Dr David Klein is Statement at the Government Meeting on Sep. 1
Comments Made by the Governor of the
Bank of Israel
In choosing a macroeconomic scenario on which to base the planning of the national budget for 2004, it is necessary to bear the following points in mind:
1. There is more uncertainty than usual because of the importance for economic development of two factors that are not controlled by the government's economic policy: the pace of global recovery and the intensity of the conflict with the Palestinians.
2. The extent of the government debt has been growing in the last three years as a result of the government's inability to adjust its level of expenditure, which is one of the highest in the world relative to the size of the economy, to its declining revenues. At the end of 2000 the ratio of the government debt to GDP was 90 percent, and it is liable to reach 110 percent by the end of 2004-also one of the highest in the world.
The combination of these two factors makes it necessary to adopt a conservative base for the 2004 budget, both because it is likely to materialize and because even if the more optimistic scenario transpires this will serve merely to shorten the transition period-estimated at several years-in order to converge to the deficit and government debt levels that are in line with those accepted in the world for a small open economy such as ours.
The practical implication of this is that the 2004 budget has to be based on the assumption that the GDP growth rate will be one percent-a slight improvement over the growth rates of the preceding three years. Although this growth rate is far from satisfactory it reflects an economic strategy that favors structural economic change, i.e., the reduction of the public sector and stimulation of the private sector. In the short term, it is true, the contraction of government spending will restrict economic growth, but at the same time it will divert sources to investment, enabling the process of interest-rate cuts to continue. As a result, if this policy persists, the business sector will grow faster than the economy in general. It is on that aspect of growth-business-sector growth-that we must focus rather than that of the economy in general.
Furthermore, it is widely assumed that the overall GDP growth rate is relevant for estimating tax revenues since it depends on the development of the various tax bases, such as private consumption, imports, wages, and-from this year on-financial revenues, too. Therefore, in this respect also, GDP growth is only of secondary importance.
The ongoing pressure to reduce government expenditure emphasizes the need to establish this on changes in the way the government works and the division of labor between it and the private sector in providing services to the public. This approach has already found expression in the recent economic package for 2003, and the government debate on the 2004 budget must focus on its components.
Note, however, that it is not only the budgetary aggregates which fall within the framework of economic strategy. The return to a growth path requires the formulation and implementation of policy in another four spheres:
Each of these subjects merits a separate discussion by the government, such as it intends to hold with regard to the budgetary aggregates and the 2004 budgets of the various ministries. Each topic has objectives in the medium run, and the results of the discussions have direct implications for the extent of the public's confidence in the government when it announces-as it has done in the past but failed to keep its word-that the deficit and the debt ratios will continue to decline in the years following the forthcoming budget. The government's credibility is particularly important if it decides to deviate once again from its commitment to reduce the deficit next year to less than 3 percent of GDP. This credibility is expressed on an ongoing basis in the price the government has to pay for its debt, both by the public in Israel and by foreign investors, as well as in the extent to which there is readiness to invest in the country-which constitutes a necessary condition for the return to a growth path.