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30 May - 5 June 2002
Issue No.588
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Published in Cairo by AL-AHRAM established in 1875
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War costs
The almost two-year-long Intifada and the recent Israeli operation in the occupied
territories has hit hard nearly all sectors of the Israeli economy, writes John
Sfakianakis*
There is little doubt that the Israeli economy has been facing a serious downturn, if
not a recession for more than a year and a half. The economy shrank 0.6 per cent
last year, after seeing 6.2 per cent growth in 2000. On the employment front, too,
things have worsened, with the unemployment rate now exceeding 10 per cent. The
budget deficit is expected to widen from three per cent to 3.9 per cent. On 22 May,
the cabinet endorsed a $2.7 billion emergency plan to prevent a fiscal crisis, caused
in part by increased defence spending after Israel's offensive. It included Shk6
billion
($1.25 billion) in cuts and $625 million in tax rises (mainly in indirect taxation
such as
diesel oil and cigarettes), public wage freezes and a four per cent cut in social
security payments. Although the economy has experienced in its history a much
higher budget deficit -- in 1984/85 the budget deficit hit an all-time high of 13.2 per
cent of GNP. For today's global economy, such a deficit is alarmingly steep.
Additional fiscal measures are awaiting parliamentary approval. These include
raising sales taxes by one per cent and increasing the tax on diesel oil and
cigarettes.
Such measures are not growth-oriented, but only temporary fixes. Additional fiscal
gaps will be covered with deficit spending, a standard practice that the country has
heeded since its inception. Strong growth in the first quarter of 2002 can be
attributed
to government spending, mainly on defence, which accounts for 20 per cent of GDP.
This kind of state-sponsored growth should not be favoured by any economy. These
and other developments led Standard & Poor's international rating agency to reduce
Israel's rating outlook from 'stable' to 'negative.' Following the cabinet's decision
Israel's business leaders launched an attack on the government's emergency plan
and warned that the programme could lead to a financial catastrophe. Undoubtedly
the economy is faced with two major problems: a global slowdown and increased
defence and security spending as a result of the recent Israeli offensive and the
Palestinian Intifada. The economic aftershocks of the recent violence have been felt
throughout the Middle East, as international investors gauge the region with a higher
risk premium.
The Intifada as well as the recent Israeli offensive have not been good for the Israeli
economy. The Bank of Israel (BOI) reported on January 2002 that the Intifada had
cost Israel some Shk13 billion, or four per cent of GDP. The Intifada has a direct
effect on tourism and the construction sector. The slump in tourism is particularly
grave. It began at the end of 2000, with the eruption of the Intifada, and was
exacerbated by the 11 September attacks in the US. Tourist arrivals in 2000 grew by
three per cent while the following year fell by more than 50 per cent. In December-
February the number of tourist entries by air into Israel was down by 37 per cent from
the equivalent period last year. Vacancy rates in Israeli hotels amount to 90 per cent,
according to a recent article in the Wall Street Journal. Construction has also been
affected since approximately one-third of the sector's total workforce had until
recently been Palestinian.
Notwithstanding increasing interest rates by the BOI, consumer spending has also
plummeted over the past few months as a result of the ensuing violence in Israel.
Israel is facing a new obstacle in its attempt to develop its gas distribution network.
Tractebel SA of Belgium recently pulled out of a consortium to build a distribution
network in Israel due to political pressures to cancel projects with the country.
The Intifada as well as the recent Israeli offensive have impacted the much-
respected Israeli high-tech sector. Many high-tech companies provided employment
to Palestinians engineers from the occupied territories, although on a less equitable
basis than to their Israeli colleagues.
However, the Israeli economy has not been dependent on the Palestinian, the
relationship is, in fact, the inverse. Pre-Intifada 2000, Israel annually sold about
$25
million in goods to Palestine, while some 25 per cent, or $2 billion, of the
Palestinian
GDP, came from its trade with Israel. Palestinian exports to Israel accounted for 60
per cent of all Palestinian sales.
Increasing violence has exacerbated troubles in high-tech industries since customers
and investors are more reluctant to travel to Israel. During the tech boom, Israel
gained acclaim as one of the most vibrant breeding grounds for technology outside
the Silicon Valley -- a status it shares with India and Ireland. Certainly Israel's IT
boom is attributed to, among other things, a large domestic market, a large defence
industry which has been so vital in nurturing talent, a well- developed capital market
to back its genuine entrepreneurs, highly skilled engineers, aggressive global
marketing strategies and last but not least ties with various Wall Street investment
houses. Israel has more than one hundred companies on Nasdaq, the US
technology-focused exchange. The global slowdown is also a cause for a loss of
momentum by Israel's high-tech sector. The global technology slump, along with the
violence of the past year and a half, made raising funds abroad difficult. Israeli
venture capital funds forecast a recovery in fund-raising abroad only in 2003 or 2004,
with just $250 million raised this year compared with $1.4 last year and a record $3.7
billion in 2000. As a result, venture capitalists in Israel are targeting local pension
funds and insurance firms, with an estimated $75 to $100 billion in assets.
In currency terms, the shekel has fallen by 16 per cent since the end of December
2001. Several of the above factors have combined to weaken Israel's currency. Many
companies have suddenly stopped borrowing dollars from the banks, after taking out
massive forex credit in recent years. Households have also started shifting shekel
deposits into dollar or dollar-related investments. The fall in tourist receipts and
foreign investments, particularly in high-tech companies has been dramatic. Foreign
direct investment fell from $1.1 billion in 2000 to $761 million in 2001. A sudden drop
in interest rates created a wave of fleeing capital, especially in the form of
financial
institutional and retail investors. According to a recent report by Bank Leumi, the
second largest commercial bank in the country, Israelis -- both institutional and
retail
investors -- had about $16.4 billion in holdings abroad at the end of 2000. In April
interest rates on unindexed 10-year government bonds rose to seven per cent --
about one percentage point higher than at the beginning of the year -- and interest on
indexed debt rose by a similar amount in that period to 4.8 per cent. The increases in
these interest rates cause a parallel rise in other interest rates and depress
investment and employment. Stock market activity has not been very promising
either. The fall in the share price index in Israel is a reflection of the low level of
profitability of Israeli companies. The 25 largest quoted companies on the Tel Aviv
Stock Exchange (the Tel Aviv 25 Index), made a cumulative loss of about $330
million in 2001, compared to a profit of around $730 million in 2000.
Banking has been facing tough times recently. In March 2002, Bank Leumi
announced that net profits plunged 46 per cent last year as provisions for doubtful
debts jumped sharply amid an economic slowdown and violence. The drop in profits,
Leumi's first in seven years, followed a 45 per cent fall in annual net profits at Bank
Hapoalim, the country's biggest banking group. The two banks together control about
two-thirds of the Israeli banking sector. Leumi said the slowdown had adversely
affected the ability of companies in hard-hit sectors (telecommunications,
construction, real estate and tourism) to repay loans. Israel also has a reputation for
suffering financial scandals for which the banking sector will have to pay the bill.
The
latest such scandals hit the Trade Bank, which was defrauded of around $45 million
by an employee.
* The writer is a research fellow at Harvard University's Centre for Middle Eastern
Studies.
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