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As the government hammers out the agenda for the 2008 state budget, international credit rating agency Standard & Poor's warned this week that the country's credit rating outlook could be at risk if the government fails to maintain budget discipline.
"Our positive outlook on the Israeli rating incorporates our expectation that fiscal strengthening will remain a key political priority and that the debt burden will fall at a regular pace. Should these expectations be misplaced, the outlook on the ratings could revert to 'stable,'" S&P cautioned. "In light of the past three years' budgetary outcomes, demands are likely to build for easing fiscal policy as the 2008 budget enters its preparation phase."
S&P warned that it would lower Israel's credit rating from "positive" to "stable" if the 2008 budget deviates from fiscal policy lines set by the government between 2005 and 2007.
Economists weren't necessarily concerned about S&P's threat, however.
"S&P's warning is not worrying. The government should be able to keep an upper budget deficit limit of not higher than 1.7 percent of GDP for 2008," said Shlomo Maoz, chief economist at Excellence Nessuah.
S&P added in its report that the budget discussions were expected to be intense and vulnerable to small parties in the governing coalition seeking to increase national insurance stipends.
"Additional sources of budgetary strain could emanate from public sector wage negotiations and from repeated demands to increase allocations to the defense and education budgets. Such expenditure hikes, were they to materialize, would require cuts in other areas for Israel to respect the 1.7% real spending growth targets in 2008 and 2009," the report stated.
Morgan Stanley analyst Serhan Cevik, meanwhile, noted that that normalizing interest rates would help keep the Israeli economy at a "sweet spot" of high growth and low inflation.
"The Israeli economy shows no sign of moderation, with all the indicators pointing to an inflationary surge in domestic demand," Cevik wrote in a research note.
He welcomed the Bank of Israel's decision this week to raise its key base lending rate by 25 basis points to 3.75%.
"While currency-linked prices posted a 4.5% decline in the first five months, those untouched by currency fluctuations were up 3.2%. In other words, excluding the exchange rate effect, inflation has already been above the target range [of between 1% and 3%] and we expect further tightening (about 50 to 75 basis points) in the remainder of the year," he said.. "Global pressures and the rise in domestic demand will push inflation higher. Real GDP growth has accelerated to 6.3% in the first quarter of this year significantly above the economy's potential growth rate of around 4.5%, according to our estimates."