THE 10 ECONOMIC DECISIONS OF 1995 - 02-Jan-96

(Article by Judy Meltz, "Ha'aretz", Jan 2, 1996, p.C6)

The beginning of a new civil year provides a good reason to review a number of the important economic decisions not necessarily the best ones that were made in 1995. We will focus upon 10 decisions and upon the people behind them.

CANCELLATION OF THE CAPITAL GAINS TAX ON THE STOCK MARKET

The tax on capital gains from the bourse was to have gone into effect on 1.1.95, but as of that date, no solution had been found for a number of technical problems which prevented the tax from being carried out. The longer the delays, the greater the pressures on the Finance Minister, Avraham Shohat, and the heads of his ministry to cancel the tax. Late Prime Minister Yitzhak Rabin, who, in August 1994, supported imposition of the tax, began having second thoughts. Since the Governor of the Bank of Israel, Jacob Frenkel, decided it was preferable to distance himself from this controversial process, which, from the outset he was not involved in.

In the end, the Finance Minister was not able to withstand the pressures, and at a dramatic press conference at the end of January, he announced the cancellation of the tax. It must be noted, that even today, the Finance Minister does not hesitate to declare he still supports its imposition.

CUTS IN THE BUDGET

At the beginning of 1995, the Government approved two cuts in the budget one of NIS 800 million, and a second for the sum of NIS 1.2 billion. This occurred after it became clear that first without "budgetary adjustments", the Government could not reach its deficit target for 1995. Secondly, it became apparent that the Governor of the Bank of Israel would not reduce interest rates without a Government effort to trim expenses.

The cuts convinced the Bank of Israel Governor to reduce interest rates, although in actuality, the cuts did not bring about a reduction in Government demands. It did just the opposite. 1995 statistics on national accounts show that national savings did not fall due to a drop in private saving as it did in earlier years, but rather, due to a drop in public savings. Also, after two budget cuts, it became apparent that the actual deficit for the year would be far greater than the planned deficit of 2.75% of the GDP. The optimists speak of 3.75% and the pessimists talk about 4.5% of the GDP.

How did this happen? Apparently, the two cuts were actually fictitious, because the majority of the money was to be taken from the personnel areas of the budget. The Finance Ministry proposed trimming position quotas from Government ministries. A good idea in theory, but in reality, most ministries are not meeting their quotas, because the actual number of Government employees did not fall in 1995, but rose instead.

SOLVING THE PENSION FUNDS PROBLEM

Yitzhak Rabin and Avraham Shohat decided that the time had come to deal with one of the Israeli economy's chronic problems the actuarial deficit of the Histadrut Pension Funds. Therefore, they formulated a rescue plan, which obligated the Government to guarantee all of the pension funds' commitments to pensioners for the next 40-50 years.

This solution to the pension funds' problems created two types of citizens: those who were members of the funds by the end of 1994 who would continue to receive preferred conditions, and those who joined the funds from the beginning of 1995, who received far less favorable conditions. Professionals defined the plan as a retreat from actual reforms in the capital markets.

SOLVING THE KIBBUTZ DEBT PROBLEM

Over two years ago, it became clear that an agreement was needed to a full systematic treatment of the kibbutz debt problem, because the original solution from 1989 did not solve the debt problem of dozens of kibbutzim. The professionals in the Finance Ministry were against an overall solution, arguing that each kibbutz had to be dealt with separately. Nonetheless, Rabin and Shohat decided to negotiate with the kibbutzim as a whole. The negotiations blew up a number of times, and Rabin was ready to give up on an agreement. At the end, those who finally influenced him, were not the heads of the kibbutzim, rather the heads of the banks primarily the Chairman of the Board of Bank Hapoalim Amiram Sivan because the agreement was probably even more important to them than to the kibbutz leaders.

THE OPTIONS PLAN

In March, a committee headed by Finance Minister David Brodet, submitted for Government approval a plan for mass distribution of options to the public of Government-owned companies and banks in an effort to quicken the pace of privatization. Within the framework, it proposed granting to every citizen over the age of 18, a package of options which could be changed into shares at a discounted price, or to sell in the market. Since then, 10 months have passed, and legislation has yet to be submitted to the Knesset. It has become clear that a majority of the concerns who were candidates for joining the options plan are not ready for it. Thus, it seems that only the banks will be sold through the options plan. When will this happen? Probably not until 1997.

EXPANDED RANGE OF MOVEMENT IN THE EXCHANGE RATE.

The decision by the Governor of the Bank of Israel to raise the interest rates in order to fight inflation caused an unexpected negative result at the beginning of 1995 a massive influx of foreign capital. As a result, large surpluses of foreign currency exchanges were recorded in trading, and the shekel's value rose significantly. But until the end of May, the shekel was allowed to move only 5% above or below the diagonal line bisecting the currency basket. Thus, massive intervention from the Bank of Israel was required to prevent the currency basket from falling beneath the lower boundary. Because those active in the market knew that the exchange rate must remain more or less stable, they took advantage of the gap between the interest rates in Israel and abroad, in order to profit in arbitrage deals.

In order to moderate the movements of capital and restrict the level of risk inherent in these deals, the heads of the Finance Ministry and the Bank of Israel decided, at the end of May, to expand the range of movement to 7%. Immediately following the change, the Bank of Israel almost totally refrained from intervening in foreign currency trades, allowing the exchange rate to fall to 5% below the diagonal-line. The Governor of the Bank of Israel was convinced that as the exchange rate fell farther, the public would understand that the devaluation, which had been anticipated for a year, would be greater. As a result, the trend in trading would naturally reverse and create demand. However, this did not occur, and the Bank of Israel was forced to enter the market, and to act to reverse the trend.

SETTING AN INFLATION TARGET

The day before Yom Kippur, Shohat announced he had decided to set an inflation goal of 8-10% for 1996. At the outset, the decision on setting the inflation goal was taken unilaterally by the Finance Ministry, without coordination with the Bank of Israel. Frenkel had initially proposed setting the target at 6-9% in 1996, which the Finance Minister opposed. Then, the Governor of the Bank of Israel proposed a less ambitious target of 7-10%, to which the Finance Minister also objected. When he heard of Shohat's decision, the Bank of Israel Governor reacted angrily and announced that anyone who thinks that setting a goal of 8-10% will convince the Bank of Israel to be more flexible in it monetary policy, is very mistaken. And it is a fact, that until a week ago, Frenkel had not reduced the interest rates.

The assessment was that 1995 will end with inflation of 8-9%, and thus the Governor of the Bank of Israel said Shohat's proposed target was analogous to, at best, "treading water in place." Now, it seems that inflation in 1995 will likely be less than 8%. In other words, we are not talking about treading in place, rather about a retrogression.

ADOPTION OF THE BRODET COMMISSION REPORT

A week ago, the Government approved the Brodet Commission's recommendations to cut back on the real (non-financial) holdings of banks, with some slight variations. The person who fought behind the scenes over the past two years to establish the commission for dealing with the issues of bank control in non-financial institutions was a senior member of the Bank of Israel's management, Dr. Avi Ben-Bassat. But the person who worked to get the recommendations accepted into an actual Government decision, was Finance Minister, Avraham Shohat. Shohat was first to publicly announce that he was adopting the Brodet Commission's recommendations, and all of the other ministers in the privatization committee joined with him.

REDUCING INVESTMENT INCENTIVE GRANTS

For years, the heads of the Finance Ministry had attempted to bring about changes in the investment incentive regulations to reduce the grants given to approved enterprises. Until only a few weeks ago, all of these efforts had failed. But this time, Shohat managed to enlist the aid of Prime Minister Peres, and have the Government pass changes in the law, over objections of Industry and Trade Minister Micha Harish. Shohat proposed an immediate cutting of the grants from 38% to 30%, but in order to appease development town mayors, Peres formulated a compromise proposal: reducing the grants in two stages, from 38% to 34% immediately, and from 34% to 30% in 1997. This reduction was allowed to occur following "the problem" of over demand on a limited budget, that has been accruing over the past few months.

CANCELLATION OF THE ECONOMICS AND PLANNING MINISTRY