Posted on 03/13/2003 3:08:37 PM PST by anotherview
“The restoration of peace, given Israel's strong fundamentals, would yield substantial economic gains to the region as a whole.”
Globes correspondent 13 Mar 03 17:22
The International Monetary Fund (IMF) today released its annual review of the Israeli economy, in which it urged expenditure cuts from the government and small interest rate cuts from the Bank of Israel The report reads, “On March 7, 2003, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Israel”
Background
”The Israeli economy is in the midst of a deep recession. Waning exports and investment, combined with stagnant private consumption, led to negative growth in 2001 and 2002. The stagnation can be attributed to the burst of the technology bubble, the global slowdown, and the deterioration in the security situation. Recently, some indicators suggest that economic activity is stabilizing, but there are no signs of recovery in sight.
”Despite the recession, the shekel had been remarkably stable until December 2001, when the Bank of Israel (BoI) slashed its policy rate by 2 percentage points as part of a policy package. During the following six months, the shekel depreciated by about 20 percent vis-à-vis the currency basket. The shekel's slide led to a surge in inflation; the CPI rose by 6.3 percent during the first half of 2002 alone, well above the inflation target range of 2-3 percent. Furthermore, inflationary expectations soared toward June 2002.
”In an effort to halt the shekel's depreciation and the surge in inflation, the BoI raised its policy rate in June by 4.5 percentage points to 9.1 percent. This rate hike partially reversed the shekel's slide and reduced inflationary expectations, and the BoI cut the policy rate by 20 basis points in December 2002. However, exchange rate volatility remains high, and substantial risks to exchange rate stability loom ahead, such as further economic deterioration, a loss of fiscal credibility, and a war in Iraq.
”The government has struggled to retain control over the fiscal deficit in the face of falling revenues and security-related expenditure increases. The 2002 budget was adjusted twice, with each adjustment accompanied by an increase in the deficit target from 1.75 percent to 3.9 percent of GDP. The debt/GDP ratio continued to rise, reaching 104 percent by end-2002. The 2003 budget envisages a deficit of 3 percent of GDP, with an aim to return to a declining trend in the deficit, expenditure, and debt to GDP ratios. However, many analysts believe that a further significant expenditure cut will be needed in order to meet the deficit target, primarily due to revenue overestimation.
”Labor market conditions are worrisome. Unemployment is high at 10.1 percent, one-third of which is accounted for by the long-term unemployed. The participation rate is low, partially because of disincentives to work and inefficient employment services. At the same time, the number of foreign workers is estimated at 11 percent of the labor force, a share second only to Switzerland among industrial countries.
”External indicators are mixed. Despite the deterioration in the trade balance, the current account deficit is estimated to have increased only moderately in 2002 to around 2 percent of GDP. Capital inflows, especially foreign direct investment, have declined substantially. Gross external debt has risen above 60 percent of GDP, although net external debt remains negligible, and foreign reserves fully cover short-term foreign liabilities.
”Bank profits have suffered from the deteriorated macroeconomic environment. The credit quality of the corporate sector has declined, and problem loans have risen considerably. Bank supervisors reacted promptly by requiring banks to increase supplementary provisions. They have also conducted focused on-site examinations of major banks to assess their credit classification and to require higher specific provisions so that banks' loan assessments better reflect underlying risks.
”On the structural front, the government pushed forward a broad-based tax reform and introduced some labor market reform measures. Privatization has seen only limited progress.”
Executive Board Assessment
”Directors noted that the Israeli economy is facing major difficulties, which were caused largely by shocks that were either external or noneconomic in origin, although policy credibility has also been an issue. Directors observed that the ongoing security problem is of particular concern, and that its impact is gradually spreading to the whole economy through weaker investor and consumer sentiment. They emphasized that the restoration of peace, given Israel's strong fundamentals, would yield substantial economic gains to the region as a whole.
”Directors considered that, under the current economic conditions, it is crucial for the authorities to pursue credible, transparent, and consistent policies that would maintain market confidence and stability. The cost of policy slippages could be high at this juncture.
”Directors underscored the importance for the government to re-establish a declining path of debt, deficit, and expenditure ratios, so as to strengthen market confidence in the authorities' commitment to fiscal consolidation. In this respect, they commended the authorities for introducing a number of important fiscal reform measures, including tax reform and reductions in social benefits.
“However, Directors considered that achieving the 2003 fiscal deficit target would require additional measures, as revenues appear to be overestimated. They expressed concerns about the negative effects that a revenue shortfall might have on market sentiment, and urged the government to introduce additional expenditure cuts consistent with the deficit target as soon as possible. In this connection, Directors looked forward to the new comprehensive economic plan to be announced shortly.
”Over the medium term, they underscored that sustained reductions in the fiscal deficit and strong economic growth are essential to prevent further increases in the already high public debt-to-GDP ratio. Directors urged the government to take steps to ensure a declining path of the debt ratio, if necessary by cutting deficits faster than currently envisaged in the years ahead.
”Directors stressed that the government should take a number of additional structural steps to enhance the credibility of the fiscal adjustment process, thus cushioning market reaction to temporary shocks. These should include, in particular, a medium-term fiscal program in which future spending plans and commitments, as well as the expiration of any one-off deficit cutting measures, are clearly identified in a transparent way.
”Directors considered that the recent labor market reforms, including lower welfare payments and improved incentives for hiring, should serve to improve the low and falling participation rate, stem the high and rising unemployment, and absorb welfare recipients into the labor market. Effective implementation of these policies is necessary for strengthening the fiscal position. Directors also called for measures to reduce distortions favoring the employment of non-Israeli citizens and to improve the efficiency of employment services.
”Directors underscored that a strong monetary policy is of paramount importance to shield the economy from shocks. They noted the difficult trade-off that the Bank of Israel (BoI) was facing between the need to ease the burden on the recessionary economy stemming from high interest rates and the need to maintain market stability by pursuing a cautious approach to reducing interest rates.
”Directors agreed that the BoI's task was to strike the right balance between easing its policy too fast and waiting too long. To this end, cutting interest rates by small steps whenever market conditions and inflationary prospects improve seems to be preferable to a less gradual approach. In this connection, Directors welcomed the BoI's rate cut in late-December 2002 as a good start, but recognized that the BoI's room for maneuver is currently limited, in light of the recent weakening of the shekel in the context of the geopolitical tension and the fiscal risks. Directors welcomed the shekel's attainment of full convertibility as a result of the removal of the last remaining capital control measures.
”Directors underlined the increasing importance of the BoI's role as bank supervisor against the backdrop of declining bank profitability. They encouraged the BoI to be proactive in strengthening banks' ability to withstand an economic downturn, and urged the authorities to improve their capability to deal with banking sector problems should the need arise. Directors also encouraged the authorities to make further progress in improving their compliance with financial sector standards and codes, including through enhancing information exchange among supervisors, and strengthening insurance supervisors' powers and expertise. They were pleased that Israel had made significant progress in improving its regime for anti-money laundering and combating the financing of terrorism, and called for further efforts in this area. Directors welcomed the authorities' request to have a fiscal transparency Report on the Observance of Standards and Codes.
”Directors observed that Israel meets the Special Data Dissemination Standard specifications for coverage, periodicity, and timeliness of data, and that the quality of the data is adequate for the purpose of surveillance.”
Published by Globes [online] - www.globes.co.il - on 13 March, 2003
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