Macro-Economics and Israel - www.i-biz.co.il

The Governor moves ahead again

2009-11-25T15:06:00.001+02:00

Most analysts thought that the Bank of Israel would leave its interest rate unchanged in December at 0.75%, for the 4th consecutive month, but central bank Governor Stanley Fischer surprised with a 0.25% increase – to 1%. Following the decision, analysts' reactions varied from one end of the spectrum to the other – from a statement that the interest increase constituted a serious blow to the business sector, which has just begun to recover from the recession, to the opinion that recent signs of initial recovery justified the increase in interest, which still remains low and far below equilibrium.

In its press statement on the interest rate increase, the Bank of Israel gave three main reasons for the decision:
A concern about accelerating inflation: over the last 12 months, inflation was 2.9%, very close to the upper bound of the 1-3% annual inflation target, and the bank considers that in the months ahead, inflation could pass this upper bound (this is strange because most forecasts point to restrained inflation over the next 6 months). Thus higher interest is needed to maintain inflation within the target range.
Economic activity is beginning to revive: GDP in the 3rd quarter grew at an annualized rate of 2.2% and was the second consecutive quarter with positive growth (see the blog of 22.11.09 entitled "Everbody's growing"). This and other recent signs of revival show that interest can be increased without fear of compromising the revival. In any case, a 1% interest rate is still very low and can assist activity to continue expanding.
Signs of interest increases in other countries: though some central banks have increased interest in recent months, the US Federal Reserve and the European Central Bank still have not. However, the Bank of Israel claims that these central banks are making preparations to begin increasing their interest rates during 2010, for the same reasons that interest has already been raised in Israel.

There is no doubt that Governor Fischer received "backing" for his decision from the accelerated growth of exports in recent months, proof of an initial global revival, and from devaluation of the shekel of some 3% against the US$ over the past month: he obviously considers that the higher interest rate will not strengthen the shekel enough to alter the positive export trend.

Will the recent interest hike lead to further increases in the near future? This is unlikely, even though most analysts consider current interest to be too low. The Governor will certainly wait and see what happens with interest policy in the US and Europe: at the moment, the consensus is that the Fed will not begin to increase interest before the 2nd half of 2010.

After the recent increase, interest in Israel is now 0.75 percentage points above interest in the US. The Governor will not want this gap to widen much further.

Posted on the I-Biz blog on 22 November 2009

Everybody's growing

2009-11-23T19:51:00.004+02:00

GDP in Israel grew by an annualized 2.2% in the 3rd quarter of 2009. As the media reacted, this is an impressive performance: the second consecutive quarterly increase after two quarters of negative growth, an accelerated increase compared to the previous quarter (where growth was revised up from 0.8% to 1%), and overall, a clear sign of Israel's recovery from the recession. But perhaps the most important economic news is that most industrialized economies showed positive growth in the 3rd quarter. As Professor Stanley Fisher, Governor of the Bank of Israel, has stated frequently, revival of the economy will only be assured when the global economy begins to revive.

Israel did not experience the fastest 3rd quarter growth: GDP in Korea, Japan, the US, Germany and Italy grew faster. Israel is also not the only industrialized country with two consecutive quarters of renewed growth to its credit: the Japanese, German and French economies also began growing again in the 2nd quarter of 2009.

What is certain is that the recession in Israel was much shorter than in practically all other industrialized countries, which experienced 4-5 consecutive quarters of negative growth compared to Israel's two (the one exception was Korea, with only one quarter of declining GDP). The two main industrialized economies still showing negative growth in the 3rd quarter of 2009 are the UK and Spain: for both, this is the 6th consecutive quarter of declining GDP.

The impressive nature of Israel's 3rd quarter growth performance is also reflected in the developments in the main GDP components which increased rapidly: private consumption – by an annualized 8.9% (following an 8.1% increase in the previous quarter, fixed capital investment – by 23.2%, and exports of goods and services – by 21.8% (following a 14.6% jump in the previous quarter).

The 2.2% increase in total GDP seems limited compared to these sharp increases in GDP components. The explanation is the parallel steep increase in imports of goods and services in the 3rd quarter – by 61.9%. This increase in imports is in itself an indicator of recovery, in an economy as dependent as Israel is on imports as an ingredient of growth.

Other indicators of activity in October (such as the Purchasing Managers' Index) show growth continuing in the early part of the 4th quarter. But there are still some major sectors where the latest data point to a long way to go to return to pre-recession levels: one example is industrial production which in September 2009 (the latest month for which data are available) was still more than 8% lower than in mid-2008.

So however impressive 3rd quarter GDP data look, the consensus is that the revival, in Israel and elsewhere, is still very much in its initial stages. It could take a long time before we can conclude that the global economy is finally "out of the woods".

Posted on the I-Biz blog on 22 November 2009

Has inflation returned?

2009-05-18T10:50:00.001+03:00

For four consecutive months – November 2008 to February 2009, there was negative inflation in Israel. All the analysts said: naturally, obviously, there's a recession developing which is causing inflation to decline. And then consumer prices increased by 0.5% in March while on 15 May, the Consumer Price Index (CPI) for April was published, showing a sharp 1% increase. Were the analysts wrong? Are there specific reasons for the strong April inflation or do the March-April consumer price increases indicate a new positive inflation trend?

The first point to make is that April inflation is traditionally high, because of seasonal factors. In the past five years (2004-2008), consumer prices increased by an average 0.9% in April. The seasonally adjusted increase in consumer prices in April 2009 was just 0.3%, compared to the 1% increase in the unadjusted index.

What are the main seasonal factors in April? One is seasonal increases in fruit and vegetable prices as new summer fruits come onto the market: in April 2009, the fruits and vegetables component of the CPI increased by 2%: in the previous three years (2006-2008), this component jumped by an average 4.4%.

Another seasonal component is clothing and footwear prices, which increased in April 2009 by 3.5%: in the years from 2000 to 2008, these prices jumped by an average 5.8 in April. Yet another seasonal element of the CPI in April is education, culture and entertainment prices: in April, these prices increased by 1.1%, identical to the average annual increase in this CPI component in the previous 4 years (2005-2008).

Besides these seasonal components, transportation prices increased by 3.3%, with a sharp 6.2% in the foreign travel sub-component (mainly as a result of the shekel devaluation in that month) and a 2.9% increase in the car purchase and maintenance sub-component (mainly as a result of the increase in fuel prices at the beginning of April).

But all this does not add up to a new positive inflationary trend, to cause concern to policy makers. In this respect, it is interesting to ask what the decision will be regarding the central bank interest rate, to be made at the end of May. The current rate of interest is 0.5%, set at the end of March. At the end of April, the Governor of the Bank of Israel decided to leave the rate unchanged, even though most analysts expected him to lower it further to 0.25%. The question now is whether Professor Stanley Fischer will again leave the rate unchanged, or – after two months of positive inflation - decide to increase it, in reaction to the inflation.

Given the clear indications of continuing recession, this is unlikely to happen. But the Governor might argue that the rate of interest is so low in any case, and a further reduction in the rate is unlikely, on its own, to make any difference to reviving economic activity. However, interest policy could be used (by raising the rate of interest) to cut off the possibility of increasing inflation.

In the context of this possibility, analysts argue that if the 2009-2010 State Budget, recently approved by the Government (see the I-Biz blog: A budget…at last) finally becomes law, it could lead to higher inflation for two main reasons: the tax increases built into the budget and the agreed-to 3% increase of government expenditure, instead of the original intention to increase expenditure by just 1.7%.

Who knows: it could well be that inflation, instead of turning out to be just a reaction to declining activity, could turn out to be a major topic of economic discussion in the months ahead.

A budget... at last

2009-05-18T10:42:00.001+03:00

It's not all over yet, but at last – and at least – the government has approved (on 13 May) the new-fangled 2-year State Budget for 2009-2010. It's not over because the budget still has to past muster with the Knesset Finance Committee – always a difficult hurdle – and has to be approved into law by a plenary session of the Knesset, another not simple task. But the first step in the process has been taken and this is good news. Or is it?

The government approval of the budget was preceded by an incredible amount of political wrangling, with threats to bring the government down issued pretty much on a daily basis, "if this or that is not included in or excluded from the budget".

There were also major problems with the management of this initial stage of the budget approval process. A week before government approval, the Ministry of Finance published a list of draconic measures to be included in the budget, which immediately raised storms of indignation, both in the general public and among politicians from all parties, not only from the opposition. The main claim was that the measures would mostly adversely affect the lower-income population.

It is extremely unlikely that Prime Minister (PM) Binyamin Netanyahu was unaware of these proposed measures before their publication by the Finance Ministry, and yet immediately after they were announced and in reaction to the public and political criticism, the PM scolded the Ministry, demanding that it take another look at the measures and scrub most of them.

Another problem is with the question of who is responsible for the approved budget proposal. The Minister of Finance, Yuval Steinitz, has little experience with economic matters and from the outset of this new government, the PM stated that in addition to his being PM, he would also act as a kind of Super-Minister for Long-term Economic Strategy (he was the Finance Minister in 2003-2005 – with not inconsiderable success at the job, so at least he has experience with economic affairs). There are accusations that the recently approved budget is mostly not the work of the Finance Minister and his staff (as it would normally be) but rather the work of the PM and his chief economic adviser, who were accused of bypassing the Finance Ministry.

One potentially serious outcome of this internal struggle was the resignation of the head of the Finance Ministry's Budget Department, immediately after the budget was approved by the government: he stated that he could not take any responsibility for the approved budget (or was not given responsibility for it) and therefore felt that he had no choice but to resign.

And then there is the question of who won the political battle over the budget. The main argument was over the expenditure increase. The PM and his Likud party wanted the increase to be limited to 1.7% - the Labor Party, a coalition partner, argued for a much larger increase, in line with other governments around the world who have adopted large government expenditure increases to help their economies emerge from the recession. The compromise in the approved budget was a 3% expenditure increase both in 2009 and in 2010. As usually happens in Israel, after the compromise was reached, all sides claimed victory.
Does the government-approved budget match the campaign promises of the PM? The answer is no: among other things, the PM promised tax cuts as a way of reviving the economy, but in fact the budget calls for tax increases (VAT is to increase from 15.5% to 16.5% and VAT is to be levied on fruits and vegetables for the first time in Israel's history).

The government obviously felt it had no choice here: the recession has brought about a drastic decline in tax revenues, while the plans of the Finance Ministry to lower government expenditure in 2009 and 2010 will only partially materialize: this is particularly true of the defense budget, by far Israel's largest budget at the ministry level, where the compromise in the approved budget was to lower expenditure by just 25% of the expenditure cut that the Finance Ministry proposed (it turns out that the Minister of Defense is the leader of the Labor Party, which pushed for the far larger increase in overall government expenditure).

The outcome of all this is that the expected budget deficit is 6% of GDP in 2009 and 5.5% in 2010, a recession-level deficit, whose financing will call for a dramatic increase of government debt, both domestic and foreign.

So is the government approval of the budget good news? Only time will tell if the new budget contributes to reviving the economy. Certainly the lower income groups can be satisfied – almost all of the draconic measures initially proposed by the Ministry of Finance have been abandoned.

Is 2009 a lost year?

2009-03-01T15:41:00.001+02:00

It was really only a matter of time before the developing recession in Israel showed up in the ultimate macro-economic data – GDP and unemployment: in most other developed economies, data have already been published showing negative GDP growth and increasing unemployment, with dire forecasts for 2009. But no such evidence was available in Israel – until 4th quarter 2008 data for GDP and unemployment were published in the last week of February. What light do these data shed on the Israeli economy during 2009?

Here are the dry facts: GDP declined by an annualized 0.5% in the final quarter of 2008, while 3rd quarter growth was revised down to 0.9%, compared to an earlier estimate of 2.3%. Growth in the complete 2nd half of 2008 was reduced to 1.1%, compared to 4.8% in the 1st half of the year. The 4th quarter decline in GDP is the first since 2002, when the Israeli economy was in recession.

Results for business sector product, more sensitive to cyclical movements in the economy than GDP, were even worse: negative growth of 1.2% in Q4/08, with the 3rd quarter increase revised down to just 0.5% (an earlier estimate for this quarter was a 1.9% increase). Business sector product growth has now been lower than GDP growth for two consecutive quarters, a clear indication of a brewing recession.

Now unemployment: the unemployment rate increased to 6.3% in Q4/08 (based on the Labor Force Survey for that quarter, the most comprehensive labor market dataset in Israel) from 6% in the previous quarter: this is the first meaningful quarterly increase in unemployment since 2003, when the economy was still in recession (up to mid-year).

This initial increase in unemployment was not paralleled by a decrease in total employment (even though marginal employment indicators are already showing a decline in the demand for labor), but there were nevertheless significant declines in unemployment in Q4/08 in commerce, industry and business services.

In addition, there was a sharp decline in full-time employment and a parallel steep increase in part-time employment: this is classic textbook labor market behavior in the initial stages of a recession, with employers cutting costs by transferring workers from full-time to part-time employment. The Israeli economic press has been full recently of reports about companies – particularly in the high-tech sector – moving over to a 4-day week.

What does all this tell us about the prospects for 2009? The Bank of Israel, prior to the publication of these new data, had already forecast a 0.2% decline in 2009 GDP. However, soon after that, the Economist in London published its own forecast for Israel – a 0.9% increase in 2009 GDP. After the 0.5% decline in 4th quarter GDP was published, expectations were voiced that in the opening quarter of 2009 the decline of GDP could accelerate to 4%.

The truth is that no-one really knows the answers to the two most important economic questions at present: a) when will the recovery begin; b) how fast will it be once it begins. Regarding the US economy, we have heard answers to the first question ranging from Ben Bernanke, Chairman of the US Federal Reserve – that the recovery could start by the end of 2009, to Warren Buffett, who recently claimed (after his holding company Berkshire-Hathaway suffered a 96% drop in profits in Q4/08) that the recovery might not even start before 2011. Another still unanswered question is whether stock exchanges around the world have reached their low points, and whether it is now worthwhile purchasing shares. Everyone agrees that if and when the recovery begins (both in real economies and in capital markets), it will be exceedingly slow.

The chances are therefore that 2009 will be a lost year for economies around the world – for Israel as well: low or negative growth, contracting world trade, burgeoning budget deficits are only a few of the characteristics of a lost economic year. Everyone also agrees that the current crisis has brought/will bring about fundamental changes in the "rules of the economic/financial game" that determine behavior in the global economy. It seems now that the speed of the recovery, once it begins, will depend very much on the extent to which the new rules are accepted and adhered to.

The election and the economy

2009-02-12T21:40:00.001+02:00

The February 10 general election was extremely inconclusive. The 2 leading parties, Kadima and Likud, won a practically equal number of seats in the new Knesset, with each one's share less than 25% of the total 120 Knesset seats. There is no certainty as to which of the leaders of these parties will be asked first to try and form a coalition (both claimed victory immediately after the election), there is consensus that each leader will have a formidable task in forming a coalition, and there is a general feeling that even if a coalition is formed eventually, it will not last long. How will all this affect the economy?

First things first: the 2009 State Budget. Knesset approval of this budget (generally by 31 December of the previous year) was postponed until after the election and it will now be further delayed until after a new government is formed, when there will be a new Minister of Finance in place.

Based on what we know at present, the party leader asked to form a government will not be invited to try and do so (by the President of Israel) much before the end of February. He (Binyamin Netanyahu, the leader of the Likud party) or she (Zippi Livni, leader of the Kadima party) then has up to 42 days to create a coalition – which brings us to mid-April. If he/she fails, the other party leader then gets a chance and another 42 days – which could bring us to the end of May. It will then take time to formulate the budget (there is a budget proposal on the table, but presumably a new government will want/need to make – possibly significant - changes to it), which will then need to be approved by the Knesset. All this could take us up to mid-2009.

Is there a problem with this? If the approval of any budget proposal is delayed, the government is allowed to spend each month during the delay period 1/12 of the total budget expenditure of the previous year, so there is a de facto budget. But the new budget is supposed to reflect the government's economic policy for the current year, so a delay in approving the new budget means a delay in implementing necessary economic policy. This creates uncertainty, particularly unwanted when the underlying economic situation is bad and in itself a source of great uncertainty, as it certainly is at present.

This brings us to the declared economic policy of each of the two party leaders vying to head the new government, both recognizing the fact that the Israeli economy is clearly on its way to recession or is already in recession. One major proof of this is a steep decline in tax revenues that began in early 2008 and is forecast to continue in 2009. About one thing there is complete consensus regarding the 2009 budget – the budget deficit is going to be much higher this year, as a direct result of the decline in tax revenues: it was already higher in 2008 (2.1% of GDP) than in 2007, when the budget was balanced.

Back to declared economic policy: in its election campaign, the Likud announced that if it came to power, it intended to reduce tax rates to help the economy exit the recession. This planned policy is strongly opposed by both the Ministry of Finance and the Bank of Israel – if the 2009 budget deficit is already going to be much higher at existing tax rates, they argue, lowering tax rates will only make the deficit situation worse. It is not clear at all how the Kadima party intends to extract the economy from its current plight.

Given the severity of its current economic situation and the deep uncertainty it has created, Israel would have benefited greatly from a clear-cut result in the recent election: this would have enabled a new government to take office quickly and get on with solving current economic problems. The actual election outcome casts significant doubt on the ability of any government to find a suitable solution to the economic malaise. Since the election, politicians from many parties have stated that what is needed is a radical change in the electoral system. But even if this were feasible (there has been talk about this need for a very long time, without any results), the economy cannot afford to wait until the change takes place.

The interest gap is closing

2009-01-27T16:51:00.000+02:00

With the US Federal Reserve interest rate down to 0-0.25%, there is little room left for maneuver for interest rate policy in the US, to help revive the American economy. In Israel, on the other hand, with interest holding at 1.75%, there was still a way to go. However, on 26 January, the Bank of Israel announced its decision to reduce interest further – to 1%, thus narrowing the interest gap between the US and Israel. Will it be narrowed further? We will have to wait a month to see.

This is the 6th interest reduction in Israel since September 2008, when interest stood at 4.25%: at the same time, the US Fed interest rate was a much lower 2%. The recent process of interest rate reduction has therefore been much more dramatic in Israel than in the US: since September, interest in Israel has fallen by 3.25% (from 4.25% to the current 1%) while in the US, the reduction has been 1.75-2%. So the narrowing of the interest gap between Israel and the US has been going on now for several months.

The concern in Israel – and the rationale for the interest rate reductions – has been the same as in the US: the slowdown in the economy and the strong possibility that the slowdown will turn into a recession (a period of negative GDP growth). This is already accepted in the US but now it is also accepted by the Bank of Israel. In July 2008, the Bank published a forecast of 3.4% growth in 2009. This was reduced to 3.1% in August, to 2.7% in October and to 1.5% in November.

Just one day before its most recent interest rate decision, the Bank published is latest 2009 growth forecast according to which the Israeli economy will be in recession in 2009, with negative growth of -0.2% (see our blog of 14 January – "Growth forecasts for 2009 keep getting reduced"). The performance of the economy in 2009 may well turn out to be even worse than this.

Will the interest rate reductions work, helping to revive the Israeli economy? In the press statement that accompanied the reduction of interest to 1%, the Bank of Israel complained – not for the first time – that interest rate reductions by the central bank since September have not been followed by similar reductions implemented by the commercial banking sector and that the commercial banks have not eased up on the credit crunch.

This of course is what has to happen if the reduction in interest is to work. The central bank cannot force the commercial banks to lower interest when it lowers interest, but in the past, commercial interest has generally followed central bank interest closely. The commercial banks argue that since interest payments constitute a major part of their income, lowering interest too much could jeopardize their stability.

However much the Bank of Israel would want to avoid this possibility (especially in view of the collapse of major banks in the US and elsewhere), the banks' argument is not regarded as satisfactory by the Bank of Israel. The counter argument is that it is in the commercial banks' own interest to do everything possible to help revive the economy.

Central bank Governor Stanley Fischer announced that if the commercial banks do not come through of their own volition and lower interest, he will have no choice but to implement (perhaps regulatory) measures to make them do so. Everyone is now waiting to see what these measures could be.

The amazing case of housing prices

2009-01-18T15:26:00.000+02:00

The global economy is in recession – probably the worst since the Great Depression that began in 1929 – and the Israeli economy has been dragged in to the crisis. A major feature of the recession is the real estate slump, which began with the sub-prime mortgage crisis, and one of the main features of this slump is a sharp fall in housing prices in many countries around the world – except, it seems, for Israel.

Since mid-2008, housing prices in Israel have been increasing significantly, even though the demand for housing is clearly weak, as is to be expected in a severe economic slowdown. Here are the facts: during the second half of 2008, the total Consumer Price Index (CPI) increased by a monthly average of 0.2%, while the housing price component of the index increased by 2.2%, on average. During the final four months of 2008, the total index declined by 0.6%, while housing prices increased by 7%. Preliminary forecasts for December were that the total CPI would decline by as much as it did in November (-0.6%: the December CPI was published on 15 January), but it declined in fact only by 0.1% - the main reason: a 1.7% increase in housing prices in December.

What is the explanation for this strange behavior of housing prices in Israel? One explanation brought forward is that it is connected with the transfer of real estate transactions from dollar-denominated to shekel-denominated. For most of Israel's history, housing prices (both rental and purchase) have been denominated in dollars, but when the shekel began strengthening against the dollar, a process that began in 2006 and continued during 2007 and 2008, sellers/renters of real estate began to realize that they were losing money and began to denominate prices in shekels.

It seems that the translation of housing prices from dollars to shekels more than compensated for the loss of value of the dollar against the shekel (sellers/renters sought compensation for the accumulated loss as a result of the continuing weakening of the dollar against the shekel), so that housing prices increased in shekel terms even though real estate demand was weak. For some – not very clear – reason, purchasers/rentees went along with this and allowed housing prices to increase.

But this transfer process from dollar-prices to shekel-prices had more or less worked itself through by mid-2008 (according to official data, the share of new rental contracts denominated in shekels increased from 34.7% in December 2007 to 74.4% in July 2008, and then trickled up to 81.5% in December 2008), and it is not clear that it explains the rapid increase in housing prices in the second half of 2008.

Another possibility is that the recent housing price increase is a result of increasing prices of construction inputs. But even though the price index of inputs to residential construction did increase by 1.1% during the 3^rd quarter of 2008, it declined by 2.1% during the 4^th quarter: so this is not the explanation.

One other simplistic explanation is that the Central Bureau of Statistics does not measure housing prices correctly within the total CPI: this claim has indeed often been made in the past.

All we can say at the present time is that there is no really satisfactory explanation, at the present time, of the recent increase in housing prices. But we are prepared to forecast that housing prices will decline during the first half of 2009, as the weak demand for housing kicks in.

Growth forecasts for 2009 keep getting reduced

2009-01-14T15:01:00.004+02:00

They began at close to 3%, were then revised down to 1.5% and are now reduced further to 0%. We're talking about growth of GDP forecasts for the Israeli economy in 2009. These are international forecasts – the "close to 3%" and "revised down to 1.5%" forecasts belong to the International Monetary Fund (IMF) while the 0% forecast was recently published by Merrill Lynch.

But local forecasts are not that different: the Bank of Israel, which also revised its 2009 growth forecast down to 1.5%, recently announced that it soon intends to reduce it further. Local forecasts are essential for the 2009 State Budget, which will only be approved once a new government is formed after the February 10 general election (because of the Gaza offensive, there is no absolute certainty that the election will take place on 10 February, so approval of the 2009 budget may be delayed even more).

Every State Budget has a growth forecast built into it, which is the basis for calculating expected tax revenues, which in turn are taken into account in determining the targeted budget deficit - and everyone knows the importance of the budget deficit in establishing an economy's credentials, both internally and internationally.

The 2008 budget deficit, published on 13 January 2009 by the Ministry of Finance, is already a cause of initial concern in this area. After declining steadily from 2004 to 2007 while the economy grew rapidly, the deficit increased from 0% of GDP in 2007 to 2.1% of GDP in 2008, 3.8 billion shekels (1/2% of GDP) above target. The main factor here: the below-target tax revenues during 2008 (total real tax revenues declined by 7.7% compared to 2007), a direct result of the developing economic slowdown. If the much slower forecast 2009 growth materializes, tax revenues will continue to decline in 2009 (as indeed most analysts expect them to do), causing a much bigger budget deficit headache.

There are two questions about the revised 2009 growth forecasts. Firstly, they appear to close the growth rate gap between Israel and other developed economies, for which the 2009 growth picture is also very dismal (with several forecast to experience negative growth), while the gap in 2008 was quite significant. It is true that estimates of Israeli GDP growth in 2008 were recently revised down from 4.5% to 4.1% (compared to more than 5% annually in 2004-2007), and are quite likely to be revised down further – to below 4% - as data for the final months of 2008 become available, but this still leaves 2008 growth in Israel significantly faster than in the other developed economies (which grew at 1% or less in 2008). The question is: why will the growth rate gap narrow in 2009?

The second question is, referring to both the global and Israeli economies: when will the recovery from the current slump begin? Few analysts argue that it will begin during 2009, most claim that at the earliest, the recovery will start in 2010 and will be very slow. An additional relevant question regarding the Israeli economy is: can a recovery in Israel begin independently of the recovery in the global economy. In a recent statement, Professor Stanley Fischer, Governor of the Bank of Israel, maintained that an Israeli recovery is highly dependent on the global recovery.

Just as recently, a poll of a group of senior economists in the US reported that based on growth patterns in previous severe economic crises, the current recession is likely to be deep and continue for anywhere from 2 to 5 years.

If we take together the expected length and depth of the current global economic crisis and Israel's dependence on the global economy, it is not difficult to appreciate why 2009 growth forecasts for Israel are being revised down all the time and why the gap in growth rates is likely to narrow significantly in 2009.

Even though there are some optimists who argue that we will see the start of a recovery in Israel during 2009, the consensus is that however glad we were to see the end of 2008, 2009 is most likely to be an even harder year for the Israeli economy.

The Gaza Offensive and the economy

2009-01-04T10:08:00.000+02:00

Since the Gaza offensive began on 27 December, there has been much rhetoric and media coverage about the possible effects of the offensive on the Israeli economy. If we look at periods of military conflict in the recent past, we can report that the effect of the 2nd Lebanon War in July-August 2006 on the economy was minimal – just a short-term slowdown on GDP growth and a surprisingly limited effect on incoming tourism. But all this may have been because at the time, the Israeli economy was in the midst of a rapid growth period.

At present, the economy is showing signs of significant slowdown, as part of the overall global slowdown/recession. Is it possible that the effect of the Gaza offensive will be heightened as a result of these different economic background conditions? Our answer to this is: no.

Firstly, on the assumption that the slowdown will continue during (at least the first half of) 2009, we will have no real way of isolating the effect of the offensive on the economy from the general trend of slower activity, resulting from the global crisis.

Secondly, there is consensus that the slowdown in the Israeli economy is lagging the global slowdown so the downward trend in economic activity in Israel still has a way to go, regardless of the possible effect of the Gaza offensive. Recent data indeed show how the economic situation in Israel is deteriorating. Revised estimates of GDP growth in 2008, published on 31 December, show a more severe slowdown than that shown by preliminary estimates, published in October – 4.1% compared to 4.5%. 3rd quarter GDP growth slowed to just 2.3% (these data were published in November and undoubtedly contributed to the revised annual growth estimates).

Consumer confidence in Israel took a steep dive in December. The Bank of Israel again lowered interest rates sharply at the end of December (in line with interest rate slashes by central banks around the world), as a way of contending with the worsening slowdown. Revised IMF growth forecasts for 2009, published in November, show the Israel economy growing at just 1.5%, compared to an earlier (October) forecast for Israeli growth of 2.8% in 2009.

All this is happening without the influence of the Gaza offensive, and it is unlikely that the offensive will add significantly to these downward trends. Could incoming tourism be affected by the offensive? Based on the experience of the 2nd Lebanon War, the effect – if at all - is likely to be limited. It is worth noting that incoming tourism increased significantly throughout 2008: if it begins receding in 2009, it is more likely that this will be the result of the global slowdown affecting tourism in general around the world, rather than the result of the Gaza offensive.

One possible cause for concern is the effect of the offensive on the Israeli budget deficit in 2009, given the decline in tax revenues (a major feature of 2008) as a result of the economic slowdown, which is expected to continue in 2009. While other countries have decided to increase budget deficits as a fiscal way of dealing with the global crisis, the Israeli government has for the moment withstood pressure to go down the same path. The possibility of increased defense expenditure as a result of the Gaza offensive may make this target more difficult to achieve, though most defense sector experts argue that the offensive will not call for any increase in the defense budget.

The effect of the Gaza offensive on the economy depends of course on how long the offensive will continue and at the present time, with the offensive having just begun, there is as yet no answer to this question. So we will most likely be reporting here on this subject in the months ahead.

Unemployment just won't budge

2008-12-18T15:55:00.003+02:00

Should unemployment not be increasing in Israel if there is an economic slowdown – as there is? Unemployment is certainly increasing in other developed economies, often sharply (for example, in the US). And yet according to the latest figure on the trend rate of unemployment in Israel, for October 2008 (published on 17 December), the rate remains "stubbornly" stable at 6%, where it has been since May this year.

Can policy makers in Israel claim – on the basis of the latest unemployment data – that the current slowdown in Israel is less serious than elsewhere? Or that the slowdown is still not affecting the labor market in Israel? Or even that there is really no slowdown to speak of in Israel? Are there other indicators that show that the labor market is being affected?

Firstly, based on past experience, it seems that the unemployment rate in Israel lags other labor market indicators when the economy enters a slowdown period, so that the present stability of the rate does not have any particular significance when it comes to interpreting current economic trends, Secondly, yes – there are other indicators showing growing labor market weakness, besides all the references in the economic media in recent months to companies firing employees.

One indicator, from the "family" of unemployment indicators is the number of job seekers at Employment Exchanges in Israel: the number increased by 13% from April to October 2008, and we are now waiting for the November figure (to be published towards the end of December) to see if the upward trend in job search is continuing, and even possibly accelerating.

Equally important, there are indicators of the demand for labor that clearly show the effect of the economic slowdown on the labor market. One such indicator is a quarterly Employers' Survey, published by the Ministry of Industry, Trade and Employment. It just so happens that together with the October 2008 unemployment rate published on 17 December by the Central Bureau of Statistics, the Ministry published preliminary 4th quarter survey results on the number of job vacancies reported to the survey by employers.

The number of vacancies has in fact been declining since final quarter of 2007, but the speed of decline has quickened dramatically since mid-2008: in Q4/08, the total number of vacancies (exc. construction and agriculture) has shrunk to 25.1 thousand, compared to 59.5 thousand a year earlier. The new survey also reports an increase in the number of layoffs to some 151 thousand in Q4/08 compared to 119 thousand a year earlier.

Why is this weakness in the demand for labor not yet reflected in the unemployment rate? The answer may be connected with the way the data on unemployment are constructed and also – as already mentioned – with the fact that unemployment tends to lag other labor market indicators.

There is no doubt, however, that we will soon see – either in the full 4th quarter of 2008 or in the opening quarter of 2009 – an upturn in unemployment.

The government steps up – but will it be enough?

2008-11-20T23:40:00.001+02:00

The government, under great pressure to "do something" about the burgeoning economic crisis, announced its emergency program on 19 November to revitalize the economy, currently characterized by clear signs of slowdown. The program has 4 main parts:
Increased investment in infrastructure
Special help to the hi-tech sector
Financial assistance to small businesses
Increased vocational training

All of these are classic measures: infrastructure investment is a textbook solution for enhancing economic growth, the hi-tech sector – extremely important in the Israeli economy – is already suffering significantly from the slowdown, small businesses in general tend to be the early victims when growth slows, and increased vocational training may well be called for when unemployment is growing.

But will all this be enough and will it have the desired results? The Minister of Finance announced that the program will involve expenditure of some 22 billion shekels in 2009, a very impressive sum. But this is far from the complete truth: part of the program is already built into the 2009 State Budget (which has still not been approved), so the actual increase in expenditure that the program calls for in 2009 is only 4-5 billion shekels. Secondly, part of the designated expenditure – in the area of infrastructure investment, for example – will only be forthcoming after 2009.

Another question regarding the program is how soon its implementation will begin. A general election has been called for February 10, 2009 and based on experience, little policy making takes place in the run-up to an election, and then after the election, forming a coalition is usually a very lengthy process. So it may be 5-6 months before anything concrete can be done with the program. In an election spirit, some critics of the program are already arguing that the program is no more than pre-election "spin", designed to help the ruling Kadimah party improve its election chances. In any event, the program still has to be approved by the Knesset, and some political parties may take advantage of this as the elections approach and make demands on the budget in return for voting in favor of the program.

But the biggest question of all concerns the fact that the program includes no measures to deal with the problem of long-term savings, whose value has dropped steeply as a result of the crisis in the financial and capital markets in 2008 as a whole but particularly from September. The Histadrut – Israel's nation-wide trade union – has demanded a "security net" whose function would be to protect long-term savings. Now that the emergency program has been announced without the security net, the Histadrut is threatening to call a national strike. This may seem a strange thing to do when unemployment is increasing, but in the past, it is proved the most effective way to achieve the Histadrut's aims.

It is still early days for the new emergency program, and its being an emergency program may increase the chances of its implementation. But in the meantime, the negative indicators keep rolling in.

Unprecedented

2008-11-20T23:30:00.002+02:00

The Bank of Israel surprised again – for the 2nd consecutive month – and lowered interest early in November (on 11 November, to be precise), prior to the official interest rate policy announcement this month, scheduled for 24 November. As with the early October reduction, this latest one was of the order of magnitude of 0.5% (following the early October reduction, interest was again lowered – by 0.25% - at the end of October). What makes this particular reduction special is that it brings central bank interest in Israel to the unprecedented low level of 3%.

Will the current level of interest remain unprecedented? Probably not – there are strong rumors that interest will continue to be reduced, an expectation not fundamentally different from expectations regarding interest rates in other developed economies. Most major central banks have lowered interest rates in October-November (with the star role given to the Bank of England, which lowered interest in early November by a gigantic 1.5%) and these reductions are expected to continue.

Governor Stanley Fischer of the Bank of Israel is clearly worried – as are other central bank governors within their own economies – about the possibility that the Israeli economy will slip into a recession, brought on by the developing global recession and the credit crunch, which is firming up in Israel as well.

Every new piece of data recently published in Israel points clearly to the developing slowdown: two indicators published by the Bank of Israel itself show this – the State-of-the-Economy index, an indicator of overall economic activity, which has been trending down now for the past 4 months (through September) and the central bank's Company Survey for the 3rd quarter of 2008, with companies in all sectors reporting a slowdown of activity in this quarter (contractions of activity were reported by companies in industry, commerce and construction) and providing even more pessimistic forecasts of activity for the 4th quarter of the year.

Consumer confidence is also beginning to reflect the current situation, with a sharp fall in October in Hapoalim Bank's Consumer Confidence Index.

Data expected later this month are GDP estimates for the 3rd quarter and the Labor Force Survey – the broadest dataset on labor market developments. Questions waiting to be answered here are: 1. Will GDP growth slow significantly in Q3 (annualized growth was still high at 4.2% in the 2nd quarter of 2008, though lower than the 5.6% growth of Q1/2008)?; 2. Will the unemployment rate show an increase: up to now (the latest data on unemployment are for August), there have been no signs of increase in unemployment, but at the same time, the economic press is full of reports of companies firing workers, particularly – but not only – in the hi-tech sector.

The answers to these questions will surely influence Governor Fischer as he prepares for his upcoming interest rate decision on 24 November, when a new precedent may indeed be set in

the area of interest rates in Israel.