"There are no sacred numbers"

Leo Leiderman  credit: Inbal Marmari
Leo Leiderman credit: Inbal Marmari

Bank Hapoalim chief economist Prof. Leo Leiderman outlines how economic policy should respond to the outbreak of war.

The first week of fighting in the bitter war in Israel’s south is almost over, with the financial markets trying to gauge the damage that the Israeli economy will sustain. Clearly, we are talking about a very significant event, but the fog of war makes it hard to estimate its full consequences. The main index on the Tel Aviv Stock Exchange, the Tel Aviv 35, fell 6.4% over the week.

Prof. Leo Leiderman, chief economic adviser at Bank Hapoalim and a professor of economics at Tel Aviv University, sets out for "Globes" his proposals for rehabilitating the economy and repairing the damage that the war will cause.

What has been going through your mind in these first days of the war?

"What most preoccupies me is not the economy but concern for the families of the soldiers, the wounded, and the captives, and solidarity with them. I have four relatives from Kibbutz Nir Oz who are still missing, and we have no information about them. I find it hard to understand how a war like this landed on us in a country as powerful as Israel. But we have no choice but to win."

As for the effect of the war on economic activity, Leiderman says: "First of all, the duration and character of the war will have a decisive impact on the depth of damage to the economy. Many studies, as well as past experience, indicate that the longer the war lasts, the broader will be the impact on the economy. It is also known that this connection between the length of the fighting and the economic damage might not be linear. And of course, the more the war widens to more fronts, the greater will be the economic damage."

Do you have a forecast for the consequences of the war for economic growth?

"It’s too early to make a quantitative estimate of the effects on the growth of the economy in 2024 and 2025. We have a great deal of information about loss of growth and product in various episodes in the past, such as the Yom Kippur War, the Lebanon War, two intifadas, various military operations, and the Covid pandemic.

"We see this is a completely different episode, however. This is a new situation that has no precedent as far as the damage to the economy is concerned. There’s a whole spectrum of possible scenarios, from a short war on the southern front only, to the nightmare scenario of a prolonged war with additional sectors involved. We are only in the fifth day of the war, and it’s to be hoped that the picture will start to become clearer."

Which industries will be hit by the war?

"A substantial decline can be expected in private consumption, particularly of services. This is not just because of the damage to output and income, but also for psychological reasons. Distress, uncertainty, the possibility of prolonged reserve duty by some of the public - all these things will affect consumer sentiment. Alongside this, tourism, commerce, transport services, entertainment, and restaurants will be hurt. As in the Covid pandemic, the self-employed and small and medium-size businesses may be hurt, particularly those that operate with high leverage."

On Monday, the Bank of Israel announced a dramatic plan to sell $30 billion of its foreign currency reserves to stabilize the shekel. The shekel has in fact recovered slightly, and is traded at around NIS 3.96/$.

What’s your view of the Bank of Israel’s move in the foreign exchange market?

Leiderman: "It’s important to welcome the Bank of Israel’s decision to intervene, as necessary, in the foreign exchange market, in order to ensure the market’s regular operation. The decision to extend the term of Amir Yaron as governor of the bank at least for the duration of the war, and I hope beyond that, is also a stabilizing factor. The banking system is stable, and there is enough liquidity in the system. The behavior of the investment community in Israel, including the financial institutions, indicates high confidence in the economy’s resilience and financial strength. It’s important to maintain a level-headed, correct economic policy that will preserve this ‘asset.’"

What about the economic cost of the war?

"As with any war, the current war has and will have direct and indirect impacts. The war will substantially raise defense spending in the coming years, for procurement of equipment, ammunition, and advanced systems in accordance with the new needs. Another direct expense is payment for the reserve duty days of those mobilized. Given current interest rate levels around the world, the cost of servicing public debt as a proportion of GDP will rise. Besides all this, there will be a decline in state revenues from taxation and a rise in the fiscal deficit."

How can this larger deficit be financed?

"It’s reasonable to argue that besides the hope of financing part of the deficit through aid from the US (President Biden approved $8 billion military aid this week, H. S.), and that will happen, it’s permissible for a country at war to raise its fiscal deficit by what is seen as the right amount. This is in order to ensure that the economy functions properly, to carry out rehabilitation actions, and to prepare for recovery and a return to growth in the near future."

How high should the deficit go?

"I mean a deficit of 3% of GDP, or 5%, or 8% - there are no sacred numbers. As was said during the Covid pandemic, the state has to do whatever it takes to achieve these goals. Nevertheless, it’s important to make sure that the growth in expenditure and in the deficit is temporary, until economic activity gets back to normal. I’m also sure that there are various budget items that were approved that don’t support economic growth, and that don’t need to be implemented in the new reality. Such a policy will be accepted with complete understanding by investors overseas and in Israel, and also by the credit rating agencies."

What else do you propose on the economic policy plane?

"Despite the uncertainty over how the war will develop, alongside an emergency budget, this is the time to start preparing a general economic plan with a strategy for rehabilitating the economy after the war. It’s important to start planning professionally and in detail all aspects of rehabilitating the settlements that have been damaged or destroyed in the south, rehabilitation of infrastructure, the health system, and the civilian systems that need attention."

How do you propose doing this?

"One possibility is to task the Bank of Israel and the Ministry of Finance Budgets Division with coordinating the work, with help from the various research institutes and economists, engineers, and professionals in academic institutions and in the private sector. It’s important to talk to the private sector, and to understand in every place and every industry what the main damage is and what they need in order to get back to normal. It should be done professionally, preferably with no politicization of the recommendations."

What do you think the Bank of Israel should do in its next interest rate decision, on October 23?

"It’s still to early to tell how the war will affect the rate of inflation in the short and medium term. Just as there are new inflationary factors, such as the depreciation of the shekel, there will also be factors working in the opposite direction, given the expected decline in private consumption, tourism, and other items.

"As with fiscal policy, here too a country at war is allowed to deviate temporarily from the set inflation target. At the moment there is no surge in inflation expectations, and the investment community is aware of the existence of index-linked assets and the exchange rate that can assist in hedging inflation risk.

"As for cutting the interest rate, it’s too early to consider that. The current interest rate is at the right level for the state of the economy, and together with the policy on exchange rates, it contributes to ensuring financial stability," Leiderman concludes.

Published by Globes, Israel business news - en.globes.co.il - on October 12, 2023.

© Copyright of Globes Publisher Itonut (1983) Ltd., 2023.

Leo Leiderman  credit: Inbal Marmari
Leo Leiderman credit: Inbal Marmari
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