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. Last Updated: 07/27/2016

Analysts: Israel Must Focus on Economy

TEL AVIV, Israel -- Israeli Prime Minister Ariel Sharon spent his first year in office grappling with a Palestinian uprising, but analysts warn he must now turn his attention to Israel's ailing economy or risk another year of recession.

Reeling from a global slowdown that cut into demand for technology exports as well as the 17-month-old Palestinian uprising that hurt tourism and construction, Israel in 2001 turned in its worst economic performance in decades.

But things could get worse.

If Sharon fails to cut spending to reign in a ballooning budget deficit, government debt will rise further, Israel's credit rating could be downgraded, inflation could be reignited and unemployment lines could grow, analysts say.

The foreign exchange market has already voiced its lack of confidence in the government's ability to deal with the economic crisis, with the shekel falling 10 percent since interest rates were slashed in December in an attempt to boost the economy.

"There's a combination of negative elements working on the shekel, including a fiscal policy that is not credible and even dangerous, and it's not at all clear where it will take us in coming years," said Jonathan Katz, macroeconomic strategist at Ofek Securities. "We could see towards the end of the year a formal worsening in the credit ratings."

Although thrust into a situation that would have tested even the most venerable of leaders, many economists say Sharon's government did little to prevent the economy's deterioration.

"Israel did not fit itself as a country to the new conditions of war, meaning a decline from 6.4 percent economic growth in 2000 to a 0.5 percent drop in 2001," said Yoram Gabbay, chairman of Bank Hapoalim's Peilim Portfolio Management Co. and a former senior Finance Ministry official. "The government has cut itself off from reality, living with the illusion that in most areas, life could continue as usual."

Most economists forecast growth of less than 1 percent in 2002, compared with the government's prediction of 2 percent.

Gross domestic product last year contracted 0.5 percent -- the biggest annual decline since 1953 -- while unemployment rose above 10 percent for the first time since 1993.

At the same time, the shekel's depreciation threatens to revive inflation just as the country had begun to believe that battle had been won.

Analysts slammed the package deal announced in late December in which the Bank of Israel agreed to chop its discount rate by 2 percentage points to an all-time low of 3.8 percent in exchange for a promise to pass a tight 2002 budget and an easing of the foreign exchange regime.

Parliament finally passed the 2002 budget in February, five weeks late. But most analysts predict the government will not be able to meet its budget deficit target of 3 percent of GDP. In fact, many say it could surpass 5 percent.

"You can't cut rates by two points in this kind of environment. It will only result in a depreciation, and interest rates will have to rise again," Gabbay said.

Katz gave Sharon a "mediocre-minus" score for his first year in office, saying the prime minister has been involved in economic issues only "sporadically, and then [he]disappears."

He echoed other analysts who say the budget is not credible and predicted the government will undershoot its tax revenue target by 25 billion shekels ($5.4 billion). This would translate into a deficit of 6 percent of GDP.

Moreover, the budget lacks the boost in infrastructure investment needed to stimulate job growth and pull the economy out of a recession.

Although acknowledging that Sharon had his hands full in dealing with the security situation, Katz said he should have initiated structural and tax reforms.

Some economists are willing to give Sharon's government the benefit of the doubt, pointing to the very difficult environment, particularly following the Sept. 11 attacks on the United States.

"A team of Nobel Prize winners would have difficulty steering through this quagmire," said Augusto Lopez-Claros, senior international economist at Lehman Brothers in London. "The government has done reasonably well, though that's not to say they couldn't have done better. Their approach has been fairly cautious, certainly on the Bank of Israel front."