IMF: Poverty in Israel among worst in OECD

The Annual Report on Israel finds the economy strong, but with long-term problems.

"Israel's economy remains strong," concludes the IMF in its draft concluding statement of the 2012 Article IV Consultation Mission to Israel, but it cautions, "vulnerabilities remain."

The IMF states, "Public debt is high relative to stronger OECD and emerging market countries, and, reflecting regional tensions, security expenditures severely constrain room for fiscal maneuver. House prices have surged by over 50% in recent years, and notwithstanding welcome reform initiatives following the Hodek committee recommendations, structural fragilities in the corporate bond market remain. Despite strong growth, overall poverty is among the worst in the OECD, raising sharp social and sustainability concerns, notably in the Israeli-Arab and haredi (ultra-orthodox) communities. And finally, a decade of stagnant real wages contributed to an eruption of social protests in 2011, with significant implications for spending and taxation policies over the medium term."

Notwithstanding strong signs of a slowdown in the Israeli economy, there is little chance of a hard landing. "A severe downturn in 2012 is unlikely - absent an external crisis or contagion from within the corporate bond market - but the output gap will likely reopen a little," the report says.

In view of the new macroeconomic circumstances, the IMF advises Israel's leaders to adjust policies to the new reality. The main challenge is to keep debt under control, a critical task which the IMF believes has become considerably more difficult. The main reasons for this are slower near-term growth projections for the Israeli and global economies, social concern over prices that will constrain options to raise indirect taxation, calls for increased social and security spending, unfunded fiscal commitments amounting to 0.75% of GDP for 2012 (NIS 6 billion), and the likelihood that revenue shortfalls from housing and the capital market will persist.

The deficit target in the 2012 budget is 2% of GDP, but the Ministry of Finance believes that the deficit will reach at least 3.4% of GDP.

Under these circumstances, the IMF says, "We warmly welcome the authorities' commitment to maintain the total spending limits in the 2012 budget." But, it adds, "More is needed - in particular, a decisive effort to approach the 2013 budget deficit ceiling should be made. This will require contributions from all sides - from expenditure restraint including defense, from initiatives to raise additional revenues, and from efforts to strengthen the productive potential of the economy."

The IMF says that more tax hikes may be necessary, in view of the fact that "key non-security spending items - such as health and education - are around levels of moderate-spending OECD peers." At the same time, Israel's "VAT rate is only 16%, and given the priority attached to strengthening environmental housing taxation, revenue increases in these areas alongside curbs to tax expenditures could reinforce the credibility of plans to lower public debt."

Raise salaries at the Bank of Israel

If Israel adopts the fiscal policy recommendations, the IMF believes that it will be possible to further relax monetary policy, given the drop in inflation and inflation expectations. But a credit crunch is possible, due to requirements to raise core tier 1 bank capital, possibly compounded by strains in the corporate bond market.

As for the housing market, the IMF says, "Any remaining concerns with renewed housing inflation should be addressed with other tools. These include measures to smooth the supply of land and steps to increase the taxation of second properties, possibly backed up by additional macroprudential steps."

The Bank of Israel is also a target of implied criticism. The IMF advises lengthening the horizons of published inflation and GDP forecasts, which are changed too frequently. The IMF also advises increased emphasis on the mid-point of the (1-3%) inflation target range as the goal for policy.

The IMF also advises raising salaries of Bank of Israel staff, because, "current limits significantly impede recruitment and retention of appropriately qualified new staff, and the mechanisms raise concerns with effective independence of monetary and supervisory policy. If unaddressed, these issues will corrode the bank's core anti-inflationary and supervisory functions."

As for the exchange rate, the IMF says, "Considerable intervention and the use of limited administrative controls on inflows were warranted by the exceptional circumstances of recent years. So while continued use of these instruments is appropriately not ruled out, continued signals that the clear preference is for their use to remain the exception rather than the rule will support the credibility of inflation as the prime target for monetary policy. Exit strategies from use of all of these instruments should be prepared."

The IMF concludes on a pessimistic note. "But even if all these fiscal, monetary, and financial stability steps are taken, stability in Israel in the long run will remain in question unless the low participation in labor markets of minority populations -notably the Arab-Israeli and haredi communities - is addressed." It adds, "Both communities want work, and the realization of that goal should be encouraged." Necessary steps, according to the IMF, include the provision of basic child care and transportation in the Arab areas, the inclusion of haredi men in the armed forces, and equalization of education and adult education.

Minister of Finance Yuval Steinitz said, "We are always pleased to welcome IMF staff, because they mention both good and bad things. One of the recommendations is to reduce poverty, especially among Arabs and the haredim. The IMF emphasized the contribution of the biennial budget in general, and in these times in particular. They also emphasized the importance of preserving the budget framework, and not according to all kinds of demands."

Published by Globes [online], Israel business news - www.globes-online.com - on February 13, 2012

© Copyright of Globes Publisher Itonut (1983) Ltd. 2012

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