IMF: Israel faces economic weakness and deficit risks

Growth estimate for '09 cut to 1.5%; modest recovery seen in 2010.

Stanley Fischer 88 248 (photo credit: Ariel Jerozolimski)
Stanley Fischer 88 248
(photo credit: Ariel Jerozolimski)
Israel responded promptly to the global financial crisis despite political limitations, but economic stimulus measures need to be contained to avert a ballooning budget deficit, the International Monetary Fund cautioned in an initial country report released on Tuesday. "Policy-makers have responded promptly, political constraints notwithstanding. While much has been done, planning for contingencies needs to proceed further and urgently," the report reads. "If policy credibility, effective coordination, and clarity of objectives remain the standard which further initiatives have to meet, Israel will pass through this turbulence successfully." The IMF delegation that arrived in Israel at the beginning of the month published the initial report at the conclusion of the mission, in preparation for its annual country report compiled in Washington, which has an important bearing on the rating of Israel's economy. In their final meeting with Bank of Israel Governor Stanley Fischer and Finance Minister Ronnie Bar-On, the head of the IMF delegation Peter Doyle said that in comparison with other countries around the world, Israel is in a better position to cope with the global crisis. The main message Israel needs to send to the markets is an assurance that the government will continue its policy of bringing down the country's debt-to-GDP ratio, which in turn will help overcome other challenges, Doyle said. "Successful sustained tight budget control by the Finance Ministry, and the associated reduction in public debt ratios to below 80 percent of GDP, has secured a considerable degree of fiscal credibility. Now is an appropriate time to deploy this credibility to cushion the domestic economy from some of the effects of the weak external environment," the report recommends. "But the likely moderate extent of the economic slowdown in 2009 and the still high debt ratio counsels against going much further than that, since aggregate tax collection ratios will not return to levels seen in recent years, even once global economic conditions normalize." The report cautioned that Israel's economy will be hurt by the global crisis, and outlined the risks going into 2009. "Israel faces a period of economic weakness with marked downside risks. With investment and exports weak, our central scenario anticipates a decline in economic growth to 1.5% in 2009, with average inflation around 2%, all assuming implementation of policies recommended to support credit flows and stability, a flexible near-term budget stance backed by enhanced commitments to public debt reduction in the medium-term, and further monetary relaxation," the report states. "A modest recovery is projected for 2010. However, financial sector vulnerabilities abroad imply that risks are firmly to the downside." The IMF praised the sizable recent reductions in interest rates by the central bank and the policy-makers' turn of attention to credit flows and financial stability. "The package of initiatives [from the Finance Ministry] constitute a first step. If downside risks materialize, abroad or domestically, more may be needed," states the report. "In this regard, developments in bank share prices and nonguaranteed bond yields may be monitored for signs of heightened stability concerns." The IMF report estimates that the draft 2009 state budget and the necessary policy initiatives are likely to deliver a consolidated general government budget deficit in excess of 4% of GDP. "Out turns of this order of magnitude could persist in 2010, even in the central case scenarios. These are large numbers. They will push public debt ratios up markedly again. Duration of the deterioration underscores the need to reinforce confidence in long-run fiscal sustainability now," according to the report. "If that confidence falters, far from cushioning external blows, the fiscal actions proposed could aggravate broader economic difficulties. Adjustments to the framework of fiscal rules will help to address these concerns." The IMF expects inflation to slow to 2.25% next year, falling into the government's price stability target range of 1%-3%. "Scope remains for further significant reductions in policy rates. Concerns not to surprise markets with large steps may be attenuated with prior guidance and by the increased market familiarity with large steps globally."