Governor of the Bank of Israel Prof. Stanley Fischer spoke today at the Knesset Finance Committee's discussion of the government's economic program. The following are the main elements of his remarks.
As is known, the global economy is not in a good situation. Growth in the US is expected to be about 2 percent this year, while in Europe, a recession is already apparent and growth there is negative. The situation in the emerging and developing markets is a little better, although some of them have recorded a downturn in their growth rate. World trade is growing at a below average rate, and our principal export markets are expected to remain in a difficult situation in the near future.
The situation in Europe is particularly severe, and unemployment rates there are very high. Especially worrying are the yields on the bonds of the crisis-hit countries, principally Spain and Italy, where yields have risen to over 6–7 percent. With yields at these levels, it will be very difficult for the governments concerned to continue financing their expenditures. In Greece the yield is a double digit figure. The Greek government has effectively lost control over its fate, and is now at the mercy of the EU countries in a situation where it is not certain that they will agree to continue lending to Greece.
The Israeli economy during recent years has been a success story: Growth in every quarter from the beginning of 2008 was higher than in the advanced economies, including in the period of negative growth at the height of the recession. Since the beginning of 2011 however, the pace of growth in Israel has slowed. According to the new method of measurement, the unemployment rate in Israel fell very rapidly once the recession ended, and is now in the region of 7 percent. Exports fell heavily during recent months as a direct result of the weakness in the global economy and especially in Europe, which is Israel's principal export market. This drop in exports is the main reason for the downturn in growth which we are now experiencing.
Inflation over the past twelve months amounted to 1 percent. Inflation is expected to rise as a result of the increase in VAT and higher commodity prices in world markets. However, we still expect inflation to be close to the center of the target. I would also like to mention that the shekel has depreciated recently, and this is expected to support exports and alleviate the downturn in growth.
One important point to be noted is that even though we are m managing the economy responsibly, the burden of interest rate payments in Israel as a percentage of GDP is high compared with the average for the OECD countries. The yield on government bonds is higher than in other countries that are not in a crisis situation, and interest expenses are around NIS 40 billion or 4 percent of GDP. It is important to prevent an increase in the interest burden, since everyone knows that there a lot of things that can be done with forty billion shekels.
As for the future, two scenarios are possible: Under the first scenario, Europe succeeds in coping with the current situation. The growth forecasts which we have presented to date are based on this scenario. But the second scenario also exists and under this scenario, some member countries may leave the eurozone. We do not know what the results will be of the financial crisis that would occur in a situation such as this. Actually, no one knows, and we do not know what the implications will be for the European economy and the Israeli economy. We must be prepared for such a possibility, meaning that we must deal with the situation in the economy before we encounter a crisis of this nature, by maintaining the stability of the financial system and by dealing with the government's fiscal situation.
The original budget deficit target for 2013 was 1.5 percent of GDP or approximately NIS 15 billion. A month ago, the government decided to raise the deficit target to 3 percent, by raising additional debt in the region of NIS 15 billion and thereby reducing the need for increasing taxes by NIS 15 billion. This means that the claim now being voiced, whereby we should have increased the deficit instead of increasing taxes, is not valid because this is exactly what the government has done—increased the deficit in order to make fewer tax hikes today, and effectively it passed on the burden to the next generations. As is known, I believe that the deficit should have only been raised to 2.5 percent of GDP. In any event, the government made the decision and what is now important is to adhere to the target. It should be realized that planned expenditures currently exceed spending based on the expenditure rule by NIS 15 billion. The government will have to cope with this as well, by reducing the planned growth in expenditure. I would like to point out that if we do not deal with the deviation from the expenditure target, the deficit will amount to approximately 4.5 percent in 2013. Moreover, if the government does not increase taxes, the deficit is likely to reach some 6 percent of GDP—a very dangerous level for an economy that is growing at around 3 percent a year.
Right now, how we came to this situation is less important. What is important is that the government must now deal with the situation. If we do not deal with the situation and the crisis in Europe worsens, we will be forced to take contractionary measures at the very height of the recession, and any criticism leveled at such measures will definitely be justified. We are not in a recession at present, and now is the time to deal with the fiscal situation which we have encountered.