Bank of Israel’s Yaron says fiscal restraint needed to curb debt

Bank of Israel Governor Amir Yaron said Tuesday that the nation must strive to boost growth through investment and reforms while also reining in its structural deficit.

“Some sort of fiscal restraint will be dictated by reality,” he said. Economic growth will be slower because of the restraint, but such a policy “will not lead us to worlds of unreasonable debt” and will stabilize the debt-to-GDP ratio, he said.

“It is advisable not to raise taxes in 2021 and 2022, but it is important not to increase the structural deficit” that had accumulated in recent years. The government’s structural deficit for 2021 and 2022 should not be allowed to increase, he said.

Yaron spoke at the annual Eli Hurvitz economic conference in Jerusalem held by the Israel Democracy Institute.

The S&P ratings agency, Yaron said, warned in a recent report that “pressure on the ratings could build if, beyond immediate pandemic-related effects, Israel lacked a medium-term fiscal consolidation plan,” and if government debt keeps rising as opposed to stabilizing at under 80% of GDP. Israel’s debt-to-GDP ratio climbed to over 72% in 2020, from 60% in 2019, and is expected to climb further to some 77% in 2022 and 2023, according to an S&P forecast.

The 80% figure is not set in stone and higher debt levels may be excused, but Israel faces more than a few challenges that could further increase debt levels, Yaron said. Thus, fiscal responsibility must be maintained.

Israel is emerging from the coronavirus pandemic in a better condition than other developed economies, with its GDP contracting only by 2.5% in 2020, because of the “iron dome” provided by the nation’s tech industry. “But we must remember,” he warned, “you can drown even in a shallow pool.”

Israel’s economy will recover by the end of 2022, he said, but unemployment rates will not return to pre-crisis levels. Once the furlough payments, put in place to cope with the pandemic, are halted, the number of people rejoining the workforce will rise and the employment market will improve. “Even so,” he said, “the question is how much structural unemployment will remain.”

The main casualties of this chronic unemployment will be young people, Arabs, and people with only a high school education and medium-level skills, he said. “The solution is to improve human capital.”

Karnit Flug, a former governor of the Bank of Israel and currently a VP of research at the Israel Democracy Institute, disagreed with at least part of what her successor said (Finance Minister Avigdor Liberman said the same thing), saying she believes “there will be no escape from taxation.”

There is consensus today regarding the need to boost economic growth in Israel by investment in infrastructure, improving human capital, cutting back on regulation, she said. But how to finance this remains a question, she said. The ability to cut back on public spending is limited, she said, as it is already close to its bottom level, and there is a question about how much, if at all, will be cut from the defense budget.

Thus, she said, “there will be no escape from taxation,” though the same effect could be achieved by doing away with tax exemptions that have no “economic or social justification,” even in the face of heavy pressure to maintain them.

Economist Michael Sarel, the head of the Kohelet Economic Forum, said that even if the government decides that steps to rein in debt should not be implemented before 2023, it is wiser to announce what these will be now, at the start of the government’s term, rather than later, when the government will be subject to greater political pressures as new elections loom.