the government TEL AVIV 00003336 002 OF 003 would benefit the Likud. He added that he wants the bill quashed, but he will not be the one to do it. (Comment: Likud members remember that Netanyahu's fiscal policies cost the Likud the support of its core backers in the lower socio-economic stratum and in the periphery in the last elections. They do not want to remind the electorate of this by having Netanyahu take a public stand now in favor of fiscal responsibility. End Comment). -------------- MOF: Very Bad Idea, Really Crazy -------------- ¶4. (C) Michal Finkelstein, Senior Advisor to the MoF DG told Deputy EconCouns that the Braverman bill is a "very bad idea, really crazy." She said that the guiding principle of the GOI's economic policy is fiscal responsibility, controlling spending, and budget discipline. Opening up the 2008 budget to revision now would cause terrible problems. Finkelstein indicated that this is extremely unlikely since the cabinet has already approved the 2008 budget and it has also passed its first reading in the Knesset. She noted that "everyone in the ministry is doing everything in his power to stop this," adding that BoI Governor Stanley Fischer strongly opposes the bill, as does the Head of the National Economic Council Manuel Trajtenberg. She reported that yesterday, Finance Minister Bar-On ran into Braverman in the Knesset and "accused him to his face of acting like a populist demagogue." She did not know if Braverman responded. Asked whether the bill could pass, Finkelstein said that since outsiders cannot directly impact what happens in the Knesset, she could not give a definitive response. She reiterated that the government strongly opposes it and is doing everything it can to prevent its passage. -------------- BOI, PMO Strongly Oppose -------------- ¶5. (C) The Braverman bill's submission has received relatively little coverage in the press, but numerous economic and financial leaders have spoken out in opposition to the concept, among the most important being Fischer, who said that while a small increase in spending would do no harm, instituting large increases would endanger the GOI's ability to borrow on the international markets at reasonable rates during the next recession - which will inevitably come. He also said that it is important for Israel to keep its commitments to both itself and others, an implicit reference to Israel's commitment to the U.S. to restrain spending in the context of the Loan Guarantee Program. The Prime Minister's Office issued a press release indicating that reopening such a fundamental discussion with regard to the 2008 budget is a non-starter and will not be considered. However, it mentioned that longer term, the National Economic Council is studying how to change the budget framework to reduce the gap between the rich and the poor while maintaining a policy of fiscal responsibility. ¶6. (C) Former Ministry of Finance (MoF) DG Yossi Bachar said in a lecture last week that any move to raise the budget ceiling requires consultation with Washington, as the LGA with the U.S. commits Israel to maintain the 1.7 percent budget ceiling. (Note: This contrasts sharply with GOI actions when Bachar was MoF DG and Olmert Finance Minister during which time Israel unilaterally raised the budget ceiling from 1 to 1.7 percent, before later seeking retroactive approval from the U.S. - successfully. End Note). MoF Budget Director Kobi Haber is quoted in the press as saying that proposals such as Braverman's harm Israel's economic credibility. Other unnamed sources in the MoF are quoted saying that increasing the budget ceiling without consulting the U.S. will harm the economic confidence between the two sides. -------------- Bad Timing: Israel's Rating Under Review -------------- TEL AVIV 00003336 003 OF 003 ¶7. (C) Braverman's move comes at a time when international rating agencies (Standard and Poors, Fitch, Moodys) are doing their annual assessments of Israel's credit rating. An overt move to increase spending could damage Israel's long-running efforts to increase its rating, although many economists maintain that such an improvement would yield only marginal benefits to Israel in the international bond markets, reducing the rate at which Israel can borrow only very slightly - not enough to be a driving factor in Israel's spending decisions. -------------- Comment -------------- ¶8. (C) The 2008 budget - which adheres to the 1.7 percent formula - has already been approved by the cabinet and passed its first reading in the Knesset. It is now with various Knesset committees for fine tuning before final passage which is supposed to happen by the end of the year. For a fundamental change such as that proposed by Braverman to be acted upon in time to affect the 2008 budget, it needed to be proposed and debated long ago. Passage of the bill would be a severe embarrassment for the government, which will likely take extreme measures to prevent it, if necessary. It would also call into question the stability of the Coalition, since the bill was submitted by a member of the Coalition. Regardless, the bill's resonance is an indication of what lies ahead, and the difficulty the GOI will have maintaining its policy of fiscal responsibility in the face of strong public pressure to narrow the gap between the rich and the poor through social welfare programs. Since the Netanyahu economic reforms, the economy has performed spectacularly, but the perception persists that the lowest socio-economic sectors have been left behind. While their economic situation has in fact improved, the wealthy have clearly benefited the most. Even many in the MoF and the BoI support increasing the budget expenditure ceiling in the outlying years beyond 2008 to enable the country to prudently take advantage of its growing economy to meet its social and defense needs. Dealing with these problems while continuing to control spending and maintaining strong growth will be one of the most important challenges to face Israel's government in the next few years. End Comment JONES