Global uncertainties threaten economy, warns IMF in report

"Although Israel is a global exit front-runner, it is not yet out of the woods," International Monetary Fund writes.

January 27, 2010 04:38
4 minute read.
Global uncertainties threaten economy, warns IMF in report

Tokyo Stock Exchange 224. (photo credit: AP [file])

Israel has had a good "great" recession but global uncertainties still pose a threat to the country's growth rate, the International Monetary Fund said in its annual report on the Israeli economy released on Tuesday.

"The resilience of the Israeli economy during the global crisis reflected strong policy responses, robust fundamentals, prudent bank supervision, public debt reduction and structural reforms in recent years. Although Israel is a global exit front-runner, it is not yet out of the woods," the IMF wrote. "The global outlook remains highly uncertain, and the slower medium-term global growth would have adverse implications for Israel's potential growth rate."

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More specifically the report said that further ahead significant reductions in the growth of potential output of the major economies will likely lower Israel's medium-term potential growth rate by some half a percentage point annually, to 3-3.5%. The IMF projects that Israel's economy will grow by 2.5% this year, up from an estimated 0.1% increase last year. The forecast is more pessimistic than the projection of the Bank of Israel, which this month raised its growth forecast for 2010 to 3.5%, from 2.5%, citing "positive information" on the global and local economies.

The IMF said that while Israeli output, consumption, and confidence are close to their fall 2008 levels, exports, imports, and fixed investment were far from fully recovered.

"Unemployment has edged up to some 8%, the stock of bank credit to corporates has fallen through much of the year, and inflation has been above target for much of that time," stated the report. "And though safe haven factors that earlier put upward pressure on the currency appear to have eased along with global financial sector stabilization, concerns about the excessive strength of the shekel have not entirely been put to rest. Upward pressures on the shekel could pose new risks."

Echoing the demand raised by the report on the Israeli economy from the Organization of Economic Cooperation and Development published last week, the IMF urged the Bank of Israel to formally terminate its foreign currency policy of discretionary interventions for all but the most exceptional market circumstances.

Looking ahead, the challenge is to implement an effective exit strategy, as the credibility of the new deficit ceiling rules has yet to be fully established, while public debt is high and is expected to rise in the near term before resuming its downward track, said the IMF.

"A key message that needs to be underscored to the public is that given global uncertainties, actions which might compound downside risks, need to be avoided," stated the report. "This concern precludes early commitments to sizable permanent remuneration increases, notwithstanding the encouraging economic performance so far.

"In particular, wage settlements for public sector employees due in 2010 should be tightly restrained. This would send an appropriate signal to private sector wage setters, help keep inflation and interest rates low as output strengthens, and thus promote continued good economic performance."

The IMF also raised concerns over the planned medium-term caps on public spending, in particular in light of the government's plan to gradually reduce corporate and income taxes through 2016.

"The planned reductions in headline income tax rates assume this further spending compression, which creates a vulnerability for public debt reduction," stated the report. "Such precommitments to tax reductions may therefore cast doubt over the pace of debt reduction, and this could undermine or eliminate the supply side gains from the tax cuts, by pushing up risk premia and the cost of financing for firms."

The report recommended that to avoid this, tax reductions should follow demonstrated debt reductions consistent with the debt target and interim ceiling. The IMF said that a debt target of 60% of GDP by 2020, anticipating further reductions thereafter, with an interim ceiling of 70% of GDP by the middle of the coming decade would be appropriate. Israel's public debt is currently equal to about 80% of its GDP.

Speaking at a conference of the Finance Ministry's budget division, its Supervisor Udi Nissan said on Tuesday that the viability of the government's tax policy plans needed to be reexamined and tested in accordance with the ability to reduce the country's debt-to-GDP ratio.

"At the moment the economy is growing well and revenues are coming in, but we need to remember that the risk level is still high in view of global uncertainties," Nissan told The Jerusalem Post on the sidelines of the conference. "This could create a trade-off situation between the target of bringing down government expenditure and the country's debt-to-GDP ratio and plans to reduce taxes."

Although the IMF report writers said that the Israeli banking system has weathered the crisis well, they see scope for a further strengthening of the banking prudential framework.

"Comprehensive banking stress tests, regular publication of a financial stability report by the Bank of Israel, and closer coordination among various regulators would all strengthen transparency and stability," the report said.

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