BOI PROPOSED SPENDING INCREASE TO COMBAT RECESSION

UNCLAS SECTION 01 OF 04 TEL AVIV 000725

SIPDIS

NEA/IPA FOR GOLDBERGER, SACHAR; EEB/IFD FOR JACOBY; TREASURY FOR
BALIN

E.O. 12958: N/A
TAGS: ECON EFIN PGOV ELAB IS
SUBJECT: BOI PROPOSED SPENDING INCREASE TO COMBAT RECESSION

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Summary
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1. The Bank of Israel (BOI) presented a plan of modest spending
increases to combat Israel's economic downturn. The cost is about
NIS 4.4 billion (USD 1.1 billion),designed to offer incentives for
the labor market, for infrastructure investment and for exporters.
Implementation would raise the deficit, but the BOI says that, given
Israel's excellent record of fiscal responsibility over the past
five years, the markets should understand the need for these
one-time spending measures. If the downturn turns out to be harsher
and longer than expected, the BOI said it might be necessary to
implement a variety of spending cuts to maintain fiscal discipline,
including delaying or canceling certain aspects of its plan. It
also strongly recommended that the new government come up with a
comprehensive and credible economic program based on multi-year
fiscal targets to enable it to focus on longer-range goals and
priorities beyond the immediate necessity of dealing with the
financial crisis. Israel's unexpectedly successful bond offering on
the international market last week is an indication that the Israeli
economy is perceived as relatively strong compared to many others.


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NIS 4.4 billion Spending Plan
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2. The Governor of the Bank of Israel (BOI) Stanley Fischer
recently proposed modest increases in spending to combat Israel's
economic downturn. The BOI's latest 2009 growth forecast projects
1.5 percent negative growth for the year, following growth of 4
percent in 2008. The cost of implementing the BOI's proposed steps
is NIS 4.4 billion (USD 1.1 billion). The plan offers incentives
for the labor market, and for infrastructure investment and
exporters.

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Plan Would Raise Deficit
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3. Implementation of the proposal would raise the deficit in 2009
to 5.8 percent, higher than the BOI's earlier deficit forecast of
5.2 percent. However, the BOI said that as long as it is understood
that its proposal includes one-time, temporary measures to deal with
an extreme situation -- a global crisis that could cause a sharp
increase in unemployment and poverty -- the increased spending will
likely not damage Israel's credit rating or raise the risk premium
on its debt. The BOI noted that this is due to the GOI's stringent
policy of fiscal restraint since 2003, and its success in
dramatically lowering Israel's debt to GDP ratio. The "very
moderate" expenditure increase the BOI is proposing will not have
much impact on that ratio. The BOI is recommending that the
government prepare a comprehensive multi-year fiscal plan, similar
to that presented by then Finance Minister Netanyahu in 2003. It
strongly emphasized the importance of credibly maintaining a
declining debt to GDP path, despite the current difficulties.

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Labor Market Incentives
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4. The BOI plan calls for a total of NIS 1,790 million (about USD
450 million) for labor market relief. NIS 750 million (USD 188
million) would be used to implement a long-planned Earned Income Tax
Credit nationally. NIS 555 million (USD 140 million) would go
towards increasing unemployment benefits, particularly extending the
period of eligibility for receiving payments. For example, those 45
and older would be eligible to receive benefits for 200 days in
place of the present 175. Those aged 28 to 35 with fewer than three
children would receive benefits for 138 days instead of the present

100. The number of months of work needed to be eligible for
unemployment benefits would also be reduced from twelve months out
of the last eighteen, to nine.


5. The BOI proposal also calls for spending NIS 200 million (USD 50
million) to extend the "welfare to work" Wisconsin Training and
Employment Plan beyond the current pilot areas nationwide. It
envisions spending NIS 185 million (USD 46 million) on a program to
reduce the number of foreign workers in the country. Finally in the
area of labor market incentives, the plan would provide NIS 100
million (USD 25 million) to finance temporary leave for employees at
factories that are experiencing difficulties.

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Infrastructure Investment
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6. The second tranche of the program allots NIS 1.5 billion (USD
375 million) for infrastructure investment. This includes NIS 500
million (USD 125 million) for infrastructure projects, particularly
public transportation. It also includes a similar amount for
projects such as rehabilitating city centers and neglected tourist
areas, and for moving IDF bases to the Negev. This part of the
program also calls for moving forward on projects in the education
sector, and for investment in other one-time projects such as new
computer systems for the government.

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Industry and Export Incentives
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7. The NIS 1.15 billion (USD 288 million) allotted for industry and
export incentives includes NIS 750 million (USD 188 million) for
increasing R & D budgets, NIS 600 million (USD 150 million) of which
is targeted for the office of the Chief Scientist. NIS 400 million
(USD 100 million) would also be used to provide increased levels of
risk insurance for companies involved in international trade.

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Quick and Easy to Implement
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8. According to the BOI, the plan should be easy and quick to
implement. The bank stressed the importance of moving quickly to
ensure that its impact be apparent in 2009. It said that it is
preferable to increase expenditures that do not require long-term
planning - while infrastructure investment is always touted as a
tool to stimulate economies, the benefit of such expenditure is
often felt only over the long-term. The BOI also suggested that the
government attempt to reach agreement with the Histadrut Labor
Federation to delay public sector wage increases scheduled to go
into effect this year.

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Soften the Blow of the Recession
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9. As the BOI's economic forecasts have become more pessimistic
with time, the hope is that this relatively modest plan will
slightly soften the blow of the recession in terms of growth,
unemployment, and the number of people falling under the poverty
line. Following four years of greater than five percent growth, the
Israeli economy grew by four percent in 2008, despite the onset of
the worldwide financial crisis in the second half of the year. This
attests to the continued strong fundamentals of the economy. The
global slowdown took time to actually impact on Israel, which
registered 0.9 percent growth in the third quarter of 2008, followed
by a negative growth of 0.5 percent in the fourth quarter. Exports
alone declined by 43.6 percent in the fourth quarter, although the
Central Bureau of Statistics notes that export figures are given to
volatile swings from quarter to quarter

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2009 Negative Growth of 1.1 Percent with Plan
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10. While explaining the BOI's economic proposal, Fischer also
presented the bank's most updated forecasts for 2009 and 2010.
These include negative growth of 1.5 percent in 2009, which would
make this year even worse than the recession years of 2001 and 2002,
when growth was negative 0.4 percent and negative 0.7 percent,
respectively. At that time, the recession was due to a combination
of factors, including the Intifada, the bursting of the high-tech
bubble and the NASDAQ downturn. The BOI says that the implementation
of its proposed economic plan would marginally ease the present
downturn by increasing growth 0.4 percent in 2009, bringing the
overall negative growth for the year to 1.1 percent.

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Unemployment Up Sharply
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11. The BOI forecast an unemployment rate of 7.8 percent by the end
of 2009, but added that implementation of its plan could reduce this
to 7.3 percent, resulting in 15,000 fewer unemployed and 4000 fewer
people living in poverty. These numbers stand in marked contrast to
the 2008 unemployment figures of six percent in the second and third
quarters and 6.3 percent in the fourth quarter. The daily press is
filled with reports about layoffs in all sectors of the economy,
with growing numbers of people applying for unemployment benefits,
20,000 in January alone.
Labor Participation, which increased over the last few years to 52.9
percent in 2008, was also forecast by the BOI to decline to 51.8
percent in 2009. The BOI claims that implementation of its plan
would halt the decline at 52.1 percent.

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Increased Deficit and Debt to GDP Ratio
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12. While preventing spiraling unemployment is viewed as one of the
major goals that will face the new government, the BOI plan has a
price. It will increase the deficit which is already expected to be
high, and the debt to GDP ratio as well. The general view among
economists is that the deficit in 2009 will be over 5 percent as a
result of the sharp decline in tax revenues. The BOI 2009 deficit
forecast is now 5.2 percent. The BOI assesses that implementing its
economic plan would raise it to 5.8 percent, if no cuts are made to
offset the spending increases.


13. This contrasts starkly with 2007's almost-balanced budget and
the 2008 deficit of 2.1 percent. The 2008 figure was 0.5 percent
higher than originally forecast due to the Ministry of Finance's
(MOF) decision to stimulate the economy towards the end of 2008 by
spending in advance NIS 4.4 billion that had originally been slated
for spending in 2009.


14. The debt-to-GDP ratio has been on a steady and significant
decline since the implementation of the 2003 Economic Recovery Plan
under then-Finance Minister Netanyahu. It declined from about 103
percent at its height to 79.6 percent in 2007 and 78.1 percent in

2008. The BOI forecasts that it will increase to 85.7 percent in

2009. Implementation of the BOI's plan would increase it slightly
more -- to 86.2 percent this year.

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BOI Favors Anti-cyclical Intervention
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15. At the end of 2008, before the BOI had adopted its more
pessimistic growth and deficit forecasts for 2009, Fischer publicly
called for a very cautiously expansionary fiscal policy based on the
"automatic stabilizer" of an increase in the deficit resulting from
increased government expenditures - on unemployment payments, for
example - at the same time that tax revenues are reduced by the
slowdown. Now, hit by the reality of a deeper-than-forecast
downturn, the BOI thinks that the time has come to implement
anti-cyclical intervention beyond the automatic stabilizers. Their
plan, which aims to increase demand, is much preferable, in the
BOI's view, to raising taxes or significantly cutting the budget, as
these measures would deepen the slowdown. Forecasting a 0.5 percent
reduction in private consumption in 2009, compared to a 3.9 percent
increase in 2008, the BOI's assessment is that adoption of its plan
would enable private consumption to grow by 0.1 percent in 2009. In
the central bank's view, an increase in the deficit is mitigated by
the temporary nature of the plan and the extreme circumstances
dictating its implementation. The judgment is that this will not
have a large influence on the cost of financing debt.

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Low Debt-to-GDP Vital in Long Run
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16. The BOI replied to criticism that the plan's NIS 4.4 billion in
expenditures is too little to have any real impact on the economy by
saying that any spending increase needs to be moderate, in order to
minimize the increase in the deficit and the cost of financing the
growing debt. In addition, the BOI stressed that the government
must reaffirm its commitment to significantly reduce the debt-to-GDP
ratio in the medium term. Excessive expansion of expenditures
without a credible plan that includes medium term fiscal targets and
eventual budget cuts would harm the GOI's fiscal credibility and
endanger its credit rating.

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Ideas on Offsetting the Cost of the Plan
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17. Numerous commentators criticized the BOI for not suggesting
enough offsets to pay for the costs of its plan. Many note the need
for expenditure cuts which would not affect domestic activity,
implying a reduction in the defense budget. (Note: Dr. Karnit Flug,
the Chief of Research at the BOI and one of the chief authors of its
economic plan, was a member of the Brodet Committee, which decided
in 2007 that the defense budget needed to be increased while at the
same time calling for the military to implement efficiency measures
to reduce its budget. End Note).

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Sharper Cuts May be Needed
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18. The BOI notes that based on decisions made by the outgoing

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government on expenditures in the coming years, implementing these
plans will require offsetting measures in order to maintain the 1.7
percent annual expenditure ceiling, committed to by the GOI to the
USG according to the 2003 Loan Guarantee Agreement. The BOI's
assessment is that if the government does not offset the increases
in expenditures, some of which have been agreed to by the current
government, and the economic situation is severe and continues for
longer than anticipated, the deficit in 2010 could reach 7.4 percent
and debt to GDP could increase to more than 90%.


19. The BOI suggests that in such a scenario, in which the 2010
deficit will be even higher, the tax reductions planned for the last
year of Netanyahu's five year tax reduction plan - presented when he
was Finance Minister and estimated to cost about NIS 2.5 billion
(USD 625 million) - should be delayed. In such a case, it also
suggests cancelling certain tax exemptions, increasing the VAT,
curbing the increase in other government expenditures, and even
delaying or canceling certain aspects of its proposed plan. The BOI
noted that in any case, large cuts will be necessary in 2010 in
order to meet the expenditure ceiling.

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One-Time Increases OK
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20. The BOI noted that the fiscal consolidation that took place in
the last five years reduced yields on government debt and improved
Israel's credit rating. Given the shakeup in the global economy, it
thinks that it is worth risking a temporary increase in the deficit
despite of the uncertainty regarding the markets' reaction. The BOI
also noted that similar policies have been undertaken in other
countries. As long as the new government presents a comprehensive
and credible economic plan that will be based on multi-year fiscal
targets, the risk of the BOI plan is minimal.

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Most Successful Ever Bond Issuance
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21. With all of its problems, the Israeli economy is relatively
healthy in comparison with many others around the world. On March
19, the GOI successfully floated Israel's largest-ever bond issuance
on the international markets. The MOF had originally intended to
test the waters with a USD 500 million ten year-issuance, but
tripled the amount to USD 1.5 billion after receiving indications
that the market demand for the GOI bonds could reach as high as USD
12 billion. The rate of interest was 5.19 percent.

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Comment
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22. It is not at all clear what impact the BOI's plan will have on
whatever government is ultimately formed in Israel. It is likely
that, during this interim transaction period, the BOI wanted to
reassure the public and the markets that someone was paying close
attention to the country's economic problems and formulating
practical plans to deal with them. Fischer's moderate plan serves
as a warning to the new government that, while action is called for,
so is prudence and responsibility. It remains to be seen what the
final costs of the coalition agreements will be and how much money
will be left for further discretionary spending to stimulate the
economy. In any case, the success-beyond-expectation of last week's
bond offering indicates that, with all its problems, the Israeli
economy is still perceived as among the healthiest in the world.



CUNNINGHAM