Praise for the Israeli economy

International Monetary Fund says Israeli government does a good job and prescripts fiscal restraint in 2011 and 2012

By ZIV HELLMAN
economy (photo credit: Miriam Alster / Flash 90)
economy
(photo credit: Miriam Alster / Flash 90)
ON NOVEMBER 29, FINANCE MINISTER YUVAL STEINITZ and Bank of Israel Governor Stanley Fischer received an important guest: Peter Doyle, a division chief in the International Monetary Fund (IMF) European Department, who along with three other economists spent a fortnight in Israel studying the state of the economy in detail. Doyle submitted a report of the mission’s findings to Steinitz and Fischer.
The IMF report was only an interim report, with the full report expected in January: The interim report contains the essence of what the IMF considers to be the best prescription for the Israeli economy, and it does not shy away from giving a candid assessment.
The IMF praised the Israeli economy and the firm policy responses to the world economic downturn implemented by the Finance Ministry and the Bank of Israel that were responsible for the economy’s relatively good state of health. While the United States and most of Europe continue to struggle to find a foothold for renewed growth, Israel’s GDP growth in 2010 is expected to be close to 4%, and unemployment has dropped to about 6% (compared to nearly 10% in the United States). The IMF praised the Sheshinski Committee’s recent recommendation that the government review taxes on natural gas and oil findings, to increase the state’s take of proceeds from natural resource extraction.
But the IMF also pointed to several challenges, stating that “the challenge now is to sustain growth and low inflation while boosting medium-term prospects – in the context of continued global uncertainty, capital outflows from advanced countries, shekel appreciation and a housing market that is overheating.” The organization noted in particular that the shekel has appreciated by about 15% in real terms over the past two years, and is still rising, despite a great deal of currency purchase by the Bank of Israel. The strong shekel has already adversely impacted competitiveness, reflected in a loss of export market share.
Another challenge noted by the report is the skyrocketing house prices since 2008, with a climb of 40% over only two years. This, the IMF said, is an uncomfortable echo of “advanced countries in the early 2000s,” which in its opinion “cannot continue without risk of broader instability – notably in the banking sector.”
What prescriptions does the IMF issue? For one thing, more “symmetric” intervention in the currency markets, by which it means throttling back the billions of dollars being purchased by the Bank of Israel, but which will only mean more pressure on the shekel to appreciate, thus worsening export competitiveness. Arecommendation for a “balance of supply and demand in the housing market” is obvious, but not easy to attain in the near term. A recommendation that capital market supervision be taken out of the hands of the Finance Ministry and made into an independent authority, in line with the practice in the majority of OECD nations, seems sensible, but will inevitably face strong opposition by the ministry, which will not readily part with some of its domain.
But perhaps the most interesting of the IMF’s prescriptions is its call for significant fiscal restraint in 2011 and 2012. Even with expectations of an increase in the central bank’s interest rate by 0.75% to 1.0% during the next year, the IMG believes that Israeli economic planners have a tough choice ahead, between continuing to stoke growth and restraining renewed inflation. Given that, it recommends an immediate and sharp cut in the state budget deficit in 2011, down to 1% (as opposed to scheduled deficits of 3% in 2011, 2% in 2012, and 1% in 2013). This austerity is supposed to be attained by a mix of expenditure reduction and raising taxes.
The IMF is right – there will eventually be a time when economic growth may cause inflation pressures that will need to be damped. The problem is that it is impossible, at the moment, to predict when that need will arise. The uncertainty is especially acute given the fact that the world economic crisis is not really over yet. Asignificant fall in demand for Israeli exports may yet cause a different sort of distress than worrying about an overheating economy. Until the unusual amount of uncertainty in world markets clears, the government would do well to take the IMF’s report in full seriousness, but retain its right to be flexible in response to changing conditions, without committing immediately to strict austerity targets.