The International Monetary Fund on Thursday called on the Israeli government to quickly pass a budget for 2021 to help position the economy for growth.
A “prompt passage” of the budget would “help prioritize spending, position the economy for growth, and reduce economic uncertainty associated with the pandemic,” IMF officials wrote in an initial summary of the 2020 report on the Israeli economy presented to the Bank of Israel on Thursday. A final report is expected in December.
Political tensions between Prime Minister Benjamin Netanyahu and his coalition partners, headed by Benny Gantz, have prevented the passage of the 2020 and 2021 budgets.
In the report, the IMF said that policy measures implemented by Israel to contain the economic fallout from the pandemic have managed to calm markets and “limit the damage” to the economy.
Even so, the outlook remains challenging, “risks are unprecedented” and gross domestic product is projected to contract, with unemployment likely to remain in the double digits.
As the pandemic struck and social distancing requirements caused the economy to shut down, “an appropriately large fiscal package has aided the economy,” the authors said.
This, together with monetary policies and the resilience stemming from Israel’s tech sector, has caused real output to contract “less than in other advanced economies so far in 2020,” the report said. Israel’s economy is expected to contract this year by 5%, S&P estimated earlier this month.
Even so, unemployment, including those who were placed on unpaid leave, is likely to remain in the double digits, and the greater number of jobless among lower-income workers is likely to even further worsen the nation’s already high income inequality, the report said.
Recovery is projected to start in 2021, the report said, but social distancing will likely continue to constrain domestic demand and impede GDP growth.
More than 320,000 people have caught the coronavirus, which has claimed 2,700 deaths. Lockdowns introduced in March and September contained the spread of the virus but, together with social distancing, suppressed economic activity throughout 2020, the report said.
Israel should continue its fiscal support policies in the 2021 budget, the report recommended, especially if the pandemic persists and partial lockdown measures are extended longer than envisaged.
Authorities should consider additional funding for health services, extending unemployment benefits beyond mid-2021 and providing further grants for the self-employed, should the pandemic persist.
Any eventual withdrawal of fiscal support “should be timed carefully, given the challenging outlook,” the report said.
Fiscal policy should continue to prioritize health spending and gradually become more targeted. Funding should be channeled to ensure adequate hospital capacity, testing and tracing and to address other urgent needs.
Beyond health, the government should focus on setting out labor market policies to improve job prospects for the unemployed.
As the economy recovers and stimulus measures expire, the deficit is expected to decline, but the government will still need to address the higher debt levels accumulated during the crisis, to ensure it is “more firmly on a downward path.”
“Tax reforms should be at the core of this effort,” the report said.
As the pandemic struck
As the pandemic struck, Israeli authorities “mounted a large and rapid response to mitigate the impact of the pandemic.”
The Bank of Israel launched “sizeable measures” to provide liquidity, prevent a credit crunch and ease access to financial services and credit, including for small businesses and households.
Besides lower interest rates, the measures included programs to buy government and corporate bonds and funding to banks to extend loans to small and medium enterprises. Intervention in the foreign exchange market reduced pressures on the shekel, while the easing of requirements on banks allowed the lenders to support the economy.
Several fiscal stimulus packages reaching 15.25 percent of GDP (of which 10.25% of GDP was planned for 2020) were also approved, including support for healthcare, benefits for unemployed and furloughed workers, grants for the self-employed and households, guaranteed loans for companies, and infrastructure support.
Extending policies ‘remains appropriate’
The IMF said that the “decisive” monetary policy measures taken by the Bank of Israel have helped provide market liquidity and sustain the flow of credit to households and businesses.
The measures eased early pressures on exchange rates, bond yields, and corporate spreads.
Extending the current set of policies “remains appropriate” at this time, the report said, given low near-term inflation expectations, growth projected to be below potential, and uncertainties regarding the duration of renewed lockdowns.
Hard-hit firms and households should also continue to get financial aid, but criteria may need to be gradually adjusted and tightened to target viable firms, the report said.
The importance of reforms
The government must also set out structural policies that should aim to “limit long-term scarring, strengthen the resilience of the economy, and promote inclusiveness.” The focus should be on labor policies and investment in human capital and infrastructure.
These structural policies should include setting out programs to facilitate reemployment, efficiently reallocate workers from sectors and businesses that downsize, and mitigate the negative impact of the pandemic on low-income workers. Together with vocational training, these reforms “should promote reskilling and upskilling, encourage job search and reduce hiring costs.”
Expanding digitalization, reforming education and boosting investment are other structural steps that the government needs to take.
Policies that broaden digital penetration have “very high potential to increase knowledge diffusion and productivity, mitigate skill shortages, and improve the reach and effectiveness of government services,” the report said.
And because the lockdowns have created educational setbacks that could have lasting productivity and inequality implications, students must be trained in math, sciences and tech subjects to arm them with “marketable skills” for an increasingly digitized world.
Public investment, particularly in health care, transportation and digitalization infrastructure can create jobs, “mitigate the drop in demand, and encourage private investment, which has declined amidst low business confidence.” Public investment projects can also strengthen crisis resilience, the report said.
Though Israel entered pandemic strong, risks are ‘unprecedented’
Before the pandemic struck, real annual GDP growth in Israel was around 3.25% percent and the current account averaged 3.5% of GDP in the last 5 years. Unemployment had reached 3.6% at the end of 2019 — the lowest rate in the last two decades.
Looking ahead, the “risks are unprecedented,” the report said. “In the near term, the evolution of the pandemic is expected to have a major impact on the economic outlook. Early widespread distribution of an effective vaccine would lead to a faster-than-projected recovery. However, an escalation of the pandemic could require a prolonged use of containment measures and social distancing, bringing further disruptions to economic activity.”
Geopolitical risks, while still significant, have become more balanced, especially after the recent bilateral accords between Israel and Gulf nations, the report said.