B. ECONOMIC POLICY FOR
1998-99
General
Economic policy in 1998 and that planned for 1999 is directed
at speeding up the pace of recovery of Israel's economy from the current stage of
downturn in the business cycle, by adopting carefully considered measures with
long-lasting positive effects.
This policy, reflected in the proposed 1999 budget and in
numerous government decisions, is aimed at boosting growth and employment, by creating
better operating conditions for the business sector. In the proposed budget, expenditure
on infrastructure investment has been increased, at the expense of current expenditure;
this, in conjunction with steps taken in the labor market after an analysis of the various
causal factors which led to the high rate of unemployment, will certainly contribute to
achieving the purpose. These steps focused on improving the match between work-seekers and
positions available by means of in-plant training. Other key points in the budget proposal
are the rise in the defense budget, preparations for tourism in the year 2000, increasing
competition, reducing prices, and streamlining the public sector. These changes are
reflected in financial terms in the budget proposal and in qualitative terms through a
wide variety of attendant government decisions.
The objective of faster growth necessitates adjustment to the
new world-wide situation regarding the greater openness of markets. The steps introduced
this year in foreign currency, continuing the move in this direction which has been made
in the last few years with the adoption of carefully thought-out measures, represent a
further stage in the progress towards an economy in which non-economic considerations will
play less and less of a role in economic decisions. In such an economy it will be easier
to advance towards the attainment of its maximum growth potential.
Recent events in capital and foreign-currency markets
throughout the world drive home the importance of following a responsible policy. Recent
developments in Russia and East Asia show that markets react rapidly and harshly to
policies that are not such. Economic developments in 1998 and those predicted for 1999
demand comprehensive wide-ranging solutions. Immediate and narrowly specific solutions
cannot have more than a short-term effect, and their price is likely to be many times
greater than their instantaneous usefulness.
Economic policy adopted in various spheres is described
below, with the main guidelines of policy to be implemented in 1999.
Budgetary policy
In the budget proposal submitted to the Knesset
(Israel's parliament), expenditure (excluding repayment of principal and credit
granted) totals NIS 178 billion, and revenue (excluding credit repaid),
NIS 170 billion. The planned overall budget deficit (excluding credit) is thus
NIS 8 billion, about 2 percent of nominal GDP forecast for 1999.
In order to enable the business sector to develop more
smoothly and to place the economy on a path of more rapid growth, government intervention
in the economy must be reduced. Government policy, as reflected in the budget for 1999,
will therefore rest upon four cornerstones:
1. Continued gradual reduction of the budget deficit in terms
of GDP, with the objectives,
inter alia,
of helping the business sector to borrow capital for its investments, of achieving price
stability, and of improving the balance of payments. In compliance with the Budget Deficit
Reduction Law, the total government deficit (excluding credit) will be reduced from 2.4
percent of GDP in 1998 to 2.0 percent in 1999.
2. Continued gradual reduction of government expenditure as a
share of GDP, aimed at assisting the business sector. Government expenditure as a share of
GDP in Israel is higher than the norm in advanced economies, hence the importance of its
continued reduction. In the proposed 1999 budget, planned government expenditure is 46.3
of forecast GDP (at budget prices), down from 46.9 percent in 1998.
3. Continued gradual reduction of government debt as a share
of GDP, from 105 percent in 1998 to 104 percent in 1999 (at December 1997 prices). This
trend is vital, due to the exceptionally high government debt in Israel relative to the
norm in advanced economies (60 percent of GDP according to the Maastricht Treaty), and it
would also ease the burden of interest payments which the budget has borne for many years.
The government's debt burden would also be reduced by the cut in the budget deficit,
and by financing a significant share of the latter (about NIS 4.5 billion) by
privatization of government corporations and banks.
4. Not increasing the tax burden in the budget for 1999; this
is made possible by keeping the growth in government expenditure to a modest level.
(Nevertheless, a certain rise in the tax burden may occur as a result of efforts being
made to broaden the tax base and attempts to achieve true tax payments.) Increasing the
tax burden would have created difficulties for growth, hence the care taken to avoid
raising it, and even to reduce it in the long term.
The tax burden in 1998 will be the same as it was in 1997,
about 41 percent of GDP, having fallen by about 1.8 percent of GDP in 1995-96, and
risen by 1.4 percent in 1997. By tradition, the considerations behind tax policy switch
between the need to raise additional revenue to finance public expenditure on the one
hand, and the desire to reduce the rate of taxation, thereby helping economic growth, on
the other. In 1997 and 1998 the need for extra revenue increased because of the size of
the budget deficit, but the second objective was not overlooked, and the Ministry of
Finance began planning a comprehensive reform of direct taxes. In 1999 it is planned to
implement a program whose main thrust is a lowering of the rate of tax on labor income,
which will boost growth and ease unemployment. At the same time the tax base will be
broadened by abolishing various tax benefits. Another planned step, requiring all those
assessed for tax to submit a general annual return, is likely,
inter alia, to lead to more efficient tax
collection by enabling the enforcement of the tax laws to be improved.
Structural changes and
privatization
In addition to the government's decisions regarding the
total budget proposed for 1999, it was also decided to change its composition by reducing
various categories of current expenditure, while increasing government infrastructure
investment by almost NIS 1 billion compared with the figure in the original 1998
budget. The main increase is in investment in transport, which will rise some 30 percent
from the original 1998 budget to NIS 3.1 billion, and investment of
NIS 800 million in water and sewage infrastructures, an increase of about 15
percent from the original 1998 budget figure. Greater infrastructure investment will help
boost growth, not just by increasing economic activity engendered by implementing
infrastructure projects, but by expanding an advanced infrastructure-a condition for
faster business-sector development.
The proposed budget incorporates an increase of
NIS 260 million in grants to factories for investment in R&D compared with
the figure in the original 1998 budget. This aid will be directed specifically to
factories requiring government assistance to implement the investment.
The rise in the rate of unemployment and the fact that one of
its causes is the structural change which the economy is undergoing draw attention to the
benefit likely to accrue from investment in retraining. The government has therefore
decided to extend the framework of retraining by including an additional 30,000 unemployed
workers, at a cost of NIS 100 million. The main emphasis is on in-plant
training, and the unemployed worker can choose the type of school in which he or she would
prefer to receive the retraining from among those chosen by the Ministry of Labor and
Social Affairs. It is expected, therefore, that the rate of successful placement in
employment of course-graduates will rise.
In addition to these changes in professional retraining, the
government decided on other measures in the labor market intended to bring unemployed
persons back into the working population, while reducing the abuse by some of the
unemployed of the right to unemployment benefit. In order to ease the situation of
factories in traditional, labor-intensive industries, which in general have a relatively
high number of employees earning the minimum wage, the minimum wage over the next two
years will be linked to the CPI and not to the average wage as hitherto.
The privatization process, which surged in 1997, will
continue in 1999. A list of privatization targets will be set according to priorities to
be determined by the ministerial privatization committee. Privatization scheduled for 1999
is planned to yield proceeds totaling NIS 4 billion.
The government's wage and manpower
policy
Negotiations on new public-sector wage agreements were
conducted during 1998, within the framework of following the government's policy of
maintaining the real wage and granting only moderate wage increases. These principles were
observed in the agreements signed with the New Histadrut (General Federation of Labour)
during the year, with teachers, with academic staff, and various other groups in the
public sector.
In the agreement signed with the New Histadrut, a one-off
increment was paid for 1998, and negotiations on a wage agreement for 1999-2000 are
due to begin soon, as well as on a comple-mentary agreement for those whose wage
agreements expired at the beginning of or during 1997.
The real wage in the public sector remained unchanged
throughout 1997, and it is estimated that it will essentially do so in 1998. It is also
assessed that wage agreements for the next few years will reflect the government's
policy of maintaining the real wage, and that the agreements will be consistent with the
downward inflation path over the coming years, reducing the factors which tend to raise
the nominal wage automatically (the "wage crawl").
Following the government decision in 1997 to establish a
mechanism for enforcing paragraph 29 of the Budget Elements Law (which prevents budgeted
entities from changing the wage or retirement conditions of their employees by more than
the norm for all civil servants), an enforcement unit was established in the wages
division of the Ministry of Finance. Its task is to coordinate the activity required to
enforce the Law, including submitting claims in the name of the state in all matters
related to annulling agreements, arrangements, and wage deviations, and putting those
responsible on trial. The enforcement unit, operating in conjunction with the State
Attorney's Office, uses its authority to tighten control over budgeted entities, in
particular the municipalities, to prevent wage deviations.
Budget financing and
capital-market policy
In 1998 the budget deficit will be financed mainly from
domestic sources and the proceeds of privatization. The trend towards greater liquidity
and marketability in the market for government bonds will continue. As part of this
policy, increased series of bonds were issued to the general public, and new unindexed
five-year bonds were introduced. In 1999, the Ministry of Finance intends to borrow about
NIS 3 billion on the domestic market via marketable bonds.
Borrowing overseas is expected to amount to
$ 2.5 billion, divided as follows: about $ 850 million via the State
of Israel Bonds organization; about $ 500 million on the capital markets, via
marketable State of Israel bonds and/or bank loans; and the rest from the balance of the
deposit of money raised under the US government guarantee. The policy of borrowing from a
diverse spread of sources reflects the Ministry of Finance's ongoing preparations to
establish a base in international markets, as the use of the loans covered by the US
government guarantees comes to an end.
In 1999, the policy of improving and extending the
information available to the public about institutional investors will continue, by
obliging the latter to convey more detailed reports to their members and the general
public. Moreover, liberalization of rules governing institutional investments will
continue. In the field of pension savings, attention will focus on the ongoing
regularization of activity, with more supervision and competition. In the area of
long-term savings for pensions, government decisions on rationalizing benefits afforded to
different savings channels will be implemented, with priority being given to pension
savings. In insurance, the implementation of a new operating system for the insurance of
borrowers by lenders will start, increasing competition and tightening the regulations
relating to proper disclosure. The program for implementing a new system of compulsory
vehicle insurance, as passes recently by the Knesset, will continue.
Monetary policy
During 1998 the Bank of Israel used monetary policy to place
the reduction in the inflation environment on a firm footing, this being consistent with
the long-term objective of price stability determined by the government. In 1998 special
caution was required in operating monetary policy, in the light of economic and financial
crises and instability which troubled many emerging economies. The experience of these
countries indicates that financial crises, in addition to undermining price stability, are
likely to impair real activity, too.
The process of liberalization in the foreign-currency market
continued in 1998; some restrictions on activities overseas of domestic institutional
investors, and some on activities of foreign investors in local-currency derivatives were
left in force. At the beginning of August 1998, the inflation target for 1999 was set at 4
percent, the slope of the lower limit of the exchange-rate band was reduced from 4 percent
to 2 percent, and the Bank of Israel lowered the interest rate by 1.5 percentage points.
In 1998, mainly from August, the NIS depreciated considerably against the currency basket.
There was a significant decline in capital inflow, particularly in nonresidents'
financial investments in Israel and in residents' capital imports.
In 1999, the Bank of Israel will act to achieve the inflation
target of 4 percent set by the government. Attaining the target will bring the economy
closer to price stability which is the norm in industrialized countries, and which is the
government's long-term objective. Monetary policy which takes steps to achieve these
inflation targets also contributes in the most efficient way to the attainment of the
government's other economic objectives, among them advancing towards the realization
of the economy's growth potential. This is particularly the case in the light of the
financial and economic crises which are affecting many emerging economies throughout the
world, and which reinforce the importance of achieving stability.
