Striking the right balance between fiscal and monetary policy is the most urgent challenge for policymakers in Israel, according to International rating agency Fitch Ratings. The agency has issued a comment on Israel's credit outlook in light of the new government's May economic package and against the background of forthcoming deliberations on the 2004 budget.
The macroeconomic policy imbalance worsened earlier this year with the already high budget deficit and short-term real interest rates increasing anew. The economic package therefore marks an important step in the right direction. It will not prevent an unwelcome further increase in the State budget deficit this year.
But together with the dramatic fall in inflation, it should allow the nominal general government deficit, Fitch's preferred measure of the fiscal stance, to decline slightly and public debt should increase much less than in 2001 and 2002. Interest rates have begun to fall.
Fitch is also encouraged by the renewed emphasis on structural reform, including measures that will affect spending in the medium-term. In view of the constraint that weak public finances place on counter-cyclical fiscal policy, the government's main scope for promoting recovery is by combining deficit reduction, focused on spending restraint in order to facilitate further interest rate cuts, with structural reforms to raise growth potential.
Privatization is important as it not only improves economic efficiency but will also help mitigate the increase in debt. Fitch looks to the 2004 budget to deepen this strategy. A serious attempt to reduce the State deficit, as envisaged under the Deficit Reduction Law, based on realistic economic assumptions, would raise the credible prospect of turning round public finances in a context of economic recovery.
Together with further structural reform, this would make a significant contribution to stabilizing Israel's creditworthiness. However, in a low growth/low inflation environment, this will not be easy, probably requiring a fiscal adjustment at least as big as in the past two years.
Public finances remain the main pressure point on Israel's ratings, which remain on Negative Outlook. However, this is not the only consideration, as Fitch explained when it downgraded Israel's Long-term local currency rating to 'A' and affirmed the Long-term foreign currency rating at 'A-' (A minus) in October 2002. Israel's external balance sheet is also important to the rating and this has remained broadly stable.
Prospects for the fiscal position, economic recovery, the global outlook and the peace process are all highly uncertain. Fitch will undertake a new, comprehensive assessment of Israel's situation in the autumn. — (menareport.com)
© 2003 Mena Report (www.menareport.com)
