The West and Others: Huge Deficit in 2010 could destroy Israel

When the new government forms after yesterday's elections, it will receive an economy in crisis. Moreover, treasury officials are terrified, not of the giant deficit this year, but of giant deficits in the following years, which would be the road to ruin.

The figures are frightening. Tax collection in 2009 will fall as much as NIS 40 billion ($10 bn) short of earlier estimates. The budget is already short about NIS 10 billion ($2.5 bn) to meet costs because of Operation Cast Lead and other past and future demands from the defense establishment.

Almost a third of that NIS 10 billion ($2.5 bn) comes from the military campaign in the Gaza Strip, and never mind that it's over. It cost NIS 3 billion ($0.75 bn), which has to come from somewhere.

Then there is an amount to be allocated to the leverage funds, which are supposed to be joint government-private vehicles (still in the envisioning stage) to rescue businesses in trouble. These funds are supposed to lend troubled companies about NIS 5 billion ($1.25 bn) (although some observers now think the state can get away with lending less).

A third element is around NIS 1.5 billion ($375 million) to cover the demands of coalition partners in the new government, say people in the Finance Ministry.

The upshot is that with tax collection falling far short of the estimates on which the 2009 budget was based, and with costs surging far above expectations, the 2009 budget is apparently about NIS 50 billion ($12.5 bn) short. And that, dear reader, is equivalent to 7% of Israel's gross domestic product.

The 2009 deficit, which should have been 1% of GDP, will likely be 5%, no more, because Israel simply cannot allow itself a larger deficit.

The Finance Ministry plans to slash budgets by about NIS 8 billion ($2.0 bn) from defense spending, education, welfare and healthcare.

How much these essentials can be spared depends on the next government's support for reducing defense spending.

The government plans to finance the deficit by raising money through further local bond issues, and overseas too, by utilizing U.S. guarantees to raise money at relatively low cost. It would step up the activities of the Israel Bonds organization.

The treasury would prefer to raise money by taking advantage of the rest of the $9 billion in guarantees granted to Israel by the United States in 2003, during the second intifada.

That gave Israel the right to issue $9 billion worth of bonds on the U.S. market, repayment of which is guaranteed by Washington. American backing for the bonds means that the interest Israelis have to pay on the bonds is as low as possible - just a hair above the rates on comparable bond issues backed by the Federal Reserve. Israel has used only $4.4 billion of the guarantees. The last time the state issued bonds in the United States backed by the guarantees was in 2004.

However, the United States plans to deduct $1 billion out of the remaining $4.6 billion, to punish Israel for its investments in territories beyond the Green Line.

If Jerusalem can't reverse that decree, it will still have $3.6 billion in guarantees. In any case, the Finance Ministry wouldn't blow the whole amount inside a year: It would probably spread the amount to 2010 and perhaps 2011 as well.

Everybody at Finance agrees that Israel's problem isn't just a giant deficit this year. It's the state of the economy in the following years.

The Finance Ministry does not dismiss the importance of the deficit in 2009, but it's a lot more worried about the deficit of 2010.

We can deal with a one-time high deficit, say officials, but a high, multiyear deficit could destroy Israel.

The aim of the 2009 budget, which will be approved in May at the earliest, and that of 2010, which (hopefully) should be submitted for cabinet approval in August or September, is to attain manageable deficits and decrease them over time.

The Finance Ministry says that if the world begins to emerge from its crisis in 2009 or 2010, Israel could achieve modest economic growth.

But ministry chieftains say the way to keep spending under control is to trim the defense budget. It's not a new idea, yet it's a revolutionary vein of thought. What we have is top Finance Ministry people admitting up front that Israel can't increase its defense budget by NIS 100 billion in 10 years. The new government, they believe, is going to face hard choices on this issue.