FINANCE MINISTER BAR-ON SHOCKED AT FAYYAD OECD

C O N F I D E N T I A L SECTION 01 OF 03 TEL AVIV 001205

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E.O. 12958: DECL: 06/04/2018
TAGS: ECON EFIN PREL PGOV IS KWBG
SUBJECT: FINANCE MINISTER BAR-ON SHOCKED AT FAYYAD OECD
LETTER

Classified By: Ambassador Richard H. Jones for reasons 1.4 b and d.

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Summary
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1. (C) In a June 5 meeting between Ministry of Finance
(MOF) DG Yarom Ariav, his Senior Advisor Michal Finkelstein,
and the Ambassador, Ariav said that Finance Minister Bar-On
was "shocked" that Palestinian Prime Minister Fayyad had sent
a letter seeking to block Israeli accession to the OECD. The
letter disrupted the Minister's trip to Paris to discuss OECD
issues and will result in a tougher Israeli approach to the
transfer of customs revenue. The MOF will not deliberately
delay the transfers, but will pay more careful attention to
the payment of outstanding Palestinian debts, particularly to
the Israel Electric Corporation. Ariav gave no exact date
for when the current month's revenues would be transferred,
but assured the Ambassador that it would be within a few
days. On other Palestinian-related issues, Ariav indicated
that the final status economic talks were progressing and
that there is agreement on the notion of two independent
states and two independent economies. The readout Ariav
received from the Bethlehem Investment Conference was
positive, but only time will tell if it results in concrete
achievements. Ariav noted that one issue of critical
importance for the Palestinian Authority (PA) economy is the
development of a mortgage system to facilitate housing
construction.


2. (C) Summary Continued. On the Israeli economy and
budget situation, Ariav lamented that the present political
uncertainty is allowing for the proposal of numerous bills in
the Knesset which might have negative budgetary consequences.
However, with the support of the Prime Minister, the MOF
plans to maintain the present fiscal parameters for 2009 --
a one percent deficit ceiling and a 1.7 percent expenditure
growth ceiling -- and will officially inform the USG of this
decision next week in its response the May 9 letter to Ariav
from the Departments of State and Treasury. Finkelstein said
that the MOF also plans to develop a longer-term fiscal
formula, tied to Israel's debt-to-GDP ratio, to govern fiscal
decision-making in future years. While noting that the
Israeli economy is still doing remarkably well, Ariav said
that the continued strong shekel will inevitably harm Israeli
exports. End Summary.
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Bar-On Shocked by Fayyad OECD Letter
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3. (C) Ariav told the Ambassador that Finance Minister
Bar-On was "shocked" by the letter sent by Palestinian Prime
Minister Fayyad urging that Israel's OECD accession be
blocked due to its policies vis-a-vis the Palestinians. He
said that he and the Minister would never have expected
Fayyad to send such a letter. Moreover, the timing could not
have been worse, with Bar-On finding out about it just as he
was leaving for Paris to negotiate OECD accession issues.
Instead, dealing with the fallout from the letter has become
a main focus of the trip, diverting the Minister from his
mission. As a consequence, Ariav said that "if this is the
Palestinian approach," there will now be a new Israeli
approach as well. He noted that outstanding PA debts to
Israeli institutions did not hold up revenue transfers by
Israel in the past. While the revenue transfers will not be
slowed down deliberately, they will be subjected to greater
scrutiny, and Israel will no longer be so flexible regarding
outstanding PA debts, such as those owed to the Israel
Electric Corporation. Without being specific, Ariav added
that this type of PA approach "won't help in other areas
either."

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Revenue Transfer in a Few Days
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4. (C) The Ambassador said that the letter had surprised the
U.S. too. He noted that Fayyad had expressed regret for
sending the letter and said that he believes that the
Palestinian PM understands that it was a mistake. He noted
that the MOF has always been at the forefront of Israeli
government ministries in its willingness to cooperate with
the PA. He further referred to the extremely fragile state
of the Palestinian economy and the importance of timely
revenue transfers to its ability to continue to function.
Ariav said that he understands the difficult PA economic

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situation, but that the MOF approach regarding outstanding
debts will be tougher from now on, adding that "the letter
caused problems for Israel, but won't help the Palestinians."
In any case, he said that he expected the present month's
revenue transfer to take place "in a few days," but did not
give a specific date.

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Two States Two Economies
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5. (C) Regarding other Palestinian-related issues, Ariav
said that he is heading the team discussing final status
economic issues, and that there is agreement about the goal
of establishing two independent states with economies
independent of one another. The negotiations are dealing
with detailed issues such as the type of trade regime that
will be established between the two states. On the Joint
Economic Committee, Ariav said that its work continues
productively. The last meeting was held just a few days ago.


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Palestinians Need Mortgage Concept
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6. (C) Regarding the Bethlehem Conference, he said that the
jury is still out as to its effectiveness. He and his office
were not represented at the conference, but he received a
report from Amos Shapira of the Israel Palestinian Business
Council, who said that many business cards were exchanged and
that a great deal of money was pledged for investment
projects. What is not clear is whether this is new money, or
already-pledged donor money repackaged for the occasion. He
noted that investment in housing and construction projects is
critical for the Palestinian economy, as is the development
of a mortgage market to facilitate it. However, he said, the
concept of a mortgage is not well-accepted or understood in
the Arab world. The Ambassador agreed, saying that, in his
experience, progress on building projects throughout the
Middle East is generally tied to the amount of cash on hand.
He added, however, that there has been some recent success in
Iraq in introducing the concept of a mortgage, which might
bode well for similar efforts in the West Bank.

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Economy Doing Well -- But For How Long?
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7. (C) On the economic front, Ariav said that dealing with
the Knesset lately has not been easy, due to the political
instability resulting from the Olmert corruption
investigation. Numerous pieces of legislation have been
introduced that could have negative budgetary consequences.
If a 2009 budget is not passed before the end of the year,
the 2008 budget will continue to apply, with one twelfth of
its total spent each month in 2009 until a new budget is
passed. The Ambassador remarked that this at least has the
virtue of maintaining fiscal discipline in an unstable
political environment. Ariav agreed, but noted that the lack
of a budget would harm the MOF's long-term planning process.
While the economy is now performing remarkably well, it is
not clear how long that will continue. The chief concern is
the strength of the shekel, which will eventually hurt
Israeli exports. Meanwhile, unemployment is down and labor
participation is up, with 49,000 individuals joining the work
force in the first quarter of 2008 alone.

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JEDG Parameters to Stay the Same in 2009
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8. (C) The Ambassador raised the May 9 letter sent to Ariav
by the Departments of State and Treasury regarding the
formulation of the Joint Economic Development Group's (JEDG)
Loan Guarantee Agreement parameters for the 2009 budget, and
asked when a response would be forthcoming. Ariav replied
that he expected the MOF response to be ready next week. The
MOF will propose maintaining the current parameters for 2009
-- a one percent deficit ceiling, a 1.7 percent expenditure
increase ceiling, and continued reforms in a variety of
areas. He said that this would undoubtedly generate a major
debate in the government. However, he noted that Prime
Minister Olmert assured him personally of his support for the
MOF position.


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Long-Term Fiscal Formula Needed
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9. (C) For the period beyond 2009, the MOF's goal is to
establish a fiscal formula tied to the debt to GDP ratio to
govern expenditure and deficit decisions. Israel's debt to
GDP ratio, as high as 160 percent in the 1980s and 104
percent in 2003, is now down to below 80 percent, still high
when compared to the OECD average of about 58 percent. Ariav
said that his goal is for Israel to reach the OECD average by

2015. He believes this is possible, barring a deep
depression striking the economy. Continued weakness in the
dollar would also help Israel reach this goal, as a quarter
of Israel's debt is external and denominated in dollars,
whereas the debt-to-GDP ratio is calculated using shekel
balances. He repeated that a continued weak dollar would,
however, have other negative consequences, such as a general
slowdown in Israeli exports, a major sector of the economy.


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