It's going to be a big bad budget

Amiram Barkat

Getting stimulation measures through while cutting public sector pay will take all Katz and Netanyahu's political strength.

Passing the 2021 budget through the government and the Knesset will be the major test for Prime Minister Benjamin Netanyahu and Minister of Finance Yisrael Katz in the coming year. It will compel them to confront dissident ministers and unruly members of Knesset, and it will also necessitate a fight with the Histadrut (General Federation of Labor in Israel) over a public-sector pay cut. That fight will put Netanyahu and Katz on a collision course with two ministers, Amir Peretz and Avi Nissenkorn, who are former chairmen of the Histadrut.

The 2021 budget will be one of the most challenging Israel has ever seen. To understand why, we only have to go back in time three or four months in calendar terms, but an age in terms of how the world looks.

The turnaround: Goodbye contractionary budget

Outgoing Minister of Finance Moshe Kahlon leaves the economy with a high structural deficit. The next budget, the first of the incoming government, was meant to be a contractionary budget, reducing expenditure in order to tame the deficit. The Ministry of Finance prepared a list of taxes to be raised and spending items to be cut.

There was a simple but effective package consisting of 1% rises in VAT, companies tax, and income tax. And there was a more sophisticated alternative package of fixing distortions, abolishing exemptions, and closing loopholes such as online purchases.

But then along came the coronavirus pandemic and re-dealt the cards. The government that began the year with a contractionary provisional budget switched to a policy of pouring out money to help the economy extricate itself from recession.

In numbers, this means that instead of spending NIS 400 billion this year, the government will spend NIS 465 billion. If you will, it's as though the defense budget has doubled within a single year.

The fiscal deficit will shoot up from around 3% of GDP to around 10%. And that's just the start. The economy entered the crisis with an excess deficit, and that problem will remain with us even after the crisis is over, waiting for a solution, but while the crisis lasts, dealing with the structural deficit will be put off.

The timetable - 100 days

The stopwatch starts running from the end of this week. Within 55 days of the new government being sworn in, the minister of finance is supposed to bring the 2020-2021 budget before it. That brings us to around July 8. After the government passes the budget, the Ministry of Finance will need another 45 days to prepare the detailed budget for first reading in the Knesset. From there, it goes to the Knesset Finance Committee to be prepared for second and third reading.

Katz has been keeping his cards close to his chest. He has not spoken about his plans and has not named the people who will come with him in his new role. But everything will change the minute he walks into his office. The Budgets Division will seek to present the economic picture to him, the budget framework for 2021 and the list of recommendations that flow from it. Katz will send the officials to complete details and make amendments, and after the budget framework is formulated it will be presented to the prime minister in a series of discussions in preparation for submitting the budget to the government.

Expanding debt

The economic picture that will be presented to Katz will be the worst presented to an incoming finance minister, perhaps since 1985. Unemployment, which at the height of the coronavirus crisis reached 26%, is not expected to return to reasonable levels before the end of 2021. 2020, which began with the unemployment rate in Israel at a low of 3.4%, will probably end the year at about 8%. The fiscal deficit will be around 10% of GDP, some NIS 140 billion in absolute numbers, and economic growth in 2020 will be a negative5%.

2021 should look much better, but there's a big catch along the way. The macro-economic forecasts do not take into account a second, wider outbreak of Covid-19 at the beginning of winter. Such an outbreak could drag the country into a second lockdown, sending the economy on a steep downward path. Even if this horror scenario does not materialize, preparing for it just in case will require additional budgets, and the fear of it is liable to harm the expectations that drive the economy and delay recovery.

The 2021 budget will be a crisis budget, in which expenditure will rise, the deficit will remain high, and Israel's debt:GDP ratio will shoot back up to the levels of a decade ago. In 2020, government money was channeled into a safety net, to support businesses and give first aid to people laid off and furloughed. In 2021, the state will also have to invest in stimulating economic activity to get the economy back on a growth track as soon as possible. That means expanding investment in infrastructure: not just transport, water and energy infrastructures, but also, for example, building school classrooms and renovating old hotels.

Investment in professional training will be substantially increased, and the state will have to give guarantees generously. We may also see unconventional measures for encouraging consumption, such as allowing money to be withdrawn from advanced training funds, and unconventional measures to encourage employment, such as a temporary exemption from employer contributions to workers' pensions and national insurance.

Where will the money come from? Most of it will come from expanding the deficit, i.e., debt, but also from pay cuts and cuts in non-vital expenditure in government ministries. The recommendations put together by the committee of experts advising the National Economic Council speak of a budget of NIS 35-40 billion to finance government programs to restore growth.

The experts who wrote this chapter of the document, former senior Ministry of Finance officials Udi Nisan and Yarom Ariav, estimated that two thirds of this money would come from expanded government debt, but that the rest would require the government to divert spending within the regular budget, meaning cutbacks in ministerial budgets and cancellation of non-vital programs. This means, for example, reducing government procurement overseas, including defense procurement. It means temporary pay cuts as there were in 2003, when the Histadrut agreed to a graduated reduction in pay in which people on high salaries forewent part of their pay.

Battles like these cannot be won unless the prime minister and the minister of finance give them their all. At the moment, it looks as though the new government is broadcasting the opposite message: instead of cutbacks, expansion: a record number of minsters and ministries. By mid-July, not much will be left of the festive atmosphere of the swearing in of a new government, and the pictures of the unemployed will create a quite different atmosphere for ministers.

Katz is looking like the politically strongest finance minister to have been appointed in recent years, but he will need the prime minister's unreserved backing to get the budget through the government. After that, Katz will have to bring his full political weight to bear to get the budget through the Knesset, and to make sure that no coalition Knesset member is planning an ambush. If all goes as planned, Israel will have an approved state budget for 2020-2021 towards the end of November.

Katz's predecessor Moshe Kahlon was in a similar position with his first budget, for 2015-2016, which was passed in November 2015, but the similarity will probably end there.

Published by Globes, Israel business news - - on May 18, 2020

© Copyright of Globes Publisher Itonut (1983) Ltd. 2020

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