Israel, Awash In Debt, Looking For New US Taxpayer Bailout

By Frank Collins

Israel's government budget for the coming fiscal year is a shocking reminder that the Israeli government is awash in debt. The consequences of this huge debt are shown in the accompanying statistics from the Jerusalem Post, Feb. 1-2, 1989. Forty percent of the budget is required for debt recycling, that is, paying off old debts by borrowing more money. Transfer and support payments, largely interest on the debt, consume another 20 percent of the budget. Most of the debt came into existence from the cost of past wars.

Twenty percent of the budget continues to be allocated to military expenditures. This amounts to almost $1,700 per Israeli, $8,500 for a family of five. The latter is more than the total income of many Israeli families.

The interest payments on the debt are lost money. Except where the loan was invested in productive facilities, and little of it has been, the interest contributes nothing to the gross domestic product. And further, to the extent that the debt is owed abroad, it adds to the chronic deficits in the balance of payments of the country.

The costs of the government debt will almost certainly be augmented by the costs of some of the large private debts that have been accumulated through the years. These debts have been run up by the kibbutzim (collectives), the moshavim (cooperatives), Koor (the large industrial conglomerate owned by Histadrut, the labor confederation), the settlements in the occupied territories, and various private concerns such as Egged, the bus cooperative. (See The Washington Report, Dec. 1988, p. 7). All of these heavily indebted elements in the Israeli economy are lout calling for government bailouts on the grounds that their continued existence is vital to the country.

Fueling the current crisis, Israel last year took on more public debt in the form of a domestic bond issue of $3.6 billion. This was caused by a 1983 bailout of the commercial bank investors (not the depositors, as in the US). The ultimate direct cost of this commitment will amount to $7 billion without taking interest into account. The bonds were floated at an interest rate of 5 percent plus the rate of inflation. Last year's inflation rate was almost 17 percent and is certain to be higher in the coming fiscal year. Just at last year's inflation rate, the annual interest to be paid out (forgetting about the $3.4 billion yet to be raised to cover the remainder of the $7 billion commitment and future repayments on principal) will be at least $825 on a per capita basis, $4,125 per Israeli family of five.

Now the Israeli government proposes to borrow still more money to keep itself afloat as is standard procedure for many governments. Additional borrowing, however, only hikes the debt servicing costs that must be faced next year, which will balloon with each successive year. Israel's situation differs from that of other heavily indebted countries on three counts:

the small size of its population and economy relative to its debts,
the high costs of this year's expected assumption of the debts of many ailing elements of the economy and the financial shock of last year's bailout of the commercial banks, and
the continuing costs of Israeli's war against the intifada.

Intifada Costs $1.3 Billion Per Year

The true economic costs to Israel of the Palestinian uprising are a closely guarded secret. No official figures have been released by the government. In mid-February 1988, Minister of Economics Jad Yaacobi stated that the costs of the military actions against the then three-month-old intifada were $320 million, $1.3 billion on an annual basis. The costs of the adverse effects on the country's economy are undoubtedly much larger.

Under these circumstances, one might expect to see the government taking heroic steps to bring the fiscal situation under control. But no such steps are being taken, in spite of statements by some Israeli politicians to the contrary. The truth is, according to Shlomo Maoz of the Jerusalem Post, the budget is virtually "a carbon copy of last year's." Perhaps a budget involving fundamental policy changes is beyond the political capability of the present coalition government.

Minister of Finance Shimon Peres has reacted to the fiscal crisis by conventional steps: new taxes, new cuts in government services and subsidies, and a moderate currency devaluation which brings the shekel more in line with market rates. His proposed budget follows the "trickle down" ideology of Ronald Reagan. The middle class pays the tax increases, the poor lose government services and food subsidies, and the very rich are shown great consideration with tax cuts, allegedly to spur investments. Any such investments are likely to be made abroad instead of in the Israeli economy, unless stringent currency export restrictions are imposed. Even then, investment is only stimulated by the expectation of profit, which under present conditions in Israel is nil.

Americans Foot the Bill

Israelis overwhelmingly expect that the American taxpayer will continue to fund the Israeli government. It is the universality of this perception that has permitted the Israeli government to continue its extravagance year after year.

President Bush's budget requests $1.8 billion for the Israeli military budget and $1.2 billion for the civilian economy, the same levels as last year. The amount of the grant, however, may be cut in order to comply with the Gramm-Rudman act for balancing the budget. Further, Congressman David Obey, chairman of the House Appropriations Subcommittee which appropriates foreign aid money, has been quoted as saying, "I don't want to take responsibility for giving one dime to a country whose military are firing at people in retreat."

Even the continuation of the grant at last year's level of $3 billion would be insufficient to cover this year's needs for the reasons already discussed. This anticipated shortfall will require Israel to make cuts not provided for in the Peres proposed budget.

Unlike American military and economic assistance to all other countries, the US does not specify how Israel must spend its grant aid. Thus the funds may be used to build settlements in the occupied territories, to invade Lebanon, or for policing the West Bank and Gaza. Even the Shamir government might be forced to reduce these types of expenditures. Failing to make deep cuts of this kind, which would alter the whole orientation of present government policy, would require the Israelis to raise money from other sources to cover the shortfall.

To raise the money domestically in Israel is not really feasible. It would further deplete the economy of investment capital, the very capital that the proposed reduction of taxes on the wealthy is supposed to increase. Furthermore, sales of Israeli bonds on the domestic market are only possible at very high interest rates. This was demonstrated by last year's sale of $3.6 billion of Israeli bonds to cover partially the government's obligations in the 1983 commercial bank bailout. These were sold at a variable interest rate, the minimum being 22 percent. Therefore, covering the budget deficit by way of the domestic money market is obviously impractical if the Israeli economy is ever to achieve stability.

The foreign capital market is also impractical in view of Israel's notoriously precarious economic position. The sale of Israeli bonds abroad would require the offering of interest rates commensurate with the risk. The high interest problem could be resolved if the US guaranteed the loans. The interest rate then would be at the level of US Treasury bills. The transaction would be an off-budget item so that there would be no immediate effect on the US budget deficit and thus it would not come under the Gramm-Rudman act.

This is no visionary scheme. Last year Israel refinanced part of its military debt by selling bonds worth $4.8 billion on Wall Street, 90 percent of the value of these bonds being guaranteed by the US government. As the bonds were offered at one percentage point over the then current rate of US Treasury bills and were almost as safe, the Israeli bonds were quickly snapped up by private investors. Strangely, the transaction, the largest of its kind ever on Wall Street, attracted little newspaper interest. It goes without saying, however, that operations like this are fraught with danger for American taxpayers. It seems unlikely that even the usually compliant Congress would give its required consent to the extension of this method of covering of new Israeli debts by coopting the US taxpayer as unwitting guarantor.

The most sensible course for the US government to pursue is not to encourage further Israeli extravagance and adventurism but instead to reduce aid to Israel. This would force the Israeli government to end its total dependence on handouts from the US and to resolve its budget difficulties by fundamental changes in policies. These would necessarily include the negotiating of a peace settlement with the Palestinians. Such a peace settlement would contribute materially to stabilizing the Middle East, and thereby would enable Israel to reduce the inflated military expenditures at the root of its current financial crisis.

Frank Collins is an American free-lance writer who divides his time between Jerusalem and Washington, DC.