US embassy cable - 04TELAVIV6626

C O N F I D E N T I A L SECTION 01 OF 02 TEL AVIV 006626 
 
SIPDIS 
 
NEA/IPA FOR BURNS/SATTERFIELD/DIBBLE 
TREASURY FOR DOWNARD 
 
E.O. 12958: DECL: 12/19/2014 
TAGS: EFIN, ECON, PREL, IS, ECONOMY AND FINANCE, GOI INTERNAL, LABOR AND COMMERCE 
SUBJECT: ISRAELI OFFICIALS ON BUDGET, BACHAR COMMITTEE 
REFORMS, AND PRIVATIZATION 
 
Classified By: ECONOMIC COUNSELOR WILLIAM WEINSTEIN FOR REASONS 1.4 (B, 
D) 
 
1. (C) Summary.  Treasury Desk Officer for Israel Catherine 
Downard discussed the budget, privatization, and other 
subjects with Israeli officials on December 13.  Her visit to 
the Karni Industrial Zone will be reported septel.  The 
highlights of her discussions: 
-- The GOI is committed to maintaining the 2005 budgetary 
framework.  Regardless of coalition negotiations, the 2005 
budget deficit will not exceed 3.4% of GDP, including 
disengagement; 
-- The recent MoF-Histadrut labor agreement will not result 
in additional 2005 expenditures; 
-- The members of the Bachar Committee achieved consensus 
that capital market reform required more than regulation but 
rather a full separation between commercial and investment 
banking; 
-- As dramatic as the Bachar Committee reforms were, they 
were only the first part of broader financial sector reform, 
which still requires the creation of effective competition 
within commercial banking; 
-- Privatization is moving forward, but the low-hanging fruit 
(El Al, Zim) has been picked. 
-- Privatizing defense companies such as Israel Military 
Industries (IMI) is the major challenge being faced by the 
GOI. End Summary 
 
---------------------------- 
MOF BUDGET OFFICIAL: COST OF 
COALITION WON'T BREAK BUDGET 
----------------------------- 
 
2. (C) Deputy Budget Director Gordon said that he expected 
the GOI to maintain the budget framework in 2005, with the 
exception of disengagement funding.  In large part as a 
result of fiscal restraint in 2004, the major risks to fiscal 
limits -- funding of local municipalities, wage costs, and 
the new coalition's fiscal demands -- were under control. 
Gordon went through a detailed analysis of the recent 
MoF-Histadrut labor agreement, the bottom line of which was 
that it would not influence 2005 expenditures.  The 2005 
budget's 1.2 billion reserve fund would cover the new 
parties' fiscal demands, as well as pay for the cost of 
increased local municipalities funding, the other major 
unplanned expense for 2005: 
UTJ:  NIS 290 million 
Local Municipalities: NIS 700 million 
Labor: NIS 210 million. 
Should Labor demand more than what the reserves could 
cover, Gordon said the parties knew that would result in 
across-the-board cuts in other budget areas. 
 
3. (C) On disengagement, Gordon noted that, although 
disengagement funding had not yet been finalized, it would 
not cost more than 0.4% of GDP.  He noted this had already 
been communicated to the USG.  As a result, the 2005 budget 
deficit would come to no more than 3.4% including 
disengagement and the real increase in expenditures compared 
to 2004 would be no more than 1% excluding disengagement. 
 
----------------------------- 
Central Bank Deputy Governor: 
Amazing Consensus on Bachar Recommendations 
----------------------------- 
 
4. (C) Deputy Bank of Israel (BOI) Governor Sokoler spoke 
about his recent work as a member of the Bachar Committee on 
capital market reform.  He stressed that the various members 
of the committee had quickly found themselves in consensus on 
the substance and importance of the reforms.  They believe 
that the current structure of Israel's capital markets is not 
suitable for such a vibrant economy. He stressed their view 
that the GOI,s ability to address problems of conflicts of 
interest through increased regulation is limited. 
 
5. (C) Sokoler said the banks were fighting hard against the 
reforms, saying that the solution was to bring in more 
financial institutions, as opposed to divesting the existing 
banks of their investment operations.  Sokoler said such 
argumentation made no sense in Israel: the two major banks, 
which controlled upwards of 60% of the market, had shown 
their ability to crush new market entrants.  Moreover, "we 
want our banks to be a place where one can receive neutral 
recommendations on investments." 
 
5. (C) Sokoler stressed that the Bachar Committee had only 
begun the task of financial reform.  Once the mutual funds 
were hived off, who would purchase them?  Sokoler hoped 
"foreigners" would show an interest.  Who would supervise 
the new institutions?  The GOI must also find a way to 
increase competition within the commercial banking community 
by making it easier for customers to change institutions. 
Sokoler noted that these and other issues, such as 
formalization of a deposit insurance scheme and development 
of money market funds, will be addressed in a second phase of 
recommendations to be formulated in the coming months. 
 
--------------------------- 
Privatization Moves Forward 
--------------------------- 
 
6. (C) Eyal Gabbai, Director of the Israeli Companies 
Authority, said that the easy privatizations had been 
completed and the GOI was now concentrating on the hard 
cases. 
 
A. El Al: Gabbai expected Knafaim to exercise its options 
over El Al the week of December 20 and take formal control of 
the company.  Knafaim would probably make some initial 
changes, including selling and leasing back fleet planes, 
and engaging in more intense marketing.  It was unlikely to 
fly on the Sabbath. 
B. Zim:  The GOI had sold in 2004 its shares to the Israel 
Corporation, which now owns 97.5% of the company.  Zim, which 
used to be one of the five largest shipping companies in the 
world, is now likely to begin growing again. 
 
C. Bezeq:  Gabbai admitted that the GOI had priced Bezeq 
shares too high in June, resulting in a disappointing lack of 
interest by investors.  Nonetheless, the GOI stands by its 
commitment to sell all but 1.01% of the company, both 
through the stock market, and through a "strategic block" 
sale of 30-40% of the company to a private investor.  As of 
the end of October, eight companies had approached the GOI 
regarding the sale.  Gabbai expected this group to 
consolidate down to no more than 2 or 3 purchasing groups. 
The final sale would take place in the second quarter of 
2005.  Naturally, there were a number of conditions on the 
sale, including that the bidding party must have at least 20% 
of its capital in Israel. 
 
D. Defense Companies: Gabbai said he had found the 
privatization of Israel's defense companies to be the most 
challenging part of his job, in large part because the 
Defense Ministry and industry employees were utterly 
opposed to it.  That was why he was so pleased by plans to 
privatize Ashot-Ashkelon Industries (AAI), which is part of 
Israel Military Industries (IMI).  He characterized AAI has 
having 21st century technology held back by 1950s management. 
 Gabbai said the GOI plans to privatize AAI by the first 
quarter of 2005 and hopes improved management after 
privatization would show the wisdom of moving such firms into 
private hands.  He admitted that finding 
investors would not be easy: "the employees are threatening 
to set fire to the factory if privatization goes forward." 
Selling the rest of IMI would be even more difficult: it Is 
deeply indebted and faces large future pension liabilities. 
The GOI had yet to agree on how to move forward. 
 
E.  Oil Refineries: The GOI had resolved in August, 2004 to 
split the oil refineries into two companies to increase 
industry competition.  Gabbai said the GOI planned to sell 
the smaller company, Ashdod, first.  It would then sell 
Haifa through the Tel Aviv Stock Exchange (TASE). 
 
F.  Banks: Gabbai noted that the process of privatizing 
Discount Bank is very close to completion. Final proposals 
from the two remaining interested parties are expected by 
end-December. The release of the Bachar committee report on 
capital market reform may result in some discounting in the 
pricing of the sale of Discount Bank. Details of the Bank 
Leumi privatization are still being formulated. Gabbai said 
that the GOI is now considering distribute shares to the 
public rather than stock options, as initially proposed. 
Proper legislation to allow such a transaction has yet to be 
passed. 
 
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