ISRAEL: WILL DEBT SPOIL THE OUTLOOK?

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP86T01017R000302980001-8
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 6
• Document Creation Date: December 22, 2016
• Document Release Date: January 28, 2011
• Sequence Number: 1
• Publication Date: August 22, 1986
• Content Type: MEMO

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I I - '
SUBJECT: ISRAEL: Will Debt Spoil the Outlook?
NESA M# 86-20133
DISTRIBUTION:
EXTERNAL:
Original - John Holzman (State Department)
INTERNAL:
1 - DIR/DCI/DDCI/Exec Staff
1 - DDI
1 - ADDI
1 - NIO/NESA
1 - CPAS/ILS
6 - CPAS/IMC/CB
1 - C/PES
1 - NID Staff
1 - PDB Staff
1 - C/PPS/NESA
2 - PPS/NESA (One copy to analyst to source
1 - D/NESA
1 - DD/NESA
1 - NESA/IA
1 - NESA/PG
1 - NESA/AI
2 - NESA/AI/I
DDI/NESA/AI/I
'Fit
DATE /n (o
DOC NO /VISA /1 A,-dkO133
OIR
P & PD /
22 August 1986
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Central Intelligence Agency
Washington. D. C. 20505
DIRECTORATE OF INTELLIGENCE
22 August 1986
Israel: Will Debt Spoil the Outlook
Summary
The Israeli economy has made great strides toward economic
recovery in the past year, but continued progress will hinge on the
government's willingness to reduce spending while holding the line on
budget deficits. The budgetary process will come under added pressure in
the final years of this decade when the government is scheduled to repay
about $4.7 billion to bank shareholders stemming from the bank share
scandal--and subsequent stock market collapse--of October 1983. If the
economy is not sufficiently stabilized, the large anticipated
repayments--when combined with an already large outstanding debt
repayment schedule--may strain the budget to the point that further
spending cuts become difficult.
Israel's debt structure, although not presently a great burden on the
economy, may in the next few years present serious problems for economic
decisionmakers. This appears especially likely if borrowing--which
constituted about 41 percent of total government revenue in Israeli fiscal
year-(IFY) 84/85--continues to play a leading role in financing government
expenditure. If borrowing levels have to be increased--in response to
greater revenue needs stemming from insufficient budget cutting action--
the government will find an ever growing portion of the budget devoted to
debt repayment.
the government is most concerned
with domestic public debt growth. In 1985, domestic public debt--defined as total private
sector claims on the public sector--stood at 143 percent of GNP, up from
This memorandum was prepared by I Ithe Israel-Jordan-PLO Branch, 25X1
Arab-Israeli Division, Office of Near Eastern and South Asian Analysis. Information as of 25X1
22 August was used in its preparation. Questions and comments should be directed to
Chief, Arab-Israeli Division . 25X1
PJESA M# 86-20133
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123 percent of GNP in 1984. This ratio is likely to increase greatly in light of the large
anticipated bank share repayments the government will undertake from 1987 to 19891
The government appears more confident it can handle foreign debt due to its
smaller relative size in the overall debt structure. Foreign public debt--total claims by
foreigners on the public sector minus foreign reserves--stood at 60 percent of GNP in
1985, up from 51 percent the previous year.
Debt maturity length--although not currently a problem--could become a more
important issue as the decade draws to a close. At yearend 1985, short-term debt
constituted 14.7 percent of total debt, medium-term debt 15.3 percent, and long-term
debt the remaining 70 percent. This debt distribution may change drastically, however, if
the economy fails to achieve sustained economic growth and additional budget cuts are
not forthcoming. Without continued spending restraints, revenue shortfalls may
necessitate increased borrowing. Increased borrowings through short-term loans would
be a two-edged sword for Israel: on the one hand, Israel would be able to cover revenue
shortfalls but a greater burden would be imposed since the government would have to
refinance a larger debt more frequently. Additional borrowings in 1986 and 1987 would
further compound financing problems in 1987 and 1988 when the bulk of the bank share
repayment is to take place.
The bank share scandal and subsequent stock market collapse of October
1983--caused by the questionable stock trading practices of Israel's leading banks--was
resolved at the time when the government agreed to purchase back from individual
shareholders the full value of their shares, thereby assuming a large future debt
obligation. Under terms of the bank stock guarantee program, the government promised
to redeem or purchase from shareholders shares worth $6.5 billion. To date, the
government has purchased about $1.8 billion, leaving $4.7 billion still to be redeemed.
Current plans call for the government to absorb $1.0 billion in either 1987 or 1989 while
redeeming $3.7 billion in 1988.
The 1987 or 1989 bank stock repayment of $1.0 billion should not overly strain the
economy, but the 1988 repayment of $3.7 billion may have negative long-term
implications. The government's most likely approach will be to redeem the $3.7 billion in
shares through a firm created by the government and eventually to resell them to the 25X1
public. The government would lend the firm the necessary funds to buy the shares. By
1993, the firm must either repay the government or the government would have to
reclaim the shares or transform the $3.7 billion loan to the firm into a grant.
In any case, the government will have to make interest payments to bank stock
shareholders on any replacement bonds or paper issued. Larger interest payments--when
combined with increased total internal debt--will increase the pressure to compromise in
the budgetary process. Budgetary inaction--in which no further steps are taken to
reduce the budget deficit--would likely result if the government were faced with the
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difficult task of drastically cutting back on social services to accommodate larger
Manageability of external debt by a country is generally determined by the
ability to service the debt on a timely basis. This, in turn, depends on several
factors, including inflows of foreign capital, growth of exports, control of import
growth, and exogenous factors such as commodity prices and interest rates.
Countries therefore can run into debt problems through their own mismanagement or
Various ratios may be used as indicators of debt servicing problems. The
traditional debt service ratio indicates what share of exports, the principal foreign
exchange source for most countries, is being devoted to servicing the debt. A ratio
of 50 percent or higher usually signifies a strain on a country's resources. Similarly,
total debt compared to gross domestic product generally indicates the burden of the
debt on a country. Another key indicator is the ratio of net foreign capital inflows to
debt service payments. As long as this ratio is greater than one, the country should
be able to meet its debt obligations; if the figure falls below one, the country would
have to run a trade surplus or draw down foreign exchange reserves to avoid a
liquidity problem.
Thus, external debt problems will arise if a country's international payments
cannot be balanced without major changes in the level of either imports or debt
servicing. In general, a problem can be traced to specific components of the balance
of payments. Such items could include:.. export shortfalls due to declining
commodity prices or world recession, reductions in worker remittances, excessive
imports due to an overvalued exchange rate or price rises, higher interest payments
because of increasing -world interest rates, a slowdown or cessation of foreign capital
inflows, capital flight, or a bunching of amortization payments.
With regard to domestic debt, the main concern is with choosing a maturity
structure for new debt issues that minimizes debt servicing interest costs and at the
same time enhances monetary stability. Problems occur when interest costs are high
with debt at long-term maturities and when a large volume of short-term debt at low
interest rates acts as a substitute for money and continually needs to be refinanced.
By using the various debt ratios outlined above, Israel does not presently
appear to have significant debt servicing problems. The debt-service ratio, which
expresses debt service payments as a percentage of export earnings, stood at 42.1
percent in 1985, up only marginally from the year earlier figure of 41.8 percent.
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Furthermore, the ratio of total debt to GNP was 139 percent last year while the ratio
of net foreign capital inflows to debt service payments was 1.11, both within the
bounds of debt manageability.
Current conditions, however, could change drastically in the next few years.
Poor export growth, when combined with the upcoming bank share repayments, may
push the debt-service ratio over 50 percent, straining an already financially strapped
Israeli economy. In addition, any decline in US economic assistance, which makes up
a large part of net foreign capital inflows, would add to a worsening debt situation.
Israel's long-term economic outlook depends not only on the ability of the
economy to sustain meaningful growth. while fundamental changes in the economic
system are implemented, but also on the government's ability to keep debt growth within
manageable bounds. If the economy fails to perform up to expectations, the government
will be hard-pressed to undertake meaningful long-term economic reforms. A sputtering
economy may then lead to an increasingly larger share of the government's budget being
devoted to debt repayment.
The scheduled government rotation in October will be an important test because if
then Prime Minister Shamir can build upon the economic gains achieved by Peres, the
economy will be better able to weather larger debt payments. Given Likud's poor
economic track record, however, it may encounter serious problems in coordinating
economic policy with Labor, thereby imperilling the gains made during the past year and
worsening prospects for controlling debt in the future.
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Two scenarios can be developed to show what might happen to debt over the
period 1986-1990. It should be stressed that the scenarios are not forecasts, since actual
debt behavior is conditional upon the economy's performance and on government
economic policies. As such, the scenarios should be taken as conditional forecasts.
Using a simple model of internal and external debt, the scenarios assume that
--the government's budget deficit is a fixed
fraction of GNP
--the deficit in the current account of the
balance of payments is a fixed fraction of
GNP
--real internal and external debt interest
rates are fixed
--GNP grows at some constant, fixed rate
--changes in nominal monetary stocks are
ignored,
Scenario one assumes the government's budget deficit and the current account
deficit remain at 5 and 20 percent respectively of GNP for the period, real interest rates
are fixed at 5 percent, and GNP grows at 2 percent annually. If bank share repayments are
not allowed for; the debt/GNP ratio falls from 1.43 in 1986 to 0.97 by 1990. 25X1
Scenario two assumes the bank share repayments are fully paid by the
government in 1987 and 1988 along with assuming that the government's budget deficit
and the current account deficit remain at 15 and 20 percent of GNP respectively after
1987 while real interest rates are fixed at 5 percent and the economy grows at a 2
percent annual rate. Under scenario two, the impact of the bank share repayment
scheme is evident as the debt/GNP ratio would fall to 1.37 in 1987, increase to 1.54 in
1988--as the large $3.7 billion payment is fully absorbed--while increasing to 1.59 in
1989. While the forecast results are only conditional at best, they do illustrate the
potential problems for economic decisionmakers if debt levels mount under the weight of
the bank share repayments and the economy's performance remains unimpressive.
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