Macroeconomic News

By Steven Scheer and Tova Cohen

TEL AVIV, Jan 10 (Reuters) - In the heated debates on war

and peace that have marked campaigning for this month's

parliamentary election in Israel, it is easy to forget the vote

was triggered by a more workaday problem - the budget.

Ending the deadlock over an austerity package that forced

him to dissolve his coalition prematurely will be a priority for

Benjamin Netanyahu after the Jan. 22 ballot, which polls predict

will give the right-wing prime minister a new term in office.

Fearful of a voter backlash against more spending cuts and

tax hikes, coalition allies balked at approving a 2013 budget,

prompting Netanyahu to hold the election nine months early.

With the vote out of the way, whatever coalition partners he

chooses from among Israel's highly fragmented party system, a

budget compromise is likely with 45 days of the new government

taking office, since a failure would trigger a new election.

Most Western leaders would envy the task of Netanyahu's

finance minister, with the economy growing at about 3 percent, a

massive new natural gas field about to come onstream and a

budget deficit only slightly above a targeted 3 percent of GDP.

But the economy is slowing down as trading partners stagnate

and the Bank of Israel governor, internationally renowned

economist Stanley Fischer, has warned politicians of the risk of

hitting a recession that could rapidly double the deficit if the

budget is not managed tightly during the present good times.

Defence takes 17 percent of Israel's budget - 10 times what

typical European states spend - and is unlikely to shrink by

much amid upheavals across the Middle East; arguments may focus

on raising tax and structural reductions in welfare for a

fast-growing ultra-Orthodox community where many men do not

work.

The outgoing government has let spending swell beyond a

legal cap while a slowing economy has dented tax revenues.

Analysts reckon the new parliament will need to cut spending

by 14-15 billion shekels (some $4 billion), or about four

percent, and also raise taxes by as much as 5 billion shekels to

keep the deficit to 3.5 percent of gross domestic product.

'It's not good, but it's not the end of the world,' said Zvi

Eckstein, dean of the School of Economics at the

Interdisciplinary Center in Herzliya. 'They can easily do it.'

Eckstein, a former deputy to Fischer at the central bank,

expects personal income taxes to go up - with each 1 percent

increase bringing in 4 billion shekels - along with a small rise

in corporate taxation and a tightening of some tax breaks.

'It will have a negative economic impact in the short term

but I don't think it will be substantial,' he said, noting it

might shave half a percentage point from 2013 GDP growth.



BUDGET DEFICIT

Last year, parliament approved a series of tax increases -

including on income - for 2012 and 2013 and budget cuts that

aimed to boost state coffers by more than 14 billion shekels.

Netanyahu's finance minister, Yuval Steinitz, expects Israel

to meet its fiscal targets in 2013, noting similarly tough

measures taken in 2003 and 2009.

Those targets, however, are not without their critics.

Fischer and other Bank of Israel officials were irked when the

outgoing government doubled the acceptable budget deficit to 3

percent of GDP in June. Estimates put the final 2012 deficit at

above 4 percent, despite a one-point rise in value added tax.

Fischer, who has previously warned of inflationary effects

from higher public spending, urged the incoming parliament to

pass a responsible budget immediately after the election:

'We are now close to full employment and we have a budget

deficit around four percent,' he said last month. 'If we go into

a recession, the deficit will climb to six to seven percent and

then the government will have financing difficulties.'

The Bank of Israel has lowered its key interest rate - the

last move a quarter-point cut to 1.75 percent on Dec. 24 for its

second reduction in three months - amid tame inflation and

slowing economic growth mainly from weakening exports.

Economists doubt the central bank's monetary policy

committee will change its dovish stance in the coming months

unless the new government fails on a credible budget.

'We hold a relatively constructive view on the 2013 fiscal

outlook and think that the new government will enjoy enough

post-election political power to deliver most of the required

measures, probably through a combination of spending cuts and

tax hikes,' said Credit Suisse Economist Nimrod Mevorach.

'The main risk to our view is a surprising election outcome,

especially if Netanyahu joins forces with some of the left-wing

parties after elections,' he wrote in a note to clients.



CREDIT RATING

Some left-wing parties seek to raise social spending while

increasing taxes on higher income earners and companies. Small,

right-wing parties that have backed Netanyahu also defend strong

welfare spending for their religious supporters.

Netanyahu is not expected to invite in leftists unless he

has a poorer showing than polls predict. His Likud, along with

Yisrael Beitenu, is forecast to win about 30 percent of seats,

with eight or nine other groups also getting into parliament.

'If the government can't cut as much as is needed,

especially if defence doesn't participate, either we will have a

higher deficit ... or else taxes will have to be raised even

more,' said Ayelet Nir, chief economist at Psagot, a Tel Aviv

brokerage.

Nir said a higher deficit would have repercussions for the

sovereign credit rating and risk premium.

For now, Israel's A+ credit rating and stable outlook from

Standard & Poor's is safe. The agency expects the government to

stick to its debt reduction commitment that began a decade ago.

'Regardless of who wins this election, there remains a

political consensus that increasing government debt is a bad

thing,' Elliot Hentov, a sovereign credit analyst at S&P, told

Reuters, noting that Israel's budget cut needs are less than

those in Europe. 'The challenges are manageable.'

He expressed confidence that starting in 2014, Israel's debt

to GDP ratio, at 74 percent, would resume its decline. Much

depends on economic growth, however.

Israel's economy grew an estimated 3.3 percent in 2012 and

is projected to grow around 3 percent in 2013. That excludes the

start to natural gas production at the Mediterranean Tamar well,

which may add as much as a point to GDP growth in 2013 and also

start to contribute to state revenues in the coming years.

Hentov forecast a deficit in 2013 of at least 3.3 percent of

GDP but warned that the outlook for Israel's credit rating could

turn negative if government debts rose suddenly or growth looked

to slow significantly. And, in a violent region, Israel's

buoyant economy would also remain vulnerable to risks of war:

'The (ratings) outlook would change if public debt suddenly

went up again or if growth prospects crashed in the medium

term,' Hentov said. 'Or if there was a geopolitical crisis.'

($1 = 3.78 shekels)



(Editing by Alastair Macdonald)

((steven.scheer@thomsonreuters.com)(+972 2 632 2210)(Reuters

Messaging: steven.scheer.thomsonreuters.com@reuters.net))



(For a graphic comparing Israel's debt-to-GDP ratio since 2008 with other countries click: http://link.reuters.com/dym25t)

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