The global economy has undergone severe shocks in the past three years. The sub-prime crisis in the US in late 2008 sent the American economy into a severe slump. An even worse slowdown was prevented by unprecedented injections of capital by the government.
The effect of the crisis spread to Europe and Israel. In its wake came another crisis: the debt crisis in Europe, which has dragged the European economy into a recession. This crisis, the roots of which are different from the roots that caused the US crisis, began in the PIGS (Portugal, Ireland, Greece, and Spain), and recently joined by the third largest Eurozone economy - Italy.
The Israeli economy successfully handled all these shocks. After the 2000-01 recession, the economy resumed its robust 5% annual growth in 2004-08. The global crisis of late 2008 slowed Israel's GDP growth to just 0.8% in 2009, but it should be remembered the US, Europe, and other major economies had negative growth. While other economies began to slowly emerge from the crisis (if at all), the Israeli economy returned to rapid growth of 5% a year for the past two years.
What is the link between the global shocks and developments in Israel? The answer is simple. More than 40% of Israel's output is exported. A crisis in global markets, which reduces their demand, therefore affects almost half of Israel's output. Given this figure, Israel's rapid growth, despite the global recession, is extremely impressive.
Slowing growth rates
2012 is shaping up to be a year in which the Israeli economy will show signs of surrendering to the global crisis. There will not be a recession, but a sharp slowing of the growth rate from about 5% to 3%. Why?
First and foremost is the worsening crisis in Europe. The growth engines of the European economy - Germany and France - are sputtering, and their growth rates in 2012 are expected to drop sharply: Germany's from 3% in 2011 to just 0.3% in 2012, and France's from 1.7% growth to 0.5% contraction. Germany and the UK are practically the only countries expected to have any positive growth at all. A severe recession is foreseen for the Eurozone as a whole, plunging from 1.5% growth this year to 1% contraction in 2012. Asian economies, which have rapid growth rates, are expected to see sharp drops in growth. All these factors will adversely affect Israeli exports and its growth rate.
The second important factor is private consumption. Most demand in Israel comes from households - private consumption. This is partly affected by our wealth. When this rises, private consumption grows, and vice versa. The crisis in financial markets has caused the Tel Aviv Stock Exchange (TASE) to fall, reducing the public's financial assets. This will likely be reflected in the financial reports that we will get from our provident and advanced training funds. The drop in financial assets can therefore be expected to adversely affect the growth rate of private consumption.
Credit crunch
Another factor that will likely affect business activity in Israel is the probable credit crunch. One of the reasons that the Israeli economy was able to weather the global crises was the stability of its banking system. To ensure this stability, the Bank of Israel ordered the banks to increase their capital adequacy ratios. This ratio is the cushion a bank must have against risky assets (the credit it grants). Locking up too many resources for this purpose comes at the expense of a bank's ability to use resources to extend credit.
Given that business risk is rising because of market shocks, the banking systems' ability and willingness to extend credit will be affected, which is liable to create a credit crunch that will make it harder for the business sector to function.
The fact that the economy is expected to grow despite all these factors, albeit more slowly, is impressive, especially in comparison with forecasts for Europe. However, we must not take this growth for granted. The crisis in Europe is far from solved, and a recovery by global markets in 2013 is also uncertain. The success of the Israeli economy depends on continuing the cautious monetary policy by the Bank of Israel, and especially the government's fiscal discipline. Unless these are kept, the pending slowdown will likely continue, and, worse, turn into a recession.
The author is dean of the School of Banking and Capital Market at the Netanya Academic College and a faculty member at Bar Ilan University. He is a former director general of the Ministry of Finance.
Published by Globes [online], Israel business news - www.globes-online.com - on December 26, 2011
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