For the second time in three years Israel’s economy is threatened with the prospect of being pushed into a slowdown or even a recession not of its own making, prompting Bank of Israel Governor Stanley Fischer to warn the government against boosting spending or raising taxes.
“If we continue to maintain responsible fiscal and monetary policies, and if the private sector stays calm, we can get through the implications of what ever happens in Europe relatively successfully, more or less as we did in 2008 and 2009,” Fischer said on Wednesday. “That is to say we wouldn't avoid a slowdown, but it would be much less intense than what could happen.''
Hours after Fischer spoke, Israel’s Central Bureau of Statistics reported that gross domestic product expanded at a 3.4% annual rate in the third quarter, marking the third consecutive decline in the pace since it peaked at 7.2% in the final three months of 2010. Exports dropped at a 16.9% rate in the third quarter while consumer spending showed almost no growth.
“We’re talking about declining growth. We are not in a recession – we are far from a recession. We are growing more slowly,” Fischer told a Jerusalem news conference.
Fischer’s advice comes as Prime Minister Binyamin Netanyahu faces conflicting economic pressures.
Responding to a summer of mass street protests over the high cost of living and income inequality, he has pledged to step up spending on education and to create affordable housing. But slower economic growth and the crisis in Europe gives Netanyahu less leeway to increase the budget because of sluggish tax-revenue growth and jittery financial markets.
The Bank of Israel projects that GDP will expand by a healthy 4.7% this year, but it will slow 3.2% in 2012, a modest pace by recent Israeli standards. It may decelerate further if the crisis in Europe leads to a recession.
Milder growth has already begun to take its toll. The government is likely to suffer a shortfall of tax revenue amounting to four billion shekels ($1.1 billion) this year, a number Treasury officials say may balloon to 18 billion shekels in 2012. The Israel Manufacturers Association, which groups the country’s largest employers, reported this week that 19% of its members said in a poll they expect to begin laying off workers by the end of the year.
Fischer said that the budget deficit would probably rise without increased spending, which would help mitigate the economic slowdown.
As chief of Israel’s central bank, Fischer plays a critical role in domestic economic policy. But his views carry unusually large weight outside Israel as well because of his celebrated career as a top International Monetary Fund official and his success in steering the Israeli economy through the 2008-2009 global financial crisis.
The collapse of the American real estate market in 2008 had barely any impact on the Israel, which experienced only a mild economic slowdown while its banks avoided the deep write-downs their peers in the U.S. and much of Europe made. Economists have credited the country’s fiscal restraint, its current account surplus at the time and conservative monetary and regulatory policies.
Fischer said that as another financial crisis – this time starting in a Europe struggling with high levels of government indebtedness – threatens to set off a second global recession, Israel again is relatively well-positioned.
On the one hand, two thirds of Israeli exports go to Europe and North America and they have already begun to drop due to the economic uncertainty while Israel’s current account has slipped into deficit for the first time since 2003. The Arab Spring, which has created political havoc in neighboring Egypt and Syria, has heightened Israel’s security uncertainty.
But, Fischer noted, the financial markets have continued to express confidence in the Israeli economy. Spreads on credit default swaps (CDSs), a kind of insurance policy on bonds that serves as a barometer of the issuer’s financial condition, are narrower for Israel than for relatively healthy European economies, he noted.
''Something that I never expected to see is that it costs less to insure against the Israeli government defaulting than it costs to insure against the French government defaulting,” Fischer said. “The markets are looking at Europe with a great deal of suspicion.”
Working in Israel’s favor is the fact that Israel’s fiscal situation remains relatively strong, in part because it didn’t have to undertake budget-busting programs to stimulate its economy and bail out financial institutions. The country’s foreign reserves stand at close to $77 billion.
Israeli interest rates are high enough right now – the Bank of Israel’s base rate is currently 3% – that it can reduce them to help offset any economic slowdown. By comparison, the U.S. federal funds rate is close to zero.
Fischer said the situation in Europe is too much in flux to be confident about the outcome, but he suggested a break-up of the euro zone by Greece or other countries exiting would likely lead to a recession. Europe’s problems could reach Israel’s shores not only through declining demand for its products but through the financial markets.
The economy got a small foretaste of what may be coming this week when three of the country’s top five banks – Leumi, Discount and First International – issued profit warnings for the third quarter.
The banks have relatively little direct exposure to Italy, which has emerged as the new focal point of European woes, and they didn’t cite any unusual increase in problem loans. But indirectly their balance sheets were hit hard as the securities they own traded on the Tel Aviv Stock Exchange dropped in value in response to the Greek, and now Italian, debt crises.
Fischer lauded the government Trajtenberg committee, which was charged by Netanyahu with preparing a program to reorient govern policy to a more “social” agenda after last summer’s tent protests. He said the committee acted responsibly in starting off with the principle that reforms could not entail a significant increase in state spending, even though that limited the policies it could propose.
But the Trajtenberg panel’s proposals still have to be approved by the Knesset, Israel’s parliament, where lawmakers have vowed to make changes. Protestor leaders have threatened to revive demonstrations, saying the committee did not go far enough toward addressing their demand.
‘‘We have to maintain the stability of financial system, particularly the banks. We must not surrender to populism and we have to be ready if things deteriorate to move very rapidly on policy,” Fischer said. Acknowledging that the Arab Spring might require Israel to step up allocations to the military, he added: “If we have to increase our defense spending we do not have to increase it by increasing the deficit but by raising taxes.”
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