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Bank of Israel Governor Prof. Amir Yaron delivered remarks today at the cabinet meeting on the State budget. The main points of his remarks are below.
I would like to thank the Prime Minister and the Minister of Finance for the preparatory discussions on the budget. I would also like to express my appreciation to Minister Smotrich and the Ministry of Finance staff for a responsible budget, and for the Minister’s mention of the important synchronization between budgetary policy and monetary policy.
The State budget for the next two years requires tremendous caution. The macroeconomic variables show a strong economy. Growth in 2022 came to 6.5 percent, and GDP is higher than the precrisis trend. The unemployment rate has returned to the low level that was prevalent prior to the crisis, the job vacancy rate is high, and the public debt to GDP ratio has already returned to its precrisis environment—around 61 percent. However, largely due to strong demand, inflation increased in the past year, to 5.4 percent—higher than the 1–3 percent target range. The financial markets have shown marked volatility in recent months, and the shekel has depreciated significantly. These development demand tremendous responsibility in managing government policy in order to entrench trust in the markets that by their very nature occasionally behave in a nonlinear fashion. We must avoid a fiscal policy that further expands demand in the economy and thereby increases inflationary pressures in a way that delays the return of inflation to the target range and increases interest rates in the economy.
Including public sector wage agreements and the needs of the government ministries and the defense establishment as part of the proposed budget is challenging. However, the proposed budgetary framework reflects fiscal responsibility that takes into account the significant uncertainty when building the revenue forecast, and thereby strengthens the fiscal reliability of the Israeli Government.[1] The developments in Britain in the past year reminded us of the ramifications of fiscal programs that are considered irresponsible, and the cost of correcting the damage when the markets’ trust is impaired.
The Bank of Israel’s main revenue forecast[2] for the coming two years is similar to that of the Ministry of Finance. According to this forecast, approval of a budget that is in line with the proposed expenditure frameworks[3] will lead to a deficit of close to one percent of GDP in each of 2023 and 2024. These deficit rates are expected to lower the debt to GDP ratio to below 60 percent during these years, and will contribute to the State of Israel’s increased fiscal strength.
This responsible budget framework is important in balancing the downward risks that we see regarding expected revenue. We must take into account a number of risks that, if they transpire, will lead to actual revenue that is lower than the forecast during the next two years, and if not then then in the medium range, which may lead to a higher deficit.
First, as stated, the economy is at full employment, and GDP is higher than the multiyear trend. This contributes to increased tax revenues, but it is difficult to predict when and to what extent this trend will change. The international environment features risks that have already been reflected in a slowdown in exports in the last quarter. Second, the high level of revenue relative to GDP in 2021 and 2022 was due, to a great extent, from anomalous revenue that may not persist, from real estate taxes and land sales, the capital market, the trapped profits program, bringing forward vehicle purchases, the high-tech boom, and the effect of accelerating inflation on income tax revenues. An indicator of this risk is that in recent months, we have already started to see a decline in tax revenues relative to the same period last year.
Due to these risks to the revenue forecast, we must be cautious in increasing expenditures beyond the proposed budget and/or lowering taxes on the basis of the easy fiscal situation, since it reflects effects that may be temporary.
Alongside the need to maintain fiscal responsibility at this time, our recommendations of measures that will support increased labor productivity in the long run remain in place. Israel has a lower level of investment than the advanced comparison economies, particularly if we consider the population growth rate. Therefore, physical investment projects such as transport infrastructure and building educational institutions in areas where there is a lack are desirable under the current fiscal conditions. It pains me that there are not enough multiyear programs that can be advanced in the next two years. If we really can’t accelerate physical investment projects that have a high economic yield during the course of the years covered in the budget, it is preferable to utilize the relatively low deficit in order to maintain the fiscal spread by reducing the debt to GDP ratio, as proposed in the budgetary framework, while building a multiyear plan that will ensure increased growth-supporting expenditures in the next budget. In this context, the National Infrastructures Law that is included in the economic program is an important element in the ability to advance investment in such projects.
The economic program that we have presented also includes a significant number of proposed decisions and legislation in the financial realm. The Bank of Israel under my leadership has done a lot of work in recent years to increase competition in the areas of banking and payments, while maintaining the robustness of the banking system and the reliability of the payments system. Unfortunately, some of the proposals included in the drafts of the Economic Arrangements Law may achieve exactly the opposite result, and I will be holding open dialogue with the Minister of Finance about that.
To conclude, the state of the economy is good, but due to the inflation level and the risks in the international and domestic environments, it is important to maintain a responsible budget, as presented today, and to be cautious in making policy changes.
[1] Some of the uncertainty is hedged by an adjustment (reserve) budget of NIS 3.6 billion in 2024.
[2] NIS 468 billion in 2023 and NIS 498 billion in 2024, before revenue adjustment measures totaling NIS 2.5 billion, but including an extension of the temporary orders to lower fuel excise, lower the tax on coal, lower customs, and extend the tax credit for children aged 6–12, plus the cancellation of the tax on sweetened beverages.
[3] NIS 485 billion in 2023 and NIS 514 billion in 2024.