USG AND ISRAEL AGREE ON SPENDING LIMITS, FISCAL

UNCLAS STATE 076107 SENSITIVE E.O. 12958: N/A TAGS: ECON EFIN EAID IS SUBJECT: USG AND ISRAEL AGREE ON SPENDING LIMITS, FISCAL RULE ¶1. (SBU) Summary: At the June 29 meeting of the U.S.-Israel Joint Economic Development Group (JEDG),the USG and GOI delegations agreed on conditions that would govern the decision to release FY 2010 and FY 2011 tranches of loan guarantees. These conditions support fiscal discipline in Israel,s combined 2009-2010 budget and encourage medium- and long-term fiscal governance. Leading the USG delegation, EEB Acting A/S Nelson and Treasury Acting A/S Baukol commended Israel,s strong economic performance since the inception of the loan guarantee program in 2003 and noted that Ministry of Finance (MOF) support for fiscal discipline has helped Israel to better withstand the global financial crisis. MOF Director General Yarom Ariav, who led the GOI delegation, stated that conditionality established by the JEDG &helps us to help ourselves.8 OMB and CBO representatives also participated in the JEDG to help the MOF establish stronger fiscal accountability mechanisms and move toward implementing a new fiscal rule. The agreed conditions also address Israeli food import standards and IPR protection. Acting A/S Nelson noted Bank of Israel Governor Stanley Fischer had expressed interest in exploring further how the JEDG process can advance our bilateral economic relationship, but explained that the new Under Secretary for Economic, Energy and Agricultural Affairs would evaluate all bilateral dialogues upon taking office. The USG and GOI agreed to steps for verifying GOI compliance with the agreed conditions and to a mid-year review. Media reports on the JEDG outcome have been fairly accurate. End Summary. -------------- FISCAL CONDITIONS FOR 2009-2010 BUDGET -------------- ¶2. (U) While the JEDG usually meets once a year, the June 29 meeting was the first since March 2, 2007. USG and GOI scheduling conflicts prevented a JEDG meeting in 2008. ¶3. (U) The outcome of the JEDG meetings is an appendix to the loan guarantee agreement (LGA) that spells out conditions the GOI must meet in order to be able to issue bonds backed by a USG guarantee. At the June 29 meeting, the USG delegation agreed to support the GOI,s proposal for 2009 real spending growth of 1.7 percent plus 1.35 percent (3.05 percent in all) over 2008 expenditures, and 2010 real spending growth of 1.7 percent over 2009 expenditures. The USG also supports a 2009 deficit cap of 6 percent of GDP and a 2010 deficit cap of 5.5 percent of GDP. ¶4. (U) On the spending growth and budget deficit targets, DG Ariav stated that fiscal conditionality under the loan guarantee agreement has contributed to Israel,s strong economic performance since 2003 and ability to withstand the impact of the financial crisis. The 3.05 percent real spending growth in 2009, he emphasized, would only be a temporary measure, and the budget is slated to return to its path of 1.7 percent annual growth starting in 2010. Bank of Israel Research Director Karnit Flug, however, stated that the current glide path of government spending would push spending above 4 percent after 2011, and that the GOI would have to cut current commitments to achieve its 1.7 percent goal. -------------- MEDIUM-TERM FISCAL DISCIPLINE -------------- ¶5. (U) The GOI agreed to create a long-term budget analysis of Israel,s future social expenditures, including unfunded social mandates (such as health and pension system spending) and to present a roadmap to the USG during the 2009 mid-year review or 2010 JEDG that outlines the implementation of a new medium-term fiscal rule. The fiscal rule roadmap would guide expenditure growth and budget deficits through 2015 or a later date. ¶6. (U) Office of Management and Budget Deputy Associate Director for Economic Policy Michael Falkenheim chaired a roundtable discussion focused on Israel,s fiscal rule options. Bank of Israel Director of Research Karnit Flug advocated an algebraic rule that directly connects annual spending caps to a medium-term fiscal goal, such as a 60 percent debt-to-GDP ratio, which she suggested Israel would meet by 2020. DG Ariav proposed medium-term spending and deficit caps without a direct connection to the debt-to-GDP ratio. Both admitted that the primary issue for any rule is enforcement*for now, spending plans in the Knesset must only show projections that comply with the rule for three years. DG Ariav and Ms. Flug proposed to reform Knesset spending rules to make all plans comply with the fiscal rule in the long run. When pressed about when Israel will implement a new fiscal rule, DG Ariav stated that the Knesset will take up the issue after it passes the 2009-10 budget in mid-July. DG Ariav noted there is already much discussion within the GOI about adopting a framework that relies less on inflexible spending caps and more on achieving medium- and long-term fiscal goals. Falkenheim emphasized the importance of both enforcement mechanisms and escape clauses to provide credibility and flexibility to a fiscal rule mechanism. ¶7. (U) Congressional Budget Office Deputy Director Robert Sunshine provided an overview of the U.S. budget process and discussed the role of non-partisan budget oversight. Sunshine emphasized the desirability of a budget watchdog as a source of MOF credibility in budget discussions with the Knesset, and as a tool to resist overt political influence from other parts of the government in the budget drafting phase or formulation of budget projections. Sunshine also advocated the idea of a &Pay-Go8 system for Israel, in which future spending proposals would have to be offset by compensating increases in taxation, other revenue, or spending cuts. The GOI delegation was receptive but non-committal to Mr. Sunshine,s presentation. -------------- OTHER ECONOMIC ISSUES -------------- ¶8. (U) Acting A/S Nelson noted USG concern that Israeli food import standards are unclear, and trade and standards agreements established with the European Union put U.S. exporters at a disadvantage. He pointed out the lack of published guidelines and regulations cause significant delays for U.S. companies. The GOI agreed to provide to the USG answers about safety standards required for the import of food to Israel. ¶9. (U) Acting A/S Nelson raised intellectual property rights (IPR) protection, noting the USG continues to urge the GOI to make sufficient resources available to the Ministry of Health for faster pharmaceutical marketing approval and to make patent law reforms that extend the term of patent protection. The GOI agreed to continue consultations with the USG regarding levels of IPR protection. ¶10. (U) The USG agreed to support the GOI,s structural reform targets outlined in the 2009-2010 budget. These include privatization of Israel,s state-owned seaports, implementation of private sector participation in electricity production, and progress on a reform of Israel's land authority. ¶11. (U) The USG confirmed, in its term sheet, that the amount of loan guarantees released for use to Israel is $3.148 billion, subject to statutory deductions. The FY2010 and FY2011 tranches of $333 million each will be released for use after Treasury and State confirm that Israel has met the conditions signed in Appendix 10 of the Loan Guarantee Commitment Agreement (LGCA),dated June 29, 2009. ¶12. (U) Acting A/S Nelson recognized Bank of Israel Governor Stanley Fischer had expressed interest in continuing the JEDG process as a way to advance U.S.-GOI economic cooperation. Acting A/S Nelson noted the JEDG would be one of many bilateral economic dialogues the new Under Secretary for Economic, Energy, and Agricultural Affairs would have to consider upon assuming office. DG Ariav stated he was not aware of Fischer,s interest in using the JEDG process to deepen the bilateral economic relationship; he acknowledged the need for the incoming Under Secretary to establish his own priorities. -------------- REVIEW OF GOI ECONOMIC PERFORMANCE -------------- ¶13. (U) The USG confirmed that the GOI sufficiently met the conditions for the release of FY 2008 and FY 2009 tranches of loan guarantees, subject to statutory deductions. ¶14. (U) The USG and GOI agreed at the June 29 meeting that the Ministry of Finance would release reports to the U.S. Departments of State and the Treasury in March 2010 and 2011 detailing Israel,s progress on each of the agreed conditions, including a budget breakdown showing central government expenditures and deficits in 2009 and 2010. Within two months of receipt of the GOI,s March 2010 and 2011 reports, the USG will make a written determination whether Israel has met the conditions and whether the USG would agree to release the FY 2010 and FY 2011 tranches of guarantees, subject to deductions. ¶15. (U) The USG and GOI also agreed to establish a mid-year review of conditions associated with the FY 2010 and 2011 loan guarantee tranches during which the USG and GOI could amend conditions and introduce new subjects for discussion as needed, through a new appendix. Israeli Embassy Economic Counselor Asaf Vitman proposed the mid-year review be held in December 2009 in conjunction with a major economic conference in Israel. Vitman also invited CBO Director Elmendorf and OMB Director Peter Orszag to attend both the conference and the review. -------------- MEDIA REACTION -------------- ¶16. (U) Upon conclusion of the JEDG, both the USG and GOI released press statements outlining the major outcomes of the meeting and the conditions connected to FY2010 and FY2011 tranches of guarantees. The U.S. Department of the Treasury press release also attached Appendix 10 of the LGCA, signed at the JEDG on June 29. ¶17. (SBU) Israeli press reports characterized the JEDG as a "re-approval" of U.S. loan guarantees. Ha,aretz and the Associated Press correctly cited that $3.14 billion currently available to be drawn by the GOI is subject to statutory deductions, and explained that another $600 million would be released for use if Israel meets 2009 and 2010 conditions. The Jerusalem Post, however, erroneously reported that the U.S. released $3.8 billion in guarantees to Israel. Both articles failed to mention explicitly that, as the U.S. has not made a deduction from loan guarantees since 2005, Israel will likely not be able to draw on the full $3.14 billion in guarantees that is currently available. CLINTON