Slowdown threatens to become recession

Comment

The new government will have to figure out how to reduce spending while simultaneously preventing a surge in unemployment.

Judging by the flow of announcements and data about Israel's economic situation in the first quarter of 2013, there is no choice but to reach a worrying conclusion: the economy is in a major slowdown. Belying official forecasts and despite the outgoing government's euphoria, there is an obligation to ask how close is Israel to a recession.

What is an economic slowdown in Israel? We can assume no shortage of varying and contradictory definitions, but the determining criterion, under the local conditions should include undershooting the country's long-term growth potential and developments in the labor market.

Israel's long-term growth potential is estimated at 4.5% a year, but not every lower rate means a slowdown. In fact, so long as the growth is above 3% a year, it is possible to create jobs, or at least avoid rising unemployment. Growth of less than 3% a year creates a problem, because of the growth of the labor force and rising productivity. Growth of less than 2% a year means faster unemployment growth, hence, a general feeling of a recession.

The big picture

According to the Central Bureau of Statistics, GDP rose by an annualized 2.8% in the second half of 2012, down from 2.9% in the first half of the year and 3.3% in second half of 2011. On the face of it, the figures meet the growth forecast of 2.8%, excluding the effects of gas discoveries, published by the Bank of Israel late last year.

This means that even if Israel meets the growth forecast, it is headed for a slowdown, and there is no good reason for joyous announcements. Although the Bank of Israel recently hinted of a higher forecast, the revision will be negligible, and will not change the big picture.

The bigger question is what are the chances the official forecast is too rosy, and that the economy is headed for 2% annual growth, which means rapidly increasing unemployment. On this point, it is important to note that, according to the Central Bureau of Statistics data, while growth was an annualized 2.8% in the second half, it was only 2.5% in the fourth quarter.

The direct significance of the fourth quarter figure is that the economy is cooling down quite quickly. This conclusion is reinforced by all the GDP data for the second half of last year: investment in fixed assets fell by 5.5%, private consumption per capita fell by 0.7%; exports of goods and services (excluding diamonds and start-ups) fell by 1.6%; and a 10.7% drop in imports. Only public consumption increased - by 1.8%.

The picture for the fourth quarter of 2012 is even more dismal than for the second half: retail sales fell by an annualized 2.6%; tourist overnights fell by an annualized 16.7%; exports of goods fell by an annualized 10.1%; imports of raw materials fell by an annualized 16.7%; and imports of investment goods fell by an annualized 26%. Only credit card purchases rose - by an annualized 6.4%.

The political dilemma

Another clue to the rapid slowing in demand is seen in the steady drop in the inflation rate, despite rising home prices. The Consumer Price Index (CPI) fell by 0.2% in January 2013, and inflation for the year could be less than 1%.

Ostensibly, under these conditions, monetary policy should respond by cutting the interest rate to stimulate economic activity. The Bank of Israel may do this in the coming months, but it is in a trap. Any interest rate cut will boost home prices and the banks' credit risk, just when the Bank of Israel is worried that this risk is already too high.

The fiscal side also faces a political dilemma, because the coalition negotiations are dragging on far longer than expected. Even if a government is formed quickly, it is doubtful if can apply fiscal expansion to support struggling industries. On the contrary, the new government's fiscal policy will lean to austerity because of the NIS 40 billion budget deficit.

Worse, the Bank of Israel estimates that government spending in 2013 on the basis of decisions already made will be 9% more than the 2012 budget and NIS 13 billion above the spending cap approved in 2010. The government will have to rein in this overspending by slashing the budget.

To sum up, the Israeli economy will face heavy crossfire in the coming weeks from falling demand from a global economy still stuck in crisis on one side, and from economic policy shackled by the outgoing government on the other. The new government will have to figure out how to reduce spending while simultaneously preventing a surge in unemployment. The mission is impossible.

Published by Globes [online], Israel business news - www.globes-online.com - on February 20, 2013

© Copyright of Globes Publisher Itonut (1983) Ltd. 2013

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