Treasury warns war compensation fund nearly empty

Israel’s Property Tax Compensation Fund has become an alternative source of funding for the government. The government has used the fund as a source to bypass the state budget as required, for example to reduce the excise tax on fuel, and to cancel the tax on disposable plastic plates and utensils. As the fighting began, the fund took center stage. The fund will be used for business grants throughout the country and compensation for the residents of the Gaza border region and Ashkelon. However, sources in the Ministry of Finance have told “Globes” that the fund will run out after the first month of fighting.

When the war broke out, the fund amounted to NIS 18 billion. At least NIS 5 billion of this will be dedicated to compensation for the direct damage caused to the towns and villages that have been damaged during the war. Another NIS 4.5 billion is supposed to compensate businesses, but this is likely an underestimate. These estimated amounts are only for October. The compensation plan for businesses presented by Minister of Finance Bezalel Smotrich has been harshly criticized by the public as being insufficient, and it was also slammed in the Knesset Finance Committee. Now, it is estimated that the cost of the plan will further increase.

Smotrich became Minister of Finance at the start of the year without an approved state budget and without the ability to allocate funds for new decisions. As part of the coalition agreements, Smotrich pledged to abolish the tax on plastic disposable plates and utensils, as demanded by the ultra-orthodox parties. He was required to find a budgetary source, to cover the loss of state revenues. In the absence of an approved budget, he deducted NIS 2.25 billion from the Compensation Fund. This money has already run out, after being used to finance the repeal of the Plastic Utensils Law, as well as for other needs.

Even so, a senior source in the Ministry of Finance soothes concerns that residents will not receive compensation for damage. “Even if money was moved out of the fund, everything that was saved there still belongs there,” he stresses. “The fund will be able to respond according to the amount meant to be in it.”

Markets concerned about Israel’s debt

Meanwhile the markets and rating agencies have expressed concern about the way the government is financing war damage. Over the past week, the world’s three major ratings agencies have indicated that Israel’s credit rating will be cut if the fighting expands into a protracted multi-front war. Fitch and Moody’s have placed Israel on review for downgrade of its credit rating and S&P cut Israel’s credit outlook from stable to negative.

The markets, it seems, were not overly concerned by S&P’s announcement. Market sources say that the Tel Aviv Stock Exchange (TASE) has already priced in the more significant damage of a cut in the credit rating itself.

“It is more correct for the Ministry of Finance to raise long-term debt”

If Israel’s credit rating is indeed downgraded, it may make it difficult for the economy in the long term, in terms of increases in government debt. This is especially significant now, when the needs of the hour dictate a considerable increase in the fiscal deficit. Each percentage point added to the deficit requires Ministry of Finance Accountant General Yali Rothenberg to raise another NIS 18 billion against it. When the interest rate environment is already high, a credit rating downgrade could make the state’s debt repayments significantly more expensive.

A senior official in the capital market explains how the war has so far affected Israel’s government bonds. “On the one hand, yields have actually decreased in the short and medium term, so the government can raise more cheaply, but that is because of the expectation of the Bank of Israel cutting interest rates.”

The source added that Israel’s difficulty lies “in the longer term, in dollar bonds, where Israel’s risk premium has increased significantly.” Before the war, the spread between Israeli bond yields and their US counterparts was 85 basis points. Now, yields in Israel are already about 155 points higher than on bonds issued by the US.

“This means that when the government goes to raise funds abroad, it will have to pay for this gap 0.7% more per year, which is a lot. From this point of view, it is more correct for the Ministry of Finance to raise shorter-term debt right now, which will cost less money.”

S&P sees Israel’s fiscal deficit rising to about 5.3% of GDP on average in 2023-2024. As the government approved the two-year state budget last May, on the basis of an average deficit forecast of only 1.2% of GDP, even before the war, it was clear that the target was unrealistic and that the deficit would continue to climb. This becomes even more acute in view of the war expenses, the reconstruction of the Gaza border region, the compensation to the economy, and lower tax revenues.

Published by Globes, Israel business news – en.globes.co.il – on October 26, 2023.

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