The Incautious Optimism of The Israeli Finance Minister
Author: calcalist Posted December 22, 2012
So what if no preliminary deliberations have been held with all the relevant elements in the Treasury? So what if the Israeli Finance Minister’s forecast is incompatible with the forecasts of the Bank of Israel and the OECD? So what if all economic growth indicators presage the very opposite? And what if the cost of error is too high? It does not really matter, as long as Israel’s Finance Minister is optimistic all the way through to the upcoming parliamentary election
“Tell me, does [Israeli Finance Minister Yuval] Steinitz know anything about economics?” one of the Treasury senior officials was asked three and a half years ago, a couple of weeks after the newly elected Finance Minister assumed office in April 2009. “The truth is, not too much,” the senior official said in response, “however, he is learning fast.” Well, it now transpires that, while quick to learn new things, our Finance Minister is also quick to forget what he has learned. The outlandish declaration made by Steinitz on December 16, at the annual conference of the Insurance and Pension Industry Organization Adif, according to which the growth forecast for next year is 3.5% and for 2014, 3.9%, was one of the most peculiar he made in the last few years.
The first thing Steinitz has already forgotten is that no finance minister ever publicized the official Treasury growth forecast before the issue was debated at length and in detail with the Prime Minister’s Bureau officials and the heads of the Treasury Budget Department, Accountant General's Department, State Revenue Division and Israel Tax Authority.
So far, no such deliberations have been held and this, for the simple reason that the Finance Ministry is expected to officially release its growth forecast for the next year just ahead of the discussions on the state budget for 2013. And all this will happen only after the next government is established — apparently in three to four months.
As a rule, the Finance Ministry announces its official growth forecast only following lengthy and thorough deliberations and it does not rush to update its forecast as often as the Bank of Israel, for instance, does — and for good reason, as it is not just a number that is under discussion here. In fact, the growth forecast of the Finance Ministry for the following year determines the state’s tax revenue forecast, from which the government budget deficit is derived. And it is the projected budget deficit that determines in turn the economic measures that the government plans to impose on us all.
An unrealistic, groundless forecast
And that's the crux of the matter, and we should say it loud and clear: The growth forecasts tossed around by Steinitz the other night at the Adif conference in Ramat Gan are unrealistic and groundless.
Does the Finance Minister actually know whether, and to what extent, the market will grow in 2014? Hasn’t he learned the painful lesson of the last biannual state budget that he erroneously projected in the summer of 2010 — when it looked as if the recent crisis was over — which was based on a forecast market growth of 4% in 2012, anticipated tax revenues of 232.3 billion shekels [just under $62 billion] and a budget deficit of 2% (18.3 billion shekels [$4.88 billion]) of the gross domestic product (GDP)?
In January of this year, the Finance Minister was forced to update his estimates and report to the Knesset Finance Committee that reality was incompatible with his Ministry’s forecasts. According to the Treasury updated economic forecast, Steinitz explained at the time to the committee members, the market was expected to grow in the new year that had just begun by only 3.2%.
Consequently, the state’s anticipated tax revenues, on the basis of which the state budget for 2012 had been prepared, were expected to be lower than originally estimated by more than 11 billion shekels [just over $2.93 billion] and amount to only 221 billion shekels [about $58.95 billion]. At the same time, the budget deficit was expected to be much larger than previously anticipated and reach 3.4% of the GDP (over 30 billion shekels [more than $8 billion]).
However, that was not the end of the story, and even the updated forecast presented in place of the original erroneous one, turned out to be wrong. A couple of months ago, the Finance Ministry announced that the updated forecast was no longer valid and that actual tax collection this year was expected to drop by another 3 billion shekels [just over $800 million]. The state budget deficit was expected to grow accordingly and to amount this year to approximately 4% of the GDP.
The statements made by Steinitz the other night at the Adif conference are not only pretentious and unfounded; they are also outright embarrassing. All the more so considering the fact that he failed to draw the called-for conclusion from the recent, and in itself rather embarrassing experience, of someone who knows a thing or two about forecasts, certainly more than the Finance Minister: Two months ago, Bank of Israel Governor Prof. Stanley Fischer said in an interview to the Bloomberg news agency that the economic growth in Israel next year would be higher than the 3% forecast by the Bank of Israel research division a month earlier. Three weeks later, on another occasion, this time, when interviewed by CNN journalist Richard Quest, Fischer retracted his forecast, this “due to the renewed crisis in Europe.”
Swept away to remote and unknown realms
So, Bank of Israel Governor Fischer believes that the Israeli market will grow next year by a mere 3%, while Finance Minister Steinitz is somewhat more optimistic and forecasts a 3.5% growth. The unexpected growth increment is attributed by the Finance Minister to “the effect the gas discoveries are expected to have on the economy, as evaluated on the basis of updated calculations made by the research division of the [Finance] Ministry.”
It seems that in this case too Steinitz is swept away to remote and unknown realms.
According to the Finance Ministry officials, natural gas production is expected to begin in May next year and contribute to the economic growth in 2013 some 0.8% of the GDP — about 8 billion shekels [roughly $2.13 billion]. However, according to reliable data released by sources in the [natural] gas industry, the annual revenues from the Tamar natural gas field, located in the Mediterranean Sea, off the coast of Israel, are estimated at about $700 million — less than 3 billion shekels. And since no commercial gas production is expected in the first half of the next fiscal year, the natural gas revenues will contribute to the economic growth in 2013 only around 1.5 billion shekels, which are a mere 0.15% of the GDP.
Another element that has to be taken into consideration is the statistical phenomenon known in professional jargon as the “edge effect.” In the case under discussion, the term refers to a situation where economic growth is on the decline in a certain year, so that the starting point of the following year is necessarily low. Subsequently, in the year that follows, too, economic growth is expected to be lower than anticipated. This is precisely what is happening in Israel’s economy this year. Last month the Central Bureau of Statistics (CBS) reported that in the second quarter of the present year, market growth stood at an annual rate of 3.4%, while in the third quarter of the year, economic growth amounted to only 2.9% — the lowest growth rate recorded in the Israeli market in the past 13 quarters. If the trend of declining growth rates continues in the last quarter of the year, the starting point for economic growth in 2013 will be rather low, which would make it difficult for the market to reach a growth rate higher than that of the present year.
The name of the game is trustworthiness and reliability
It isn’t just the tossing around of unreliable figures — beyond that, the matter under discussion has great actual significance. When it comes to the state budget and the budget deficit, the name of the game is reliability and meeting set goals, as spelled out by the forecasts.
The government and the Finance Minister are not acting in a vacuum. The government’s actions and declarations are closely and routinely watched by all the players in the market and in the local capital market, as well as by major and highly influential international bodies like the International Monetary Fund (IMF) and the leading credit rating agencies.
When the government commits itself to reduce its budget deficit over a number of years and then abruptly changes course and doubles the budget deficit goal for 2013, the way it happened just half a year ago, once its tax revenue forecasts turned out to be far too optimistic, its conduct by no means testifies to its trustworthiness or reliability.
This scenario may now unfold all over again. When the Finance Ministry prepares the budget for the next year based on an unrealistic growth forecast, the outcome is inevitable. Towards the end of next year it will once more transpire that the Treasury coffers are short of several billions of shekels and that the actual budget deficit is larger than that originally anticipated by the Treasury in light of its growth forecast. The government and the Knesset will then be called on to ratify further tax hikes and once again, the reliability of the government’s economic policy will be put in doubt.
Be that as it may, the declaration made by Steinitz certainly augurs no good for the budget deficit or for the citizens of Israel, and Steinitz himself warned as much in his address to the Adif conference.
At the same time, Steinitz noted that the ”additional revenues expected from the natural gas taxation are unlikely to affect the forecast state revenues, since the revenues from the natural gas taxation have already been taken into account.” Steinitz went on to say that the impact of the gas discoveries on the employment rate would be limited.
According to the Treasury calculations, natural gas production from the Tamar gas field is expected to increase the state revenues from taxation by about 1 billion shekels [nearly $267 million] — a figure that is compatible for a change with the estimates of professionals in the natural gas industry. In other words, even if the new forecast proposed by the Finance Minister comes true, the state revenues will subsequently grow by only about 1 billion shekels.
Thus, it isn’t only the modest figure of a mere 1 billion shekels that is under discussion here. Indeed, it’s the same 1 billion shekels already brought into account in the Treasury calculations — a figure that cannot therefore have any impact on the current budget deficit.
The ultimate question and the called-for answer
All this leads us directly to the ultimate question: If all that we are talking about here is some kind of virtual growth, focused on a single and especially narrow sphere of activity, which at best may add to the state revenues no more than another 1 billion shekels (less than 0.5% of the overall revenues from taxation), why did the Finance Minister rush to raise the issue at this early stage — quite a number of months before the scheduled date — without consulting first with the senior professionals in his ministry?
The called-for answer is apparently that a Finance Minister who seeks to retain his office in the next government as well would do anything to attain his goal as he sees his dream drifting away, vanishing into thin air — even hold on to a reed that happens to be floating on the water.
Read More: http://www.al-monitor.com/pulse/business/2012/12/the-incautious-optimism-of-the-i.html