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(photo credit: Ariel Jerozolimski)
Bank of Israel Governor Stanley Fischer expressed support Wednesday of the budget framework presented by Finance Minister Avraham Hirchson the day before, although his call to fund war costs by raising the VAT went unheeded in the draft.
"It is essential, for the sake of economic stability and growth, to keep to the framework of the 2007 budget that the prime minister [Ehud Olmert] and minister of finance are expected to present for approval by the government next week," Fischer said in the statement.
Nonetheless, Fischer reiterated his recommendation that the costs of the war should be financed by a "moderate rise in the deficit, and by a strictly temporary increase in the rate of VAT to 16.5 percent by means of a temporary provision to expire at the end of 2007."
Expenses not related to the hostilities should be kept under the 1.7% spending growth cap set previously, Fischer added. The budget proposal presented by Hirchson Tuesday incorporates a one-time rise in the spending cap to fund war costs, alongside numerous cuts.
"Government overspending--beyond the budget changes made necessary by the one-off expenses related to the hostilities--is likely to undermine the impressive gains made by Israel's economy in the last few years that resulted mainly from a responsible macroeconomic policy that focused on a cautious budget framework," he said.
As a result of the macroeconomic policy, "domestic and foreign investors have shown and continue to show great confidence in Israel's economy," Fischer noted, adding that this confidence is reflected in Israel's "impressive" financial stability, "particularly noteworthy during the hostilities in the North."
An increase in the deficit - and the resulting rise in Israel's already very high debt burden - is likely to undermine confidence in the economy and raise Israel's country risk, which would push up medium and long-term yields in the capital market, Fischer argued.
This would, in turn, raise financing costs for the government, the business sector and households, including the costs of mortgages, he said.
Such a financing method "would be preferable" to a larger increase in the deficit that would exacerbate the "very high" debt-to-GDP ratio, Fischer said, adding that the measures proposed by the central bank would demonstrate the government's commitment to long-term fiscal targets, bolster investor confidence and "enable the economy to revert to the rapid rates of growth that it enjoyed prior to the outbreak of hostilities."
Business leaders also lended general support to Hirchson's budget.
"The criticism of the Treasury's budget proposal is too sweeping," said Federation of Israeli Chambers of Commerce's Uriel Lynn. "The core thrusts of the proposal are correct, even though several corrections must be made."
Stressing his organization's support of the budget, Lynn reserved particular praise for the Finance Ministry's decision not to exceed the budgetary growth cap and strive to keep the deficit under 3% of GDP.
"The importance [of these decisions] is in the calming message they send to the world and to the Israeli markets of the Israeli economy's stability," he said.
Though Lynn stressed the importance of continued tax reforms and avoidance of tax hikes, he added that bringing the VAT back up to a level of 16.5% "must not be rejected absolutely" as a means of keeping the budget deficit in check.
Manufacturers Association of Israel President Shraga Brosh called on the government and the Treasury "to continue along the general outline of the budget, which is expected to encourage growth," and stressed that tax reforms must continue.
Nonetheless, Brosh voiced criticism of the Treasury's announced NIS 1b. cut to the railway development program in the budget proposal, arguing that "we must not go back on the program of investments in infrastructure as planned before the war."
Brosh called on the Treasury to add NIS 600m. to the research and development budget for 2007 to bring it to NIS 1.8b. in total, and add another NIS 700m. in 2008. Furthermore, the budget for grants aimed at encouraging capital investments should be expanded by NIS 150m. in 2007 to NIS 600m., and brought to NIS 1b. in 2008.
If it were not for the war, the deficit could have been brought down to 0.5% of the GDP, as opposed to the nearly 3% deficit currently envisaged in the budget, Brosh noted.
Israel Hotels Association President Eli Gonen attacked the cut to the Tourism Ministry budget included in Hirchson's proposal as a "scandal" that would exacerbate unemployment.
"If the dreary forecasts of tourism industry bodies are realized, we expect to see a massive wave of lay-offs among hotel employees, aviation and cruise companies, travel agencies, tour guides, drivers, site and attraction operators, and providers of food and services to the tourism industry," Gonen said.
"Instead of increasing the Tourism Ministry budget for 2007 in order to halt the drop in incoming tourism following the second Lebanon war, the state comes and cuts," he said, adding that "with proper management, it is possible to bring the tourists back, as occurred after the Gulf War."