1998 BUDGET GUIDELINES - 09-Sep-97

1998 BUDGET GUIDELINES

(Communicated by GPO Economics Desk)

In August, the Cabinet approved the following guidelines for the 1998 State Budget. Total proposed expenses in 1998 will be NIS 164.4 billion, while total proposed revenues are forecast to be NIS 156.8 billion. This leaves a planned budget deficit of NIS 8.5 billion, equaling 2.4% of the country's GDP, in line with the Budget Law passed in 1992 mandating a gradual decrease in the country's budget deficit as percentage of GDP.

Durable economic growth must be based on increased growth of the business sector. In order to achieve this goal, it is imperative that fiscal policies include the following:

1. A continued phased drop in the budget deficit as a percentage of the GDP.

2. A decrease in the amount of public expenditures in relation to the GDP.

3. A decrease, or at the very least, no increase, in the tax burden.

A lower budget deficit will allow the private sector to raise capital in Israel for its investment needs at a lower price, which will in turn increase the profitability of investment. A restrained budget deficit will contribute to the achievement of price stability which itself is an important condition for the private sector's growth.

A decrease in public expenditures in relation to the GDP is a primary condition for the private sector's growth. The public sector competes with the private sector over the same production factors, and thus, a smaller public sector will serve to improve the private sector's situation. Today, government expenditures as a percentage of the GDP are high in relation to what is acceptable in Western countries against which the Israeli exporter is competing. This, itself, is an important reason to reduce this variable.

The proposed 1998 budget embodies a decrease in the percentage of the budget deficit compared to the GDP, and a reduction in government expenditures in relation to the GDP from 47.3% to 46.8%, along with an emphasis not to raise the tax burden. During a period of an economic slowdown, it is very important not to raise the tax burden because this step could bring about a worsening of the slowdown. The required reduction in the budget's basis in 1998 is NIS 2.3 billion.

THE GOVERNMENT'S POLICIES MONETARY POLICY GUIDELINES

The Government has adopted the decisions taken by the Finance Minister which were accepted by the Prime Minister after consultations with the Bank of Israel Governor, and sets the Government's 1998 monetary policies as follows:

1. To promote fulfillment of Israel's annual growth potential which today stands at approximately 5%, with the goal of achieving durable economic growth.

2. 1998's inflation goal will be within the 7-10% range.

3. The continued phased reduction in the inflation rate in order to reach long-term price stability as in western countries.

4. To increase employment in the private sector.

During 1997, an improvement in the balance of payments will be achieved not only because the budget deficit will be held to, but inflation will not deviate from its upper limit. Even so, in 1997 the rate of increase in the GDP declined and the growth rate will be close to 2.5%, compared to the forecasted 4%.

With 1998's stated goals, and with the need to continue a gradual reduction in the current accounts deficit in the balance of payments, the government feels a need to work towards a better balance between the various macroeconomic goals. These goals form the basis for implementing the fiscal policy tools as elucidated above and the monetary policy tools to be carried out by the Bank of Israel.

If it turns out that it is not possible to reach all of the policy goals or that there exists some discrepancy between the goals related to the carrying out of the above policies, the Finance Minister will initiate cabinet discussions, which is required for changing the goals' priorities.

INCREASING INFRASTRUCTURE INVESTMENTS

Investments in infrastructure are known to have an influence on long-term economic growth rates. Modern and efficient infrastructure represents a necessary condition for private sector growth.

In 1996-97, total investment in infrastructure was approximately NIS 11 billion. These investments included developing the electricity, communications, ports, water and sewage, and transportation sectors. The expenditures were primarily funded by off-budget sources (government companies and statutory authorities).

In 1998, a budgetary increase of NIS 2.1 billion to a total NIS 13.1 billion is expected to raise these investments. This increase of approximately 20% is being carried out in order to give momentum to the infrastructure sector and to support increasing growth. Within the framework of planned infrastructure investments in 1998, it is important to note the "Ben- Gurion Airport 2000" project and continued construction of the Trans-Israel Highway, whose paving will be done by the private sector.

In addition, the government plans to create a legal framework for the establishment and operation of water and sewage concerns which have great potential for integrating the private and public sectors in these areas.

Within the transportation sector, project construction by the private sector will quicken and tenders for funding railway projects, without government involvement, have been prepared.

STRENGTHENING COMPETITION IN THE ECONOMY

The rate of inflation in the economy is derived, in part, from the level of competition between different goods and services. Goods and services that compete with each other, tend over time to have a lower increase in price than non-competing goods. An examination of the consumer price index over most of the last decade reveals that non-competing goods and services rose approximately 32% above the consumer price index, while the prices of competing goods and services decreased approximately 13% over the same period.

Great importance must therefore be given to transferring goods and services from a situation of non or limited competition to one of reasonable competition, where conditions exist for a decrease in prices, both from a transitional and long-term point of view, and to improve services and increase the range of goods and services available.

Competition of this type represents a real contribution to the private sector which thereby gains a competitive edge against its competitors. In the meantime, competition improves the situation of various households in the economy.

The government will address structural changes for increasing competitiveness in the economy in the telecommunications, transportation, energy goods and services, as well as industrial and agricultural sectors.

REMOVING GOVERNMENT OBSTACLES

In the past, legislation and government decisions imposed various limitations on activities in the private sector. These limitations ultimately hurt the ability of the private sector to expand the range of its activities.

The government is suggesting making structural changes, starting with the removal of obstacles in a number of fields. Among them, changing the Patent Law to prevent harming R&D development during the patent stage by Israeli companies, and limiting government involvement in tourism are two proposals.

The government will also deal with obstacles in the real-estate sector. This is an issue requiring fundamental treatment since it affects both the construction industry as well as business activity in general. The government is suggesting an increase in the sale of real-estate for construction and residential purposes, and to simplify and shorten the planning and construction processes.

EMPLOYMENT MARKET

Recent economic developments have been characterized by a slowing down of growth signaled by an increase in the unemployment rate and in the number of those receiving unemployment and income security transfers.

During the first quarter of 1997, the unemployment rate rose to 7.3%, compared to 6.6% during the same quarter in 1996. The rise in the unemployment rate resulted from a freeze in the number of employed during the past three consecutive quarters rather than a slowdown in economic activity.

During the first five months of 1997, the number of job-seekers rose by approximately 30%, compared to the corresponding period last year. This upward trend has continued consistently over the past two and half years, returning the number of job-seekers to the high level experienced four years ago.

The employment situation is directly connected to economic growth. On one hand, a slowdown in economic growth brings with it an increase in the number of job-seekers; while on the other hand, a flexible employment market and a solution to problems in the market's structure contribute directly to the process of economic growth.

In conjunction with the rise in the number of job-seekers, the number of foreign workers and the number of workers from the territories employed legally grew by approximately 30%. During the first five months of this year, the average number of these workers was 120,000. A majority of these foreign workers are employed in unskilled jobs and compete with Israelis for open positions. It should be noted that about one-third of the requests for work which arrive at the Employment Bureaus are requests for unskilled labor (in construction, agriculture, and industry). The percentage of unskilled workers within the job-seeking population is high: approximately 40%, of which about 15% are newly discharged soldiers who have not yet trained for a profession or received a higher education.

The steps proposed in the employment market sector and the unemployment branch of the National Insurance Institute include correcting the situation in which a person who retires to an early pension is able to receive unemployment benefits during the first six months of unemployment, and further steps to strengthen the enforcement of national insurance laws by the Employment Bureaus. As such, the government is also examining steps to cut the number of foreign workers in order to reduce the number of job-seekers and the number receiving unemployment benefits.

An additional change will be de-linking civil service and public-business sector wage agreements, because the latter must operate within their sector's economic variables.

CAPITAL MARKETS TO SUPPORT ECONOMIC GROWTH

The central role of the capital markets is to match the supply and demand of capital in which demand is the private and commercial need for funding. Without this funding, enterprises will have difficulty investing in equipment, supplies and technologies; and private citizens will find it hard to fund the activities requiring large initial expenses, such as purchasing an apartment or financing higher education. Supply is the need of those who save to distribute their various income needs over time, for example to ensure a post-retirement income which will not lower their standard of living.

Israel's capital markets are affected by a number of structural problems, including the absence of long-term institutional investors such as the pension funds and life insurance companies which form the backbone of healthy capital markets around the world, and which, remain outside the capital market in Israel. This situation is a result of offering non tradable, subsidized government bonds which discourage credit consumers from investing in long-term resources meant to finance investment in the private sector and the mortgage market. An additional element hurting the capital markets is the high level of centralization resulting in the banks controlling the provident and mutual funds they manage.

Within the capital markets a discriminatory taxation system exists towards investors and various savings mechanisms. This system, a result of historical developments, skews the investors' options. As such, similar financial instruments are taxed differently, as are individual investors.

Assets which expand over the long-term such as road infrastructures, railways, electricity generating facilities, water and sewage facilities, as well as investments made in constructing industrial or residential buildings require financing during the life of the asset. Without such financing, investors are forced to finance their investments with short-term vehicles, which come due before the projected value of the asset, such as goods and services, has been realized.

The government intends to promote savings vehicles such as those common in many countries, and which have proven highly effective in promoting retirement savings. Of course, there is also justification for policies which encourage savings for retirement because of their positive social and economic benefits since these arrangements reduce burdens imposed on the welfare system for wage earners and independent workers during the same period.

The proposed steps are intended to create long-term rationalization of investments by creating uniformity of conditions for various retirement age savings plans. In addition, the government will propose changing the rules of investment by new pension funds in order to decrease the amount of investment in special (subsidized) bonds, so that more funds will be channeled to the trading capital markets.

PRIVATIZING GOVERNMENT OWNED COMPANIES AND BANKS

In 1998, the quickened privatization process seen in 1997 will continue. Within this framework, privatization will include the sale of government owned companies and its controlling interest in the banks. Revenue forecasts from privatization in 1998 will not be less than the NIS 4 billion which was forecast for 1997. A list of concerns (not including banks) and the conditions for privatization in the 1998 program will be brought for approval from the inter-ministerial committee on privatization. Each government office dealing with the issues will carry out, jointly with the companies, all of the required operations to prepare the government owned companies for privatization.

Privatization is defined as the transference of properties from the public to the private sector. The meaning of privatization is the cutting back of the government's role and level of its direct involvement in the economy and increasing the private sector's role through control and ownership of properties.

Privatization is an important method for strengthening economic growth for the following reasons:

1. Management of business concerns by the private sector with an emphasis on economic worth and efficiency which will increase the economy's efficiency.

2. Privatization will raise the amount of resources available for the country's use. Raising these resources will lessen pressures on the capital markets (financing the deficit) and will bring a reduction on long term interest rates.

3. The sale of government owned concerns on the local capital markets will cause the capital markets to take off, deepening and widening its tradability and liquidity, increasing the number of strong firms trading in it. It will also entice institutional investors. Greater tradability and liquidity will bring greater investor trust in the capital markets both local and foreign and allow private bodies to more easily raise capital for increasing their operations.

During the privatization process, implementation of necessary structural changes must be stuck to and supervisory mechanisms must be created in those subjects requiring them before privatizing monopolies in the industrial sector. In addition, greater economic centralization must be prevented and national interests in security related fields and the country's natural resources must be protected.

FOREIGN EXCHANGE LIBERALIZATION

In 1998, foreign exchange market liberalization will continue. The Finance Minister and the Bank of Israel Governor will act towards eliminating the various restrictions currently imposed on this sector.

Since the middle of the 1980s, various steps have been carried out to ease and improve the foreign exchange market with the aim of bringing about the liberalization of the market, to open Israel's foreign exchange markets to competition and to integrate the Israeli market with the world's money markets. Within this framework, a number of changes to remove the supervision on the foreign exchange market have been taken from time to time.