"The decision to increase the deficit target to 3% of GDP and the uncertainty of meeting the target raise the concern that the credibility of fiscal policy - which was a central component of the economy's success in dealing with the previous crisis will erode," warns the Bank of Israel in the minutes of the Monetary Committee held in late July, which unanimously decided to keep the interest rate for August unchanged at 2.25%.
The Bank of Israel said, "Actual budget expenditure figures indicate a domestic deficit excluding net credit granted in the first half of the year of NIS 7.6 billion, compared with a deficit of NIS 3.4 billion in the corresponding period of 2011. In accordance with the revised growth forecast, the deficit in 2012 is projected to be greater than the Ministry of Finance's revised deficit forecast of 3.4% of GDP, primarily due to lower than expected revenues for the first half of the year. After the publication of the previous interest rate decision, the government decided to increase the deficit target for 2013 to 3% of GDP, compared with its previous target of 1.5% of GDP. To date, decisions have not been reached regarding how the government intends to meet this target. Given the growth forecast, and assuming that steps required to maintain the expenditure rule will be taken, the deficit for 2013 is expected to be above 4% of GDP. In order to meet the deficit target, tax rates will have to be raised."
The Bank of Israel also warned, "There was an additional deterioration in economic developments in Europe this month, along with further signs of a slowdown in the global economy's growth rate." It noted that the IMF cut its 2012 global growth forecast to 3.5% from 3.6%, and its 2013 forecast to 3.9% from 4.1%. It also pointed to a 30% increase in agricultural commodity prices and a 7.5% rise in energy prices in July, and warned that this would affect the inflation rate in the near term. The Bank of Israel also noted measures by leading central banks to deal with the economic problems.
The Monetary Committee members discussed at the length the lack of clarity concerning the government's future steps regarding fiscal policy, and expressed concern about the consequences of not raising tax rates on economic stability. However, since the government's fiscal measures, or lack of them, were still unknown, fiscal conduct was not yet a factor influencing monetary policy.
As for the housing market, the committee members said that it was important that the government take steps in order to provide a comprehensive solution to the role of investors in rising home prices, in view of the lack of alternative returns on other assets, and the cancellation of the initiative to extend the betterment tax exemption period. The committee members noted however, that investors increased the supply of rental housing, therefore helping to moderate the rise in rent.
The Bank of Israel concluded that the low inflation rate over the preceding 12 months, the slowing in the rise in rent (which affects the CPI), the increase in the level of uncertainty regarding the staying power of the growth rate of real activity in the recent period, and the further signs of a slowdown in the global economy's growth rate combined with the monetary easing measures by leading central banks were behind the decision to keep Israel's interest rate unchanged.
Published by Globes [online], Israel business news - www.globes-online.com - on August 6, 2012
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