"The markets and the public are looking at us. As long as we show that we are able to deal with the increase in the defense budget, then the markets will support us," Bank of Israel Governor, Prof. Amir Yaron to Globes Editor-in-chief Naama Sikuler, at the Globes Israel Business Conference. When asked about the interest rate decision on January 4, Yaron said that because the war is complex and still in progress, and its consequences still likely to result in volatility, it is necessary to behave responsibly.
The current interest rate is 4.75% and in the last two decisions, both taken since the war broke out, the Bank of Israel Monetary Committee kept the rate unchanged.
"Inflation is falling towards the target range"
So what will be the upcoming interest rate decision?
Yaron said, "It's excellent that you have organized this conference. It'sa clear that we are in the midst of a very difficult time. The very fact of this event taking place, the continuity of the economy, is first of all very important. That is the opening point of what I have to say. Our hearts are with the families and those who have fallen and we wish the injured a swift recovery and that the hostage will quickly be back with us.
"Regarding the interest rate, we see a good Consumer Price Index (the November CPI fell more than expected), But we don't look at this or that CPI but in this CPI there were elements like rents that fell, which are usually sticky. The good news is that we are on a path of inflation falling to the target range. With this process, we can reach a situation for monetary expansion - cutting the interest rate. When will this begin? Here is not the place to talk about that.
"I do want to say two things. The first is that around inflation expectations there is much greater variability today. For example, we see supply shocks in the agriculture and real estate sectors, and this may lead to inflationary pressures through price increases. But in the fields of leisure and culture there are demand shocks, and that may dampen inflation.
"Which of these will have more of an impact in a month or three months? We also don't know when this terrible event will end. Will it end in January? Or maybe it will last longer? We are in a very big environment of uncertainty. Therefore, naturally, we need to act responsibly both fiscally and monetarily. How does this relate to the state budget? The markets and the public are watching. As long as we show that we are able to deal with the increase in the defense budget, the markets will support us."
Yaron added, "I am meeting with the US Federal Reserve Chair Jerome Powell, and with most of the bank governors in the world. I can say that the Israeli economy entered this terrible event as a strong economy, according to almost all criteria: a debt-to-product ratio of 60%, a low projected deficit, expected growth that is high compared to European countries and the US. The foreign exchange reserves were large enough to deal with the attack on our exchange rate. When you look at security events in the past, you see that the Israeli economy usually knew how to deal with them."
"The security forces will need to streamline"
What do you expect regarding the state budget?
"We will have additional expenses in the defense budget. First of all, we are talking about NIS 200 billion in expenses for 2023-2025. These are direct expenses of the war. But unlike Covid, when there was a 'box' in the budget, and we knew that we would return to the situation as it was after it, here we will remain with an increased defense budget for years.
"The security forces will have to 'sharpen their pencils' because it is impossible to give them everything they ask for, and that means becoming more efficient. But their budget will probably increase. Therefore, we will have to make adjustments in the state budget and offset it. It is appropriate that we offset things from permanent items that are not supportive of growth. We will have to make adjustments of these magnitudes, because the markets are looking at us. They want to see that we have fiscal responsibility at the end of this war and that we can actually return to a debt-to-GDP ratio that will start to decline."
The Bank of Israel's economic forecast is very optimistic, even compared with the other organizations that examine Israel. You are not taking into account a significant flare up in the north?
"We are working on all factors, including the defense ones. I remind you that I finished my military service as a captain in the financial advisor's unit to the Chief of Staff. The Bank of Israel's growth forecast is for 2% growth in 2023 and the same rate in 2024. Our scenario is that the war continues into January and decreases in intensity.
"By and large, the scenario is that the war will be in the southern sector, and there will be no war in the north. This is the scenario, and these are the forecasts based on it. We had a forecast that we came out with a week and a half after the war began in October, and it was a little more optimistic, because the military scenario was a little different. The forecast of The Bank of Israel anchored most of the forecasts around the current numbers. It shaped the discourse around a healthier point."
"We must not let the war turn into a financial crisis"
The Bank of Israel was active in the foreign exchange market. What is expected in this market?
"The lessons we learn from the world of economics are that we must not allow an external event to become an economic event, because it becomes a financial crisis. As was the case with the outbreak of the Covid pandemic, which was a health event that became an economic event. So we are in a defense event that has become an economic event, and we must not let it become a financial crisis. When such events turn into a financial crisis, they have a domino effect."
Tell us why you decided to sell dollars at the start of the war
"We are very aware of the markets, including the financial markets that start operating at the beginning of Monday (Israel time), like Australia. There was currency trading where we already saw the dollar around NIS 4.2/$. We also saw other prices on trading boards. We are clear here that we were not trying to create a ceiling arrangement, but the importance was to give the markets tranquility and stability. The first thing was not necessarily dealing with inflation, but with stability. I think that the step we took (a plan to sell up to $30 billion) gave stability to the bonds and equity markets.
"Then there was a certain stabilization in the defense arena. Expectations for a northern war decreased. Since then, the shekel has strengthened. The importance was to stabilize the markets. There was no reason to act for any different context. The plan we devised almost two days later was a plan for deferring loans, and it was very important. At that point we gave certainty to the people from the Gaza border area. You can think of it as a kind of one-off interest rate reduction."
"The 2024 budget is 'money time'"
Is the discussion around the budget populist?
"The coalition funds in general have increased over the years. Ultimately, in the economy there is a budget, and there are priorities. There are priorities at a point in time and over time. At a point like this, in the end it is a decision of the elected officials. I think more could have been done, I think the 2024 budget is 'money time.' We don't know how much the defense budget will amount to, but we need to take the NIS 20 billion (of the coalition funds), and make it clear that this is really what is needed. Whatever the number is, other sources need to be found for it. This could include an increase in revenues, change in (tax) credit points and also on the spending side.
"This is where the priorities come in. We know that a growing economy is an economy with infrastructure, education for the next generation, certainly in a country like ours, where high-tech leads. We are in the era of AI, the urgency of changes and adaptation of employees to the future market will have to be greater, therefore the need for core studies (math and English) is more important, and bringing more sectors into the labor market."
During war you need short-term actions. We saw thoughts in the Ministry of Finance on taxing advanced study savings funds. What would you advise the Minister of Finance?
"I won't go into specific details. I have sent my charts on how they should act. With a spending ceiling of $515 billion in the 2024 budget, there comes a situation like when you try to organize a wedding, and they ask you for NIS 400,000, and then they want another NIS 30,000 for flower arrangements. You very quickly lose the anchor. That's why we say about war expenses: put them in a box. This money must not go to other sources.
"From the starting point of and the Deficit Law, which speaks of a 2.25% deficit, these are worlds that promise to converge with a debt-to-product ratio after the war. Against an increase in permanent defense spending, we will have to find offsets, both on the spending side and on the revenue side. When they want to hear from us what we think, ithat is already a conversation for the next stage."
Is there anybody on the other side prepared to listen?
"The word 'unity' is something that is very important these days. If the word becomes code for 'not succeeding in doing anything' then that is not the right word."
How do you see the events being experienced in the US, the antisemitism, as somebody who was at the University of Pennsylvania?
"From my personal experience, I didn't feel any antisemitism during the period I was there. The University of Pennsylvania was known as a comfortable place for the Jewish community. I think that any university that respects itself has to ensure that a situation does not occur that a Jew does not feel comfortable walking around its campus. If they have to change their code accordingly then they should change the code."
Published by Globes, Israel business news - en.globes.co.il - on December 19, 2023.
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