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