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