Bank of Israel Governor Dr. Karnit Flug on Wednesday criticized a government plan to sharply boost defense spending, saying it would come at the expense of civilian spending and probably increase the budget deficit and state's debt burden.
Prime Minister Benjamin Netanyahu told ministers last week that to meet expected threats in the coming decade, he intends to increase defense spending by 0.2-0.3% of the gross domestic product under the "2030 Security Concept."
This would see Israel's defense budget balloon from its current 72 billion shekels ($20 billion) to NIS 100 billion ($27 billion) over the next 10 years.
He said his goal was for an annual average economic growth of 3-4% and average spending of 6% of gross domestic product for all of Israel's security needs.
"The proposal to increase the defense budget over the next decade is inconsistent with the declining deficit path established in law, government resolutions about the expansion of social services, social programs and infrastructure investments, and the government's aversion to raising tax rates," Flug said in a Bank of Israel report.
"If such an outline for defense spending is adopted, it should specify stable and transparent sources of funding for the plan and should depict the adjustments that the other aggregates will have to undergo," she wrote.
If the government insists it can increase defense spending, lower taxes and raise expenditures without first security funding sources and without breaching deficit levels and the national debt, it is "deluding itself," Flug warned.
"Given its existing decisions on multiyear spending programs, its aversion to raising tax rates, and its interest in increasing the defense budget at a rate similar to that of GDP growth, the government will be rather strongly challenged to stay within the deficit-decline trajectory and to stabilize, or to continue to reduce, the debt-to-GDP ratio," her report said.
The budget deficit is expected to reach 2.9% of GDP in both 2018 and 2019, up from 1.9% last year, which was boosted by one-time factors and stronger-than-expected tax income. The solid fiscal performance led Standard& Poor's this month to raise Israel's credit rating to AA- from A+.
Still, the Bank of Israel remained concerned that keeping the budget deficit around 3% through higher spending would prevent a decline in debt burden, which was 59.4% of GDP in 2017, excluding municipalities' debt.
It noted that the government's use of creative accounting methods such as temporary provisions, future across-the-board cuts and issuing bonds, would only create budget issues in coming years.
"Other countries' experience, and Israel's experience in the past," the central bank said, "show that circumventing the budget limits, even if done with good intentions at first, may eventually end in loss of control of the budget framework and the need to make budget corrections at times that are less convenient for policymakers," Flug said.
Flug, named as the first woman to serve as Israel's central bank chief in 2013, announced in July that she will not be seeking a second term in office.
Also on Wednesday, Finance Ministry Chief Economist Yoel Naveh said that the slower economic growth noted in the second quarter of 2018 – an annualized rate of 2% compared to 4.8% in the previous quarter – was not a cause for concern.
"Despite the slower growth of the GDP, which rose by only 2% in the second quarter, the GDP continued to rise at a rapid annual rate of 4% in the first half of 2018. The slower growth in Q2 is a 'technical correction' to the high GDP growth in the first quarter," he said, adding that "after neutralizing temporary events and components, the GDP grew by 3% in the second quarter of 2018."
Naveh attributed the slower Q2 growth rate to a slowdown in private consumption, which grew at a moderate rate of only 0.5%, mainly due to the drop in car imports.
Public consumption fell by 5.2% in the second quarter, after two quarters of rapid growth.
