Israel's Q3 growth not all it seems

Amiram Barkat

Analysts maintain that the composition of growth means that the Bank of Israel might still cut its interest rate.

The surprisingly high growth estimate for the third quarter of 2019 published by the Central Bureau of Statistics has sown considerable confusion in the markets and among analysts. On the one hand, a 4.1% annualized growth rate is much higher than the forecasts by all of the experts and analysts in Israel. On the other hand, there is great concern that the figure may be affected by events having little to do with the true picture.

What then hides behind the growth figures published today? "Globes" will attempt to put the data in order, consider what the Bank of Israel is likely to do later, and whether it is nevertheless possible that our situation is not as good as it appears in the Central Bureau of Statistics' report.

The mysterious figure that distorted the results

The Central Bureau of Statistics' initial estimate took the analysts by surprise. As of this morning, the growth rate estimates for the third quarter ranged from 2.6% to 2.8%. It is true that the figure released by the Central Bureau of Statistics is an initial estimate based on partial data, and includes, for example, only the results, not a deep analysis of the sources. One estimate and one quarter are not necessarily indicative of what is to come, and there is still a general feeling that economic growth is on a downtrend. Today's figures from the Central Bureau of Statistics stand in stark contrast to the trend and the general assessment.

The immediate result of the unexpected growth estimate is an upward revision of the forecast for the 2019 growth rate from 3.1% to 3.2%.

After recovering from their surprise, the analysts quickly delved into the tables and charts attached to the announcement. The most prominent and surprising figure for them was the sharp increase in inventory. In absolute figures, it amounts to a NIS 2.7 billion increase in business inventory.

What is the cause of this increase, and what can be learned from it about the current state of the economy? It's too early to say. Anyone who studied beginning economics knows that an increase in inventory can be a sign of a slowdown - a business stuck with unsalable merchandise. On the other hand, in Israel, an increase in investment in startups is counted as an increase in inventory (intellectual property, in this case), which is a very positive indicator of economic activity.

The problem is that the Central Bureau of Statistics' analysis is preliminary, due to the absence of complete data. Inventory declined sharply in the preceding quarter, so it is possible, for example, that one huge company (in terms of the local economy) made a large one-time order that caused the growth figures to jump and created a mistaken impression that the economy is headed towards growth.

In the preceding quarter, this happened in the opposite direction. Because car imports were brought forward to the first quarter, growth in the second quarter was at a miniscule 0.7%. Without the statistical noise created by vehicle imports, the annualized growth rate in the second quarter would have been 2.7%. This is not substantial growth, but it is nevertheless growth that is close to the potential.

Did inventory play the opposite role this time? Without the steep rise in inventory, the growth picture would have been much less encouraging. According to a simulation by Leader Capital Markets macroeconomist Yonatan Katz, the economy would have shrunk by 2% without the jump in inventory. It is true that private and public spending increased by 3% and 4%, respectively, but exports excluding diamonds and startups fell 3.5%, and exports including diamonds and startups plunged 8.4%. Investment in fixed assets dropped 6.1%, and total uses in the economy dipped 1.2%.

Per capita spending was up 0.8%, but when imports of vehicles are excluded, the increase is negligible, not to mention negative.

So what's the bottom line? "5% growth in private sector product is great," says Harel Insurance and Finance economics and research department head Ofer Klein. "We have a strong growth figure with a weak growth composition, or in other words, contradictory data. In circumstances like that, what you have to do is wait."

What will the Bank of Israel do?

This question - what should be done now - is currently relevant to only for one address in the Israeli administration, the one institution that is still fully functioning and making decisions that affect the economy, namely the Bank of Israel.

On November 25, the Bank of Israel Monetary Committee will convene to decide what the interest rate should be until the end of the year. At the last meeting, supporters of an interest rate cut lacked one vote on the committee for their position; the committee decided by a vote of three to two to keep the interest rate unchanged.

This time, ahead of the discussion, the market was pricing a probability of an interest rate cut of almost 80%. The 0.4% October rise in the Consumer Price Index published on Friday is not clear cut. On the one hand, it's in line with the forecasts. On the other hand, core inflation, the purest indication of inflationary pressure, continued its decline to 0.5% (from 0.7% in September and 0.9% in August).

Even after the growth figures, there are many analysts who still predict an interest rate cut. The shekel continued its upward path, appreciating 1.9% against the effective basket of currencies, and Governor of the Bank of Israel Prof. Amir Yaron is persisting in his refusal to use the weapon of intervention in the foreign currency market in order to restrain the trend, leaving the Bank of Israel with only the interest rate weapon.

On the other hand, keep in mind that the Bank of Israel cannot lower the interest rate by very much. A negative interest rate is not on the agenda here for the present (except for one investment bank), and the Bank of Israel can therefore not lower the interest rate more than twice. Is the upcoming interest rate decision the right opportunity for a cut?

The Bank of Israel will probably find it difficult to ignore the figure published today. As long as the situation is complex and not unequivocal, it can probably be assumed that the Bank of Israel will prefer waiting to making a dramatic decision.

The budget deficit: No news for the public

The last point of possible relevance to people in general is what all of this means for the budget deficit and the 2020 state budget. In other words, what are the consequences in terms of the economic measures that we can expect in the short term?

In case anyone has forgotten, Ministry of Finance budget director Shaul Meridor has already announced his intention of bringing a nightmare budget for government approval, with a series of measures aimed at reducing the government deficit by NIS 25-30 billion, even before a possible increase in the defense budget being demanded by the IDF brass, with the support of Prime Minister Benjamin Netanyahu and the leaders of the Blue and White Party.

As of now, the budget deficit is 3.7% of GDP, and is projected to increase to 4% of GDP in 2020. Every month that passes without a functioning government makes the problem awaiting the next government more difficult.

In view of the dismal situation, the increase in economic growth is real news for the public. Why? Because more growth means more tax revenues, and more revenues and more GDP mean a lower deficit and less need for cuts and streamlining steps.

The problem is that the composition of growth in the third quarter probably does not indicate a change in the economic trend, and tax revenues are not expected to grow as a result of an increase in inventories.

It's too bad, but no miracle happened today  that will save us from tax hikes, congestion charges, across-the-board cuts, and the rest of the misery.

Analysts convinced an interest rate cut is in store

For their part, the analysts are trying to explain the surprising growth figures for the quarter, and why even after these figures, the option of an interest rate cut is still on the agenda.

IBI Investment House chief economist Rafael Gozlan says, "In my opinion, the growth figure published today paints an unrealistically rosy picture. The composition of growth gives a weaker indication, because demand (uses), net of inventories, fell 1.2%, meaning that the rise in inventories detracted from the main function of growth in the third quarter. Because the composition is poor, with weak demand, the growth figure will have little effect. The decline in the basic inflation rate and a strong shekel will therefore result in the interest rate being cut by 0.1% next week."

Leader Capital Markets' Katz explains, "Growth in the economy is higher than the market's previous expectations. At the same time, a look at the elements of growth is less encouraging. If the increase in inventory is excluded, growth is minus 2.1%. It's usually reckoned that an increase in inventory partly constitutes a bringing forward of production at the expense of the coming quarters, so that it's not a particularly cheerful figure. All in all, we still predict an interest rate cut next week, given the very moderate inflationary environment, which is far from the target range."

Published by Globes, Israel business news - en.globes.co.il - on November 17, 2019

© Copyright of Globes Publisher Itonut (1983) Ltd. 2019

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