Late last week, we got another strong indication that the deficit management games used by the government to stay within its deficit target for 2018 were probably an unwise "loan" at the expense of meeting the 2019 deficit target.
The planned 2019 budget deficit is NIS 40.2 billion, 2.9% of GDP. The deficit measured in January-February was NIS 5.6 billion, which compares with a NIS 2.3 billion surplus during the corresponding period last year. The cumulative deficit in the past 12 months is 3.5% of GDP.
The decline in Israel's fiscal performance results from a combination of lower revenues and higher spending than the forecast. Revenues from direct taxes totaled NIS 28.8 billion in January-February 2019, 1.1% less in nominal terms than in January-February 2018. Revenues from indirect taxes totaled NIS 23.7 billion in January-February, 1.9% less in nominal terms than in the corresponding period last year.
Government spending totaled NIS 54 billion in January-February 2019, 11% more than in the corresponding period last year. The budget plan for 2019 calls for spending totaling 5.2% more than actual spending in 2018. Spending by the civilian ministries jumped 16.1% in the first two months of the year, while defense spending was up 4.4% during this period. Some of the explanation for the poor tax revenue figures involves larger tax refunds than in the corresponding period last year and the timing of one-time revenues.
No change in the long-term trend
In Israel's not-too-distant past, such a negative development in management of the government's fiscal targets would have put long-term Israel government bond prices into a tailspin, and would have aroused concern about a downgrade in Israel's credit rating. Theoretically, the government's loss of fiscal credibility caused by failing to meet the deficit target and a renewed rise in the debt-GDP ratio, however moderate, justifies repricing the risks of granting long-term loans to the Israeli government, which are currently being granted at rock-bottom interest rates.
Israel's all-time low debt-GDP ratio, a result of many years of responsible fiscal policy, constitutes a cushion for absorbing the shock of a steep rise in yields in the government debt market caused by short-term fiscal miscues. It seems to me that the credit rating agencies will also not alter their rating for Israel's short-term sovereign debt; they will confine themselves to issuing warnings and signals, in a time-honored ritual.
My impression of the new Governor of the Bank of Israel brings me to the conclusion that the Bank of Israel will merely issue moderate warnings in response to the negative fiscal development, without any apocalyptic prophecies. Despite the disappointing budget figures in early 2019, I do not believe that we are headed for a change in Israel's long-term fiscal trend that will cause a renewed substantial jump in the debt-GDP ratio.
The new government is likely to institute across-the-board cuts in the budgets of government ministries in the near future, while at the same time raising indirect taxes to some extent. This will put the fiscal train back on its familiar track in the coming years, as long as there is no global economic crisis or an exceptional negative security event.
According to the best assessments, with which I agree, the Israeli economy is growing by over 3% a year, and will continue doing so for the foreseeable future. Exits by Israeli companies will continue laying golden eggs for the state treasury. Above all, regardless of what government is elected, it will behave according to the recognized rules of fiscal responsibility. This is true even if the pre-election media headlines are demagogic and promise huge budgets for redressing all of Israel's economic ills. No one is really capable of signing such a check after the elections are over.
Given the low debt yields in the developed markets, the result of a slowdown in global economic activity, the Israeli government deficit figures in excess of the target will not have a major negative impact on the pricing of government debt. Debt pricing will continue to be affected by the alternatives: the future inflation rate environment in Israel and the interest rate policy derived from it by the Bank of Israel.
Yields in the US government debt market have fallen in recent days, with the central bank there taking a softer line and tepid economic figures being published, while a new and unexpected incentives program in Europe was launched late last week. These factors are helping to offset the negative effect of the excess deficit on the pricing of Israeli government bonds, because our fiscal woes are regarded as small in comparison with the rest of the world.
In the current global economic circumstances, we expect no substantial economic penalty, if any, in the form of a steep rise in the government's debt raising costs. Therefore, despite the understandable unpleasantness of the worsening fiscal situation and the drying up of sources for distributing goodies to the electorate, there is no reason for sinking into a panic or depression. What should be done is to adjust the fiscal navigation program to current conditions.
The author is chief strategist of the Ayalon Investment House. The author of the article and/or the company are likely to hold or trade in the securities mentioned in the article. Nothing in the article constitutes a substitute for investments marketing and/or investment counseling that takes into account each individual's special particulars and needs.
Published by Globes, Israel business news - en.globes.co.il - on March 11, 2019
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