New Israel election likely to widen a swelling budget deficit

By Steven Scheer and Tova Cohen

TEL AVIV (Reuters) - Israel's budget deficit problem is about to get bigger as the country heads for its second election this year, after Prime Minister Benjamin Netanyahu failed to form a new government.

The deficit swelled to 3.8% of gross domestic product in April, considerably exceeding this year's 2.9% target. Analysts, the central bank and the International Monetary Fund have warned of consequences if the country does not rein in its budget.

Tax increases and spending reductions were expected once a government was formed following April 9 elections. But Netanyahu failed to put together a coalition and parliament voted on Thursday to dissolve itself. A new election will be held in September.

“The summer traditionally is the time for budget negotiations, but this will not happen,” said Henry Rome, a global macro analyst at the Eurasia Group. “The current budget, with its widening deficit, will remain in place through at least the start of 2020.”

Little can be done while Israel's parties are campaigning. And it might be hard to act once a government is formed, since coalition building often requires the prime minister to provide funds for partners' pet projects.

For the first four months of the year, the deficit was 14 billion shekels ($3.9 billion), with its target at 40 billion for all of 2019.

Leader Capital Markets Chief Economist Jonathan Katz believes the government will need to make budget adjustments of 12 billion to 15 billion shekels, mainly by raising tax income.

“I don't see it before January,” he said, projecting a deficit of 4% of GDP this year.

Postponing spending cuts and tax increases could boost GDP in 2019, but growth will suffer in 2020 as a result. Katz was forecasting 3% growth next year but said he will probably cut his estimate to 2.8% to 2.9%. He has trimmed his inflation forecast for 2019 to 1.4% for 2019, from 1.5% to 1.6%.

“Even before, I wasn't expecting a rate hike this year but this strengthens that conviction ... unless for some reason the shekel begins to weaken significantly on the back of political uncertainty,” Katz said.

GREY CLOUDS

Israel's fiscal woes mainly stem from Netanyahu and Finance Minister Moshe Kahlon's affinity for cutting taxes while spending generously on policies like pay rises for police and subsidies for kindergartens and housing.

The ministry said the 2020 budget will be presented to the new cabinet in December, with a final vote slated for March of next year. In that case, the government will use a pro-rated version of the 2019 budget for three months.

A ministry spokeswoman said limited government activity should help improve the fiscal situation in coming months.

Last month Director General Shai Babad downplayed the situation, saying the hole was small in relation to a 400 billion-shekel budget.

Other authorities are more concerned. Last week, the IMF called on Israel to reduce the 2020 deficit to 2.5% of GDP by cutting tax benefits and other measures.

“Leaving debt on a rising path will constrain Israel's ability to use fiscal policy to cushion shocks to the economy,” it said in a report.

However, action on Israel's rating is unlikely for now. Karen Vartapetov, a sovereign ratings director at Standard & Poor's, said he expected deficits exceeding their targets in 2019 and 2020.

“A lot will depend on the composition of the coalition and the agreements they make,” he told Reuters. “But I don't think this will blow up the fiscal story massively, even if they loosen fiscal expenditures.”