Netanyahu Set to Fight Recession With Repeat Dose of Tax Cuts


netanyahu2Binyomin Netanyahu plans to apply the same small-government policies when he becomes Israel’s prime minister as he did six years ago as finance minister. Then, his tax and spending cuts helped lift the economy out of recession. They may be less suitable this time around. The Likud party leader, who has until April 3 to form a coalition, faces a shrinking economy, a growing budget deficit and a frozen corporate bond market. The recession in the U.S. and Europe has clobbered Israeli exports, which account for about half of gross domestic product in a country whose economy is smaller than Singapore’s. His only fiscal tool for the moment is a budget drawn up in August and stalled in the parliament.”Israel must take steps in same spirit as the U.S. and Europe, to allow an even bigger deficit,” said Avi Ben Bassat, a professor of economics at the Hebrew University in Yerushalayim. “The situation requires a change in economic policy.”

Netanyahu’s plans for the economy may encounter objections from his future partners. Although assembling his coalition could take several weeks, one probable member, the Shas party, said during the election campaign that it would seek to restore child allowances that had been reduced under Netanyahu.

Israeli GDP fell at a 0.5 percent annual rate in the final quarter of 2008. The Bank of Israel, whose index of leading indicators posted its steepest drop in January since records began in 1975, forecasts a 0.8 percent decline in GDP this year. Merchandise exports fell 26 percent in January to $3.18 billion from $4.32 billion a year ago.

The Tel Aviv Stock Exchange’s benchmark TA-25 Index is down 46 percent from its peak on October 2007. Israel’s state Employment Service says a record 19,700 people lost their jobs in January.

“There will be a certain amount of deterioration before we can turn around the economy’s direction,” Netanyahu said Feb. 23 at a meeting of Likud lawmakers. “We face an economic crisis that we haven’t seen in many years.”

Netanyahu, 59, has vowed to lower Israeli taxes as he did as finance minister. He also promised during the campaign to liberalize the real-estate market, saying the Israel Land Administration’s near-monopoly inflates housing costs.

To solve the credit crunch, he says Israel should use existing U.S. loan guarantees to extend credit to companies, and proposes spending an unspecified amount of money on building roads and rails.

Gidi Grinstein, president of the Tel Aviv-based Reut Institute policy group, said that won’t be enough. He proposes the government undertake an “industrial policy” aimed at opening markets in China and India and developing new technologies.

“The paradox of Netanyahu is that he has set very ambitious growth objectives for the Israeli economy, but the steps he has proposed won’t bring about the kind of growth he is talking about,” Grinstein said by telephone.

Almost since its creation in 1948, Israel’s economy has been dominated by government. Officials decided everything from the exchange rate to whether companies could raise capital. The government and labor unions controlled such big companies as Koor Industries Ltd. and Israel Chemicals Ltd.

While liberalization began in the 1980s, it stalled in the following decade — including during Netanyahu’s first tenure as prime minister from 1996 to 1999 — as the country’s technology industry and the Palestinian peace process boosted growth.

By the time Netanyahu left the finance ministry in 2005 to protest the government’s withdrawal from the Gaza Strip, he had sold or begun selling El Al Israeli Airlines Ltd., the biggest carrier; Bezeq Ltd., the biggest telecommunications provider; and Israel Discount Bank Ltd., the third-largest lender.

“It’s very important to create an internal engine by reining in the size of government, cutting taxes and the bureaucracy,” said Ohad Marani, who served as the top aide during Netanyahu’s first year as finance minister. “He’s very much for small government.”

By cutting spending, Netanyahu helped reduce Israel’s budget deficit to 1.8 percent of GDP in 2005 from 5.1 percent in 2003. The TA-25 plunged 5.2 percent the day he announced he was stepping down. The deficit may reach 5 percent of GDP this year, Ben Bassat estimates.

“He was very decisive,” said Yossi Bachar, who replaced Marani. “He resisted all the pressures on him, even if it cost him politically.”  

Thanks in part to Netanyahu’s actions as finance minister, his government will have fewer challenges than those in the U.S. and Europe, said London-based Senior Economist Reinhard Cluse of UBS AG.

“Israel has a tough business cycle outlook, but no more than that,” Cluse said by telephone, adding that the government must take “expansionary” fiscal measures soon or risk seeing the slump extend into 2010.

One of the biggest challenges Netanyahu faces is the crisis in Israel’s corporate bond market, said Leo Leiderman, chief economist at Bank Hapoalim Ltd. in Tel Aviv.

The Tel Bond 20 index of the biggest corporate bonds fell as much as 19 percent in the last quarter as pension funds and other institutions were forced to sell securities to meet cash calls from investors. About 20 billion shekels ($4.7 billion) in non-bank debt comes due this year, the Bank of Israel estimates.

“The question is how the corporate sector will meet its obligations to bondholders and banks,” Leiderman said by telephone. “The economy is small enough that two or three significant players getting into trouble could paralyze the whole system.”

 {David Rosenberg-Bloomberg/Yair Israel}