Barclays Capital backs Minister of Finance Yair Lapid's policies in a new macroeconomic review on Israel, but is wary about the Bank of Israel's policies and warns against Dutch Disease, caused by natural gas production, and failure in the peace talks with the Palestinians.
"The latest good news out of Israel is a reversal of fiscal weakness with a rapid and deep turnaround in public finances. Under Finance Minister Lapid, the new government that took office in the first half of 2013 has both limited expenditure growth and increased revenue collection. On the revenue side, the tax packages implemented in June 2013 (indirect tax increases) and January 2014 (corporate tax increases) have led to immediate improvements. Revenue collection in first quarter of 2014 increased almost 16% year-on-year compared with no increase a year earlier. Although some of the improvements represent one-off payments, this has allowed Minister Lapid to cancel planned increases in income taxes."
Barclays warns, however, "In 2014, the budget is on track to easily be below the 3% of GDP target. For 2015, this is not the case. The government’s new expenditure rule will lead to increases that will likely outrun revenue collections. The Bank of Israel calculates that some NIS 12 billion in fiscal adjustments will be needed to reach the 2015 deficit target of 2.5% of GDP. In our view, the government will make most of the adjustments, although early elections could complicate the process."
"Israel’s economic fundamentals are strong and have improved further," says Barclays, adding, "The financial improvements create economic policy challenges. The main risk is from excessive currency appreciation which if left unchecked leads to a loss of competitiveness that could cause a hollowing-out of Israel production (Dutch Disease). This has been the major concern for monetary policy in recent years. The Bank of Israel has reacted to this threat through forex intervention, monetary policy easing, and the establishment of a sovereign wealth fund. Side effects from this are increases in sterilization costs, rises in house prices due to low interest rates, and an apparent increase in inequality due to rising asset prices."
Barclays warns, "The cabinet remains split on what caused the breakdown of Palestinian-Israeli peace talks. Clearly a portion of the cabinet was not committed to peace talks, while others were. The Palestinian Authority is now applying for membership in multiple UN organizations. Israel did not release the last batch of prisoners, has ceased government meetings with the PA, and is threatening retaliatory moves in reaction to Palestinian actions. If new elections were held, polls differ in estimating the results. However, center-left Finance Minister Lapid and peace negotiator [Minister of Justice Tzipi] Livni appear set to lose seats while the far right and left parties may gain, according to recent Yedioth Ahronoth and Dialogue surveys."
As for investment, Barclays says, "Israel investment accelerated in the second half of 2013 following a slowdown in 2012-13. While we expect the trend to continue in 2014, we subsequently expect deceleration in 2015 as the base for these increases is fragile, supported by one-off factors."
As for real estate, Barclays notes, An unwanted side effect of monetary policy loosening has been rapid appreciation of home prices, which are up about 90% cumulative since 2006. Monetary policy is not the main cause, only a factor intensifying the cycle." It adds, "The shortage will only be relieved by increased housing construction and the government has been trying to facilitate this process through increased supply of land, deregulation of the complex building process, and financial incentives. The recent Ministry of Finance initiative to eliminate VAT payments for first-time buyers is controversial. Although it will lower costs for first-time buyers, it does not address the causes of the housing shortage and will likely increase demand further. The Bank of Israel has relied on prudential regulation to cool off demand for housing. It has been successful in protecting banks from excessively risky loans, but does not seem to have slowed down the pace of overall mortgage lending much. If and when home prices fall, it will put enormous strains on the financial system. However, banks are well capitalized and probably not excessively vulnerable."
Published by Globes [online], Israel business news - www.globes-online.com - on April 22, 2014
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