US embassy cable - 04TELAVIV2167

UNCLAS SECTION 01 OF 03 TEL AVIV 002167 
 
SIPDIS 
 
SENSITIVE 
 
E.O. 12958: N/A 
TAGS: ECON, EFIN, IS, ECONOMY AND FINANCE, LABOR AND COMMERCE, GOI INTERNAL 
SUBJECT:  While Israel's Economy Grows, Unemployment Remains 
Stubbornly High 
 
REF: Tel Aviv 2067 
 
This cable is classified Sensitive but Unclassified.  Please 
handle accordingly. 
 
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Summary 
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1. (SBU) Finance Minister Netanyahu's declaration in late 
2003 that the recession has ended appears to look more 
realistic today than it did at the time.  There is 
increasing optimism in Israeli economic circles regarding a 
return to growth in 2004.  All indications currently point 
to growth of more than 3 percent in 2004, a significant 
improvement over the 2.5% figure that was used in the 
preparation of the 2004 budget last fall.  Increased 
exports, particularly in the high-tech sector, private 
consumption, and tax revenues are all headed in the right 
direction.  Unfortunately, it does not appear that all this 
good news will affect Israel's high unemployment rate any 
time soon. End Summary. 
 
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Exports: Engine of Growth 
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2. (SBU) The newfound Israeli economic optimism is based, in 
large part, on continued improvement in Israel's strong 
export sector, which grew 12 percent in the first two months 
of this year.  This sector is fueled by the recovery in 
world demand, which is expected to strengthen further over 
the coming year.  Bank Leumi underscored hopes for the year 
to come in its April macroeconomic survey by noting 
January/February 2004 exports were only 6% less than at the 
their highpoint in late 2000.  Leumi believes this 
impressive performance is destined to continue during the 
year and forecasts export growth of 8 - 9% in 2004, compared 
with 2.6% in 2003. 
 
3.  (SBU) High tech is also supplying a turbo boost to the 
economic engine.  The Central Bureau of Statistics (CBS) 
reports that electronic component and computer exports 
increased 48.8% from December 2003 to February 2004.  In the 
same three-month period, exports of control communication 
and medical equipment increased by 17.7%. 
 
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Netanyahu: Cutting Taxes to Boost Growth 
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4. (SBU) The recent growth spurt is boosting GOI tax 
revenues.  These grew 12.4% to NIS 38.6 billion in the first 
quarter of 2004 compared to a year earlier.  Finance 
Minister Netanyahu has capitalized on this windfall by 
cutting taxes twice this year alone (reftel).  In the first 
round of cuts in mid-February, he reduced purchase taxes on 
a number of consumer items as well as lowered customs and 
VAT taxes from 18% to 17%, effective March 1.  The cuts 
immediately led to increased discretionary consumer 
spending.  Import figures from February to March show this 
clearly: sales of imported refrigerators grew 193%, imported 
DVD players 109%, and imported televisions 60%.  Even the 
dormant real estate market may be coming out of its long 
sleep: land tax revenues improved by 15.2 percent in the 
first quarter of 2004. 
 
5.  (SBU) Netanyahu introduced his second round of cuts on 
April fifth when he announced the GOI was reducing income 
taxes on low and mid-level wage earners, gradually reducing 
corporate taxes between 2004 and 2007, as well as canceling 
taxes on a number of raw materials in the building sector, 
which could also provide a boost for the building and 
construction sector. 
 
6.  (SBU) Netanyahu has made it clear that he prefers tax 
cuts to increased GOI spending or to reduced GOI debt 
levels.  As of the beginning of April, 2004 tax revenues 
were forecast to exceed the original forecast used in the 
2004 Budget proposal of NIS 150 billion by between NIS 2 
billion to 4 billion.  There is agreement among many 
economists that Netanyahu's tax cuts will have a positive 
effect on spending habits, on business activity, and will 
serve to boost economic activity. 
 
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Tax Reductions Aside: GOI Will 
Likely Meet 2004 4% Deficit Goal 
-------------------------------- 
 
7. (SBU) In spite of Netanyahu's significant tax cuts, the 
most recent economic predictions indicate he will probably 
be able to meet the GOI's 2004 budget deficit target of 4%. 
This also corresponds to the conditions preliminarily 
specified in the 2003 Loan Guarantee Agreement.  It would 
also be an improvement over the 2003 deficit, which totaled 
NIS 27.7 billion, or 5.6% of GDP.  To put the improved 
budgetary framework into perspective, the deficit for the 
first three months of 2004 totaled just NIS 587 million, 
compared with NIS 4.3 billion in the same period a year ago. 
 
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David Klein: Tax Cuts Must Be Balanced by Debt Reduction 
--------------------------------------------- ----------- 
 
8. (SBU) Netanyahu's philosophy has its critics, prominent 
among them Bank of Israel Governor David Klein (reftel). 
Philosophically, Klein believes that Israel's very high debt 
to GDP ratio, which reached 105% in 2003, needs to be cut. 
He argues that reducing public sector debt would be 
beneficial both for Israel's reputation in international 
financial circles, as well as for the domestic economy.   He 
also noted in a March thirtieth press release that reducing 
debt would reduce the GOI's heavy debt-servicing load, 
freeing up funds for pressing social-economic programs. 
 
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Passover Joy in the Tourist Sector 
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9.  (SBU)   Before the Intifada, tourism (counted 
statistically as a service export) served as one of the key 
components of Israeli growth.  Since the violence began, 
however, this sector collapsed almost entirely.  Although 
the jury is still out for tourism this year, there was a 44% 
increase in tourist entries during the first two months of 
2004 compared with a year earlier.  (Note: Some of the 
increase is a result of the significant impact of the Iraq 
war on the corresponding period of 2003.)  The feared 
Palestinian reprisal over the Yassin killing, and its 
predicted impact on tourism, highlights the fragility of 
this sector, however. 
 
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Venture Capitalists also Celebrating 
------------------------------------ 
 
10. (SBU) Israeli venture capitalists have also been 
celebrating recently.  Zeev Holtzman, Chairman of IVC 
Research and the Giza VC Fund, proclaimed in a March 17th 
press release that "2003 marked the beginning of new fund 
raising after a long, difficult dry spell in the industry." 
Holtzman cited IVC forecasts that Israeli VCs will raise 
between USD 1.5 billion and USD 2 billion between 2004 and 
2005.  Another sign of an improvement in the industry is the 
success of Israeli venture capital conferences held in 
Israel, London and New York in the last two months. 
Although Ernst and Young (Israel) chairman Yitzchak Forer 
predicted in an interview with Globes on March 22 that high- 
tech activity will return to the level of 1999 this year, 
his enthusiasm is not widely shared. Israeli fund managers 
with whom we have spoken are generally cautious and say that 
investors are subjecting Israeli firms to much more rigorous 
examination than during the height of the tech boom. 
 
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Unemployment remains high and entrenched 
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11. (SBU) Unfortunately, the positive economic news has not 
yet translated into a reduction in Israel's unemployment 
rate.  Average unemployment in 2003 was 10.7%, and rose to 
10.9% in the fourth quarter of 2003.  The Israel Discount 
Bank reported in its April 5 economic summary that 
unemployment in 2004 would rise to 11%.  Bank Leumi's chief 
economist, Gil Bufman, has repeatedly commented that he does 
not expect unemployment to fall before 2005, when firms may 
begin to think the recovery will last over the longer term. 
Although the GOI is making a concerted effort to reduce the 
number of foreign workers working in Israel, this has also 
not had a significant effect on the unemployment rate. 
 
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Monetary Policy: Negative Inflation 
in 2003 Leads BOI to Continue Rate Reductions 
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12. (SBU) For the first time in its history, Israel saw 
prices fall in 2003, as high interest rates, declining 
wages, and positive exchange rate trends all worked in the 
same, unexpected direction.  The Bank of Israel reacted by 
setting out on an extended policy of interest rate 
reductions, which continued for the thirteenth consecutive 
month in March 2004.  The question now is whether the BOI 
will continue its policy of monthly interest rate cuts. 
The BOI last reduced rates by 0.2 percent on March 29, 
bringing interest rates to 4.1 percent.  This is a reduction 
of 5% since December 2002, a drop that has provided added 
stimulus to economic growth and received praise from the 
Ministry of Finance. 
 
Kurtzer