Recent Economic Developments: The fiscal situation for 2016, and trends expected over the remainder of the decade
The survey indicates that growth of GDP and most components of aggregate demand fluctuated markedly between the second and third quarters of 2015.
To Fiscal Survey
v Growth of GDP and its components were markedly volatile in 2015: after a standstill in GDP growth in the second quarter, growth recovered in the third quarter, and various indicators point to some acceleration in the fourth quarter. The labor market was resilient in 2015, and alongside low unemployment, the number of job vacancies increased by a rapid rate.
v The government budget deficit declined to 2.15 percent of GDP (NIS 24.5 billion) in 2015, from 2.8 percent of GDP in 2014. The debt to GDP ratio declined to 64.9 percent at the end of 2015, from 66.7 percent at the end of 2014. The decline strengthens Israel’s position in the capital markets and reduces the Israeli economy’s risk premium.
v Tax revenues, adjusted for an increased provision of NIS 1.5 billion to the Property Tax Fund, were NIS 6 billion greater than forecast at the beginning of the year. This was primarily due to a more rapid than expected increase in wages, and due to the sharp increase in real estate activity.
v The decline in the ratio of public debt to GDP is mostly explained by an increase in the GDP deflator alongside a decline in the Consumer Price Index, to which about half the public debt is indexed. Also contributing to the decline in the debt to GDP ratio were debt repayments by the public to the government, and receipts from land sales.
v The government increased the deficit ceiling for the 2016 budget from 2 percent of GDP to 2.9 percent of GDP as a result of structural steps—an increase in the expenditure ceiling as well as tax reductions. This deficit level is not consistent with a reduction of the debt to GDP ratio. Based on current economic forecasts, and assuming that government expenditures will be in line with the ceiling, the government is expected to meet the target.
v The Ministries of Finance and Defense agreed on a new multiyear framework for the defense budget. Its implementation will contribute to stabilization in the process of building and managing the State budget, and to increased efficiency in the administration of the defense establishment. It is important for the government to approve a multiyear work plan for the ministry of defense that will be in line with the agreed upon budget.
v An examination of the budget path indicates that the government will again face a complex challenge when approving the 2017 budget; the government’s expected expenditures—based on approved plans—are about NIS 14 billion higher than the expenditure ceiling for that year, assuming that the increase in the defense budget, in accordance with the framework, is financed in 2016 by a permanent reduction in civilian budgets.
v In the past year, the government expanded the use of recording methods which weaken the link between its activity—particularly in the housing sector—and how that activity is presented in the budget. When expenditures in the housing sector are presented in a manner that is in line with generally accepted accounting standards, the expected deficit for 2016 increases to 3.3 percent of GDP.
v In 2014, Israel did not meet the government target for renewable energy: instead of generating 5 percent of electricity usage through such sources, it only generated 1.5 percent of its electricity usage from those sources. An enhanced effort must be made in the coming years to meet government targets and international norms.
v Private consumption is affected by the scope and liquidity of households’ assets: financial assets have more of an effect on private consumption than real estate assets.
The Bank of Israel today is publishing Recent Economic Developments, which includes a periodic fiscal survey as well as deeper analysis of several economic issues. The survey indicates that growth of GDP and most components of aggregate demand fluctuated markedly between the second and third quarters of 2015. In the second quarter, GDP did not grow at all, exports declined, and the growth rates of private and public consumption slowed. In the third quarter, GDP returned to growth at a moderate rate, due to growth in exports and accelerated growth of private and public consumption. Various indicators point to some acceleration in fourth quarter growth. In the labor market, low unemployment rate and high participation and employment rates were maintained, the job vacancy rate increased, and there was a rapid increase in wages in the public and private sectors.
In the fiscal survey, the Research Department analyzes the budget developments in 2015—and the expected developments of government expenditure, revenues, budget deficit, and the debt to GDP ratio—on the basis of budget decisions reached by the government when approving the budget for 2015 and 2016. The analysis indicates that the ratio of the deficit to GDP declined markedly in 2015, compared with 2014, primarily due to an increase in revenues. Tax revenues were NIS 6 billion higher than forecast in the beginning of the year. This increase derives mostly from the increase in wages in the economy, but also from the notable increase in sales of new homes and from a larger than expected increase in nominal GDP. The debt to GDP ratio declined from 66.7 percent at the end of 2014 to 64.9 percent at the end of 2015, a decline that strengthens Israel’s position in capital markets and reduces the risk premium of the Israeli economy. The decline in the debt ratio mostly reflects an increase in the GDP deflator alongside a decline in the CPI, to which about half the public debt is indexed. Also contributing to it was repayment of debt by the public to the government, and revenues from land sales.
The government decided to increase the deficit ceiling in 2016 from 2 percent of GDP to 2.9 percent of GDP, by markedly increasing the expenditure ceiling and reducing tax rates. The increase in the expenditure ceiling reflected the government’s difficulty in achieving its social, defense, and economic targets within the framework of the existing expenditure ceiling, which dictates a continued decline in the share of public expenditure in GDP, even though the share of civilian expenditure in Israel is already very low compared with other advanced economies. This difficulty has been reflected continuously in recent years in the accumulation of expenditure programs whose total cost is higher than the expenditure ceiling, and with repeated adjustments of the budget targets alongside postponements, cancellations, and reductions of government plans shortly after they had been approved. At the same time, the government decided to reduce tax rates, and thus increase the structural deficit even more. Furthermore, the budget includes accounting treatments that reduce the reported deficit in 2016 by accounting shifts of revenue and expenditure items between years, and presenting part of its activities in the housing sector in a manner that is not in line with generally accepted accounting standards.
Assuming that government expenditures in 2016 will be in line with the ceiling that was set, the expected deficit is in line with the new target—2.9 percent of GDP. Although the budget does not include the supplement to the defense budget in accordance with the new framework agreed on by the Ministries of Finance and of Defense, in light of the performance rates of civilian ministries in recent years, and the large addition to their planned budgets based on new plans by the government, it is reasonable to assume that the amount required can be shifted from their budgets without markedly impacting their activity in 2016. With that, the notable gap that will be created as a result, between the composition of the budget that was approved only at the end of November and the budget that will be executed, adversely impacts on the quality of the public and parliamentary discussion on the government’s priorities, especially as the amount that will be added to the defense budget supplement was included in specific civilian budgets.
An examination of the expected path of the budget for 2017–20 indicates that the government will again face complex challenges when preparing the budget for 2017 (Figure 1). In large part, this is because in addition to the marked increase in the expenditure ceiling in the 2015 and 2016 budgets, the government deferred at that time the implementation of some of its decisions to coming years. The costs of executing these decisions, alongside decisions from previous years and the fact that when constructing the budget use was made of an inflation forecast that is higher than the actual increase in prices currently expected in 2016, are expected to lead to a deviation of NIS 14 billion from the new expenditure ceiling set in the law. Furthermore, a change in the Foundations of the Budget Law, which was approved within the framework of the Increasing Economic Efficiency Law, establishes that beginning with the 2017 budget, the government will need to handle, when approving the budget, the deviations from the expenditure ceiling expected in 2018 and 2019. This is an important change: it increases the transparency in budget administration and is intended to halt the process that has strengthened in recent years—providing a response to current budget problems by deferring them, while creating excess commitments for future years. According to assessments based on conservative assumptions, this required adjustment has already reached NIS 2 billion.
Source: Based on budget data.
One of the main targets that the government set for itself in recent years is reducing home prices. In order to promote this target, the government is working to vacate IDF bases from areas in high demand in order to make land available for construction, to remove obstacles to promoting construction of residential neighborhoods through the budgeting and execution of development plans for local authorities in which the new neighborhoods will be located, and to subsidize the cost of housing for population groups that meet the criteria set in the “Dweller’s Price” plan. The expenditures on plans in the real estate sector are necessary for achieving the government’s targets, but the budget presentation of the cost of the plan—as reflected, for example, in the 2016 budget presentation—is only partial, and use of “budget-bypassing” processes is liable to distort the presentation of the fiscal picture through government accounts,. This concern led the Accountant General’s division at the Ministry of Finance to include the costs of the Shoham 3 (“Marketing and Moving Bases”) plan and the transfer of IDF bases to the south in government expenses as reported in the preliminary estimates of budget performance for 2015, in contrast to the initial recording that appeared in the budget proposal. It is important to correct, accordingly, the presentation of budget data for 2016, a year in which the expenditure on these items is expected to be markedly higher, and it is important that the government act to present in an accurate and transparent manner, as a budget expense, the relevant costs of implementing the umbrella agreements and the “Dweller’s Price” program as well. If the costs of government programs in the real estate sector, which are not included in the budget, would be recorded in accordance with common accounting principles, the deficit would reach 3.3 percent of GDP. A deviation from the accepted accounting methods negatively impacts not only the precision of the presentation of the budget, but would also be an incentive for additional initiatives to bypass the limitations of the budget set by the fiscal targets and to distort the priorities in the government’s activities in accordance with the ease of use of budget-bypassing tracks.
In addition to the survey of current main developments and the fiscal survey, Recent Economic Developments includes deeper analysis of six issues. Four of them were published over the past two weeks—the effect of business cycles on the construction sector; the initial results from the designated survey conducted among those eligible for the earned income tax credit, the efficiency of tax benefits to localities in the periphery, and the effect of raising the retirement age on the decline in the share of employees who switch employers. The fifth topic examines whether financial factors impact on private consumption in Israel. It was found that the scopes of households’ assets and liquidity have an effect on private consumption, and that financial assets have more of an effect on private consumption than real estate assets. The sixth topic covers the use of renewable energy in Israel and deals with the targets set by the government for electricity production from renewable energy sources (Table 1), the reasons that the targets were not reached, and the manner of regulation and policy required in the area over the coming years.