MINISTRY OF FINANCE PROPOSES TWO-YEAR BUDGET AND

UNCLAS TEL AVIV 000457 SENSITIVE SIPDIS NEA/IPA FOR FRELICH, GOLDBERGER; EEB/IFD FOR PERDUE; TREASURY FOR BALIN E.O. 12958: N/A TAGS: ECON EFIN IS SUBJECT: MINISTRY OF FINANCE PROPOSES TWO-YEAR BUDGET AND NEW FISCAL RULE REF: TEL AVIV 194 ¶1. (U) Summary: In a press release dated February 22, the Ministry of Finance announced its intention to propose another two-year budget (2011-2012) and a new fiscal rule to the government in the coming days. The proposals have been agreed to by the Prime Minister and will be presented to the Knesset following approval by the government. The Ministry characterizes these two proposals as a "revolution in the way the government manages the Israeli economy and the state budget." GoI officials strongly hinted at these outcomes in meetings with USG officials during the Joint Economic Development Group mid-term review in December 2009 (see reftel.) Local commentary on the proposals has been largely positive, with strong criticism coming only from the most conservative. Sever Plotsker, the chief economic columnist at Israel's largest circulation daily, noted the commitments made by the GoI to the US to secure the loan guarantees. End Summary. Two-Year Budget -------------- ¶2. (U) Finance Minister Yuval Steinitz has been a vocal proponent of the two-year budget, determined to move it out of the realm of crisis-management tool and into normal practice. Touting the benefits of stability and long-term planning, Steinitz received an extra boost when IMF and OECD visiting delegations praised the two-year budget introduced when the Netanyahu government took office last spring as a positive policy measure in light of the crisis. The press release cites the main advantages as the enhanced ability of ministries to plan their activities for a limited period of time in accordance with their budget, and the freeing up of administrative time and energy from continuously dealing with the budget toward focusing on strategic thinking and building long-term plans. Critics note the difficulty in credibly planning for two years and the subsequent need to constantly adjust the budget, as happened in 2009 when increased expenditures were required for the defense and health budgets just two months after the budget was approved. Given the geopolitical unknowns, some say a two-year budget lacks the flexibility Israel sometimes requires. However, as we saw with the last adjustments, the current administration found little difficulty in getting them passed. The political calculation seems to be that the risk of opposition to future budget adjustments is small and well worth the stability gained. Revised Fiscal Rule -------------- ¶3. (U) After months of discussion between the Ministry of Finance (MoF),the Bank of Israel and the National Economic Council (NEC) within the PM's Office, an agreed-upon formula to set the increase in government expenditures from year to year has finally emerged. The new rule sets the rate of increase of expenditures as a multiplied factor of the distance from the debt goal within average growth rate of the preceding ten years. The desired debt-to-GDP ratio has been set at 60 percent (as in the Maastricht treaty) and the 10-year average growth rate (2000-2009) has been calculated at 3.5 percent. Israel's current debt-to-GDP ratio is 79.9 percent. Therefore, the calculation of expenditure for 2011 yields a figure of 2.6 percent. (3.5 percent times the ratio of 60 percent over 79.9 percent equals 2.6 percent.) The Ministry of Finance cited the following guidelines in formulation of the new rule: simplicity, absence of forecasts to ensure transparency, short and medium-term applicability to ensure sustained credibility and avoiding pro-cyclical policies that could exacerbate a recession during an economic crisis. ¶4. (SBU) The Finance Ministry highlighted the key point of consensus in designing the new rule as the continued reduction of the debt-to-GDP ratio, noting the long range goal of the 60 percent target in the Maastricht treaty. The medium range goal is likely 70 percent. In addition to guarding economic stability against external shocks, Israel's high geopolitical risk and accompanying high defense expenditures also fed into the consensus requiring the continued decrease of the debt-to-GDP ratio. Demographic changes (aging population) and the need to free resources within the budget by reducing debt servicing costs also played a role. The declining deficit ceiling, as determined by law, remains unchanged. Positive First Impressions -------------- ¶5. (U) The local economic commentators who were early to seize on the news of the proposals have largely applauded the two-year budget and fiscal rule, citing the increased expenditure ceiling for 2011 as the correct response to the public's dismay at under-funded public services over the last 20 years of conservative budgeting. The heightened sense of certainty in the government's budget policy that both proposals support solicited praise, as well as the fiscal rule's clear mechanism for downward adjustment of the debt-to-GDP ratio. Bank Leumi commentators noted the importance of this figure to international actors such as the IMF, OECD and rating agencies. Yediot Aharonot's (Israel's largest circulation daily) chief economic commentator, Sever Plotsker, criticized the artificial "boxes" the GoI employed under the previous fiscal rule, which provided the government the ability to make unique expenditures in times of need that were not included in the previous 1.7 percent per year expenditure ceiling. The new rule, he says, finally puts an end to this fiction. Plotsker also cited the government's use of the 1.7 percent ceiling as a handy tool to convince Knesset members and spending ministries to toe the line, as the ceiling was touted as a specific commitment to the U.S. in exchange for the loan guarantees. The most strident criticism of the proposals thus far has come from Ha'aretz's ultra-conservative economic commentator, Nechemia Strassler, who viewed the fiscal loosening that the new rule allows in 2011 as a betrayal of the MoF's, especially the Budget Division's, responsibility to keep a tight rein on inefficient and wasteful public sector spending. Without referring to the specifics of the formula. he surmises that this is the beginning of a negative trend. ¶6. (SBU) Comment: While the MoF's announcement is mute on escape clauses and enforcement mechanisms, the simplicity of the new fiscal rule and its emphasis on declining debt hit the right mix for the current environment. Post will engage with contacts at MoF, NEC and Bank of Israel to gauge their impressions of the cooperation in coming up with the formula, as well as the feedback they have received from across the business and economic spectrum. As building of the 2011-2012 budget gears up, we expect to see a more collaborative process with spending ministries and an effort to employ long-term budget projections that will fit into the new fiscal rule's framework. Cunningham