C. Forecast of
Developments in 1999-2001
General
The growth rate is expected to increase moderately in
1999-2001, gradually converging to the rates which reflect potential long-term
expansion of the GDP. The rate of this convergence will depend on developments in the
world economy and on the determination with which the policy aimed at preserving economic
stability, reducing economic uncertainty, and boosting growth is pursued.
According to the expectations of continued moderate growth in
the domestic use of resources in the next few years compared with the first half of the
1990s, exports continue to constitute a major factor in the realization of the growth
potential. Rapid expansion of exports over the next few years will depend on the continued
development of world trade and on the existence of a balanced economic environment,
characterized by a high degree of certainty.
The crisis from which the world economy is suffering has been
accompanied by a sharp decline in the expansion of world trade and a fall in prices of
goods, and has increased uncertainty about future developments. In the light of the
uncertainty prevailing in the international financial markets and the rapid pace at which
events have occurred recently, it is difficult at this stage to assess the extent of the
crisis, its seriousness, and its medium- and long-term effects on the economy. Underlying
the forecast national budget for 1999-2001 is the assumption that the international
economic crisis will not extend much beyond its current scope. In this case, its main
effect on domestic economic developments will be over by the end of 1999. It is clear,
nevertheless, that due to the possibility of the crisis in Asia, Russia, and South America
worsening and spreading into other economies, the world economic environment, which in the
first half of the 1990 was characterized by developments supporting growth, may be
replaced by a reality of greater uncertainty, slower expansion of markets, severe volatile
exchange rates, and reduced international capital flows. All these would make it difficult
to realize Israel's full growth potential in the period of the forecast.
In these circumstances, structural changes which help make
markets more flexible and more efficient assume greater importance. These improvements, as
well as contributing to higher productivity, helping to lower inflation, and raising the
ability of Israel's goods and services to compete in the world market, also enable
the economy to react quickly and efficiently to external shocks, thereby reducing their
negative effects.
The government, as stated, will take measures to reduce the
deficit as required by law, refraining from raising the share of public expenditure in GDP
and from increasing the tax burden, persisting in the reforms and structural changes which
the economy needs, and reducing government intervention in market activities-all
these will be aided by monetary policy directed towards attaining the government's
inflation targets.
The budget forecast for 1999, shown below, is based on the
assumption that the policy described above will be carried out. The scenario showing
targets for the years 2000 and 2001 assume that the policy of reforms will continue, and
will even be extended into additional areas, regarding which the government has not yet
reached decisions. (A case in point is the crucial importance of rationalizing the tax
system and reducing tax rates.) Consistency in pursuing this policy is a basic condition
for the achievement of a path of growth shown below in the targets scenario. A second
scenario, reflecting only partial implementation of the policy described above, is also
shown. In this one, too, the assumption is that the deficit in terms of GDP will continue
falling, consistent with the law, until 2001.
Main developments in 1999
The forecast rate of growth for 1999 on which the budget is
based is 2.5 percent, about one percentage point higher than the rate in 1998. This
forecast was arrived at in the summer of 1998, prior to the outbreak of the crisis in
Russia which spread to other markets world wide. At present, some two months after the
crisis started to spill over from one economy to another, it is estimated that as well as
its financial effects on capital and currency markets throughout the world, it will affect
economies in real terms, too. The huge amount of international trade, and the removal of
barriers to the movement of capital, goods, and services-two concepts encapsulated in
the term the "global village"-mean that the expected reduction of the rate
of growth in most countries as a result of the crisis will also harm Israel's growth
rate.
In the light of this assessment, and cognizant of the fact
that factors such as international aid extended to economies in crisis and policy steps
taken in those economies and in those affected by the crisis are likely to change the
international picture, it may be assessed with a measure of caution that growth in 1999
will probably be about half of a percentage point lower than the figure on which the
budget was calculated
6. The effect on Israel's economy is expected to be felt mainly
in goods and services exports and in private consumption. Clearly, changes in these
categories will have implications for all the sources and uses of resources in the
economy, albeit at much lower levels. The forecast for 1999, shown in Table 1, projects
the changes in these two spheres only onto GDP and the rate of unemployment, showing a
forecast range. Infrastructure changes in the tax system planned for 1999 have not yet
been approved by the government, and are not reflected in the forecast shown below. Built
in to the forecast, however, is the assumption that government decisions which have been
taken, including the proposed budget, will be implemented. Uncertainty concerning real
activity makes it essential that real developments during the year and their implications
for economic policy are constantly followed-up by means of an appropriate mechanism.
Although a growth rate of 2-2.5 percent in 1999 is
higher than that in 1998, it is nevertheless markedly lower than the economy's
potential as derived from the expected increases in manpower, capital stock, and
productivity. GDP growth would enable an increase of 2.1 percent in the number of employed
Israelis, assuming that the number of foreign workers not only does not rise but actually
declines slightly in 1999.
6
A few weeks ago the IMF estimates of growth in the industrialized countries were revised downwards by a similar amount, i.e., 0.5 percent.
The effect of the forecast range of economic growth on
unemployment would place the latter between 9 percent and 9.3 percent in 1999.
As mentioned above, the effect of the world financial crisis,
which is expected to be reflected in lower rates of growth in Israel's trading
partners, will be expressed mainly in a slower expansion of goods and services exports
than was predicted before the crisis. Exports are anticipated to grow by between 4.6 and
6.1 percent, this relatively wide gap being due to the revised estimate of the increase of
world trade in 1999, a factor which is closely related to Israel's export
performance. The terms of trade-defined as the ratio of the change in export prices
to the change in import prices-affect the profitability, and hence the amount, of
exports. After improving significantly in 1997 and 1998, Israel's terms of trade are
expected to deteriorate somewhat in 1999. Although prices of primary goods may well
decline in 1999 due to the predicted fall in world demand, the devaluation of the dollar
against the European currencies and theyen acts in the opposite direction. Taking into
account the relative large share of the dollar in Israel's exports compared with the
larger weight of European currencies in imports to Israel, this devaluation is reflected
in a faster rise in prices of imported intermediates than in those of exports, i.e., a
deterioration in the terms of trade and a negative impact on profitability. Another factor
which affected exporters' profitability and thus the amount of exports was the sharp
devaluation which occurred in the last quarter of 1998. Given the slowdown in domestic
demand, it would be reasonable to suppose that part of the devaluation would be real
devaluation, which would improve the profitability of exports, but this effect only
partially offsets the effects of the slowdown in the rise of world demand and the decline
in profitability resulting from the deterioration of the terms of trade.
Goods and services imports, excluding diamonds, are expected
to increase by 3.9 percent in 1999. Clearly, if the world crisis leads to lower rates of
increase of exports and private consumption, the rise of imports will be correspondingly
lower. As the rise in goods and services exports in 1999 is expected to exceed the
increase in imports, the current-account deficit is expected to decline for the third
successive year, to reach $ 1.7 billion, or 1.8 percent of GDP. (For purposes of
comparison, the peak deficit occurred in 1996, when it reached a threatening
$ 5.1 billion, 5.4 percent of GDP.) The improvement from 1998 is relatively
modest due to the assumption of worse terms of trade.
Private consumption is expected to continue to expand more
slowly than its rapid rate in the first half of the 1990s, and more slowly even than the
slower rates in the last few years. This is due to the relatively modest rise predicted
for private income, to the ending of the process of new immigrants equipping themselves
with consumer durables, and to seasonal factors. The events of the last few weeks are
likely to be felt in three separate channels, all acting in the same direction: first, the
steep devaluation makes consumer goods-which have a high import component-more
expensive (this applies mainly to durables, the timing of the demand for which is
relatively highly elastic), although in the short term it erodes the value of
households' wealth. Secondly, the unexpected rise in inflation in the last quarter of
the year, and what appears as a rise in inflation expectations arising from that
devaluation, will cause a certain measure of erosion of the real wage. Thirdly, the
lowering of the rise expected in private consumption as a result of the crisis on the rate
of increase of demand will also moderate demand for private consumption. If these three
factors are incorporated into the pre-crisis estimate, a forecast rise of private
consumption of between 2.4 percent and 3.1 percent is obtained.
It is estimated that domestic public consumption will rise by
about 2.2 percent from its level in 1998, meaning a small reduction in per capita
expenditure, continuing the trend evident in 1997-98. (Part B described the changes
in budget expenditure which will take effect in 1999.)
Investment in the principal industries and in residential
construction is expected to follow the trend of the last two years, with the former
adjusting to the rise required in capital stock (in the light of the growth environment),
while investment in residential construction adjusts according to the level of demand.
Investment in these two areas is expected to fall by 1.9 percent and 6.6 percent
respectively. Clearly factors such as the cost of capital and expectations regarding the
future economic environment also affect the rate of change in investment, but it appears
that the major cause of the expected fall is related to the business cycle.
Forecast for 2000 and 2001
The targets are set under the assumption that the government
will meet the requirements of the Budget Deficit Reduction Law until 2001, and that a
policy supportive of the supply side will be carried out. Such a policy includes reducing
the public sector, which would allow a reduction of tax rates alongside an increase in
public investment in the infrastructure.
In this scenario, the economy would succeed in reverting to a
rising path of per capita GDP. Business-sector gross product will rise by an average of
4.8 percent per year in 2000-01. This would be due mainly to the recovery of the
domestic use of resources from 1.6 percent in 1999 to 3.7 percent per year in
2000-01, with increased investment in capital assets after its constant decline in
the last few years. The reversal in the trend of resource uses is expected despite the
slower rise of public consumption, down from 2.2 percent in 1999 to 1.6 percent, enabling
compliance with the Budget Deficit Reduction Law. Meeting this law's requirement and
the policy supporting the supply side will be accompanied by a renewed rise in per capita
private consumption, which had also risen more slowly in the last few years. As the
economy returns gradually to a growth path, the unemployment rate is expected to fall from
between 9 and 9.3 percent in 1999 to an average of 8.3 percent in 2000-2001 (7.5
percent in 2001).
The rise of investment in the principal industries is
explained by the ending of the process of adjusting investment to the level of capital
stock appropriate to the future business environment on the one hand, and by carrying out
investments which complement the rise in infrastructure investment, and as a response to
steps adopted to lower taxation, on the other. Residential investment is expected to
recover only towards the end of the period, in line with overall economic developments.
The rate of increase of exports is expected to recover to an
average of 6.6 percent as a result of both the gradual revival of world trade and
continued real devaluation, in contrast to the long-term trend of appreciation (albeit
relatively more moderate than that predicted for 1998-99) which has been a feature of
the economy.
The second scenario does not include steps to stimulate the
supply side, but does assume compliance with the Budget Deficit Reduction Law. In this
scenario, too, per capita GDP rises in 2000-01, but more slowly than in the other
scenario. The turnaround in the domestic use of resources is more gradual, business-sector
gross product rises by 3.5 percent average in 2000-01, 1.3 percentage points less
than in the targets scenario, and unemployment falls only slightly, as a result of a
slower increase in the number of employed persons.
