S&P downgrades Israel's local currency credit rating

Credit ratings agency Standard & Poor’s on Thursday downgraded Israel’s local currency credit rating to A+ with a stable outlook, from AA-, after Finance Minister Yair Lapid announced his plan to raise the 2013 deficit target to 4.9 percent from 3% of GDP, adding NIS 19 billion to the annual deficit.

Lapid brushed aside the downgrade, saying it “is not surprising. It came in response to a situation we are fixing now.”

Earlier Thursday, the price on Israel’s 10-year government bonds fell for the first time in eight days with the news of Lapid’s plan to raise the deficit.

Lapid hopes to pass his proposal, which leaked late on Wednesday night, at Sunday’s cabinet meeting.

In addition to increasing deficit targets, Lapid’s plan also ups the limit on how much the government can increase spending from one year to the next, allowing him to spend 2.2% more in 2013 than the previous year. That would give him room to spend NIS 6.5b.

more than in 2012, according to figures cited in the proposal.

(Calculations using Treasury figures put the spending increase closer to NIS 6.3b.) If the plan were approved, the 2013 state budget would hover at around NIS 293b.

In 2014, Lapid would return the deficit limit to 3%, which is also higher than the current 2.75% target for that year.

That change would swell the 2014 deficit an additional NIS 2.6b.

Prime Minister Binyamin Netanyahu and Bank of Israel Gov. Stanley Fischer were surprised at Lapid’s decision and will meet over the weekend to discuss it.

The move is likely to meet with disapproval from Fischer, who has argued that raising the deficit beyond its set levels harms the economy’s longterm stability. Specifically, Fischer has said that higher deficits reduce faith in the government’s ability to keep its finances in order, raise future debt payments, which are higher for Israel than in similar countries, and rob the nation of tools for stimulating the economy should it come upon hard times in the future.

Fischer has conceded, however, that the deficit was likely to overshoot its target this year.

MK Reuven Rivlin requested that the Knesset Finance Committee hold a hearing on the proposal, while former Bank of Israel governor David Klein called Lapid’s plan dangerous.

“It looks like the finance minister has given up,” Klein said in an Army Radio interview.

Opposition leader Shelly Yacimovich praised Lapid for taking action to limit spending cuts.

“For the first time since taking office, the finance minister has made the right move,” Yacimovich said, adding that “even the European Union has become skeptical about the effectiveness of austerity policy.”

Measures such as increasing VAT, imposing new taxes, decreasing public sector wages and cutting health and education benefits harmed the middle class and the economy as a whole, she said.

Fellow Labor MK Avishay Braverman, who chairs the Knesset Economics Committee, seemed to disagree.

“He’s saying okay, listen: We’re not going to deal with the deficit this year; it will be 5%. But I promise Stanley Fischer, I promise all of you, that I will return to 3% in the short term. I’m very nice,” Braverman said in an interview with Army Radio.

“I always said that the deficit, when Israel isn’t in a heavy recession, should go according to the European levels, the Maastricht levels, of 3%,” he said.

Shas leader Eli Yishai, on the other hand, called for support of the deficit increase, which he said would “minimize harm to the weak classes and somewhat remove the sword on the necks of the middle class.”

According to Shmuel Ben- Arieh, market research manager at Pioneer Financial Planning, the plan was based on political considerations, not economic ones.

“Expanding the deficit target is dangerous to the Israeli economy’s image as stable and responsible,” he said.

“It’s puzzling that Netanyahu, who contributed to building this image, wouldn’t oppose the proposed move,” which he noted would further raise Israel’s borrowing costs.

Any deterioration in Israel’s security situation, Ben-Arieh added, would further swell the deficit.

In his proposal, Lapid wrote that passing the budget so late in the year limited his ability to meet the current legal targets.

“Approving the 2013 budget at a late time seriously reduces the ability of the government to carry out changes in the budgetary agenda in a way that fits its budgetary obligations,” the proposal said. Spending obligations made by the previous government “create a concern that, in the absence of adapting actions by the government, the government deficit for 2013 will rise to 5.5% of output.”

Because the government hasn’t passed a budget, it is working on a month-bymonth automatic extension of the 2012 budget. According to Treasury figures, the cumulative deficit for the past year has already risen to 4.5% of GDP.

“In truth, it’s not surprising,” said Harel Finance’s Ofer Klein. “What is surprising, and actually for the better, is that unlike the past, this time the Finance Ministry is already putting the numbers on the table in May and admits that there is no chance to meet the deficit target, and not waiting to tell us that in December.”