What exactly are you celebrating, Steinitz?

Avi Temkin

The picture that emerges from Israel's growth figures is that of Spain 2007.

On the face of it, the announcement by the Central Bureau of Statistics of the economic growth figures should be cause for celebration, and that indeed was Minister of Finance Yuval Steinitz's reaction. A 7.8% growth rate certainly sounds like an impressive figure, and something to smile about.

However anyone who reads the whole announcement, and analyses all the components of growth in the economy, must reach the conclusion that we are on the way to something far from happy, and that there is more than one reason for any finance minister to express concern, rather than boast of a situation that recalls economies that have recently gone swiftly from boom to bust. The picture that emerges from the growth figures released today is not one of a healthy economy, but the picture of Spain in 2007.

What has happened in the Israeli economy in the past six months? Output grew fast as a result of very rapid growth in consumption, both by households and by the government. At the same time, the rate of growth of exports fell, and imports rose. A rise in domestic demand went partly to imports, but partly to consumption of goods and services that are included neither in imports nor in exports, what economists call "non-tradeable goods."

What do the growth figures tell us? First of all, that the real estate bubble is still swelling, until the bitter end. Investment in construction has grown accordingly. Meanwhile, the economy's competitiveness has been eroded, and not just because of exchange rate developments. Exports rose at an annual rate of 3.7%, while inflation is on the rise, and resources are being diverted to satisfy local demand. Tax receipts have risen sharply and the fiscal deficit, but this is a phenomenon that depends completely on the real estate boom, and on local demand, and when that ends, the result is liable to be a fiscal hole that will have to be filled through very severe spending cuts.

Instead of recognizing this reality, Prime Minister Benjamin Netanyahu insists on talking about tax cuts, when he ought to take urgent action on the deficit after discounting the effect of the boom on the markets, to use tax receipt surpluses to reduce debt levels, and to plan fiscal adjustments that will reduce public consumption as fast as possible.

Secondly, monetary policy must respond immediately to these developments. The economy is overheating, and this found expression in the inflation figures released yesterday.

The CPI has risen 3.6% in the past 12 months. The picture does not change when the rise in the price of fuel is excluded. The CPI excluding energy rose by 3.5% over this period. Trend figures for October-January show that the general CPI, the CPI excluding the housing item (rent), and the CPI excluding housing and fruit and vegetables, each rose by an annualized 6.1%.

In other words, focusing solely on the volatility in fuel prices in January is liable to miss the main point: inflation in Israel has been rising fast in recent months, and this is not because of developments in any specific item. This means that the Bank of Israel will have to act soon.

The Bank of Israel has not concealed its intent to raise the interest rate to 3% by the end of 2011. The question is over the timing of the rate hikes, and it is obvious that the Bank of Israel's decisions will be based on the inflation rate and other economic conditions.

A situation has now arisen in which not only is inflation rising quickly, there are also growing pressures in the labor market for salary increases. Furthermore, housing prices continue to climb, contrary to the Bank of Israel's wish to stabilize them. All this points to a need to bring forward interest rate hikes, in the steps of 0.25% that we have become accustomed to in recent years. The central bank must act to take the air out of the bubble, before the damage it causes becomes too great.

Published by Globes [online], Israel business news - www.globes-online.com - on February 16, 2011

© Copyright of Globes Publisher Itonut (1983) Ltd. 2011

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