Bank of Israel Governor David Klein says that interest rates will probably be cut to 6.5% this year, as the Israeli economy heads towards a recession with rising unemployment, and a fall-off in the gross domestic product per capita expected.

In an interview in the Israeli newspaper

Yedioth Ahronoth

, Klein said that Israel's growth this year will come to no more than 2%, which is less than the population growth rate. He also projects that unemployment will reach 10% and that the standard of living will remain static.

When asked whether the Nasdaq is to blame for the shift in the Israeli economy, Klein replied that the damage inflicted by the Palestinian uprising on Israel's tourism and building sectors is minute in comparison to the damage inflicted on Israel's economy by the blows suffered on the Nasdaq. The American market is the key to Israeli growth, Klein said.

Klein believes that the sharp Nasdaq losses will greatly scar the Israeli economy and dampen the desire to invest. People will not return to the exchange to invest as if nothing has happened. Many have had their illusions smashed to pieces, and many distortions have been exposed. A certain amount of confidence has been undermined. Many analysts have been caught red-handed, and their integrity is being questioned. Technology firms have issued artificial financial reports covering up their real losses, and the U.S. Securities and Exchange Commission is now investigating this unacceptable phenomena, Klein pointed out.

Nor does he think it likely that the American capital market will recover significantly this year, and Klein says outright that he does not expect a quick return to the days of fast gains. Referring to the stock market losses of 1993, and the way in which they affected the behavior of Israeli investors, Klein notes that to this day the majority of the Israeli investing public has never returned to the stock market.

Yediot: But the Americans are more flexible, and their capital market fulfils a more important role in the economy.

Klein

: That's true, which is why I subscribe to the belief that the slowdown in economy of the United States will not drag on beyond the end of the year. In 2002 there will be a change for the better. The American economy will begin to grow again. As far as Israel's capital market is concerned though, it's a pity to waste words on it. It doesn't exist at all.

Is a global slump, similar to the 1920s, an actual possibility?

Categorically: No. There is no danger of sliding into a global economic crisis. Today we economists have a good understanding of the process that causes a financial shock. And we have first-rate policy tools to deal with such a situation. As far as the U.S. goes, the stock exchange crisis occurred at a time when the American administration had a huge budgetary surplus, and the public debt was very low. These are ideal conditions for implementing large tax cuts. There is no reason for an economic recession to develop in the U.S., their slowdown will pass.

Is the correction complete? Have the exchanges hit bottom?

I am not at all sure. An exchange that has dropped 50% can drop another 50% until it stabilizes and realigns itself with the new reality. Until one year ago, we had imaginary estimates of our projected growth in earnings in the business sector. These were not based on available technology, nor on real consumer demand. There was no real link between the big dreams inventors and their backers had, and the ability to actually realize them and sell their products to the market. Now a correction in that regard is taking place.

The technology stock party ended this year. Even non-technology shares are now suffering due to the change in the economic climate. But the technology itself will continue being developed in order to advance the world, and move us all forward. Eventually, the most daring dreams will become concrete, but this will occur at a slower pace than many had previously imagined.

This period of sobering up from the Nasdaq's intoxication is very painful, but it's a positive and healthy development.

When asked how the bank's interest policy will be affected by a recession, Klein said that when determining interest rates, the bank takes all factors into account, including the recession and the rising unemployment figures. But the bank's main consideration is what kind of interest rate will help meet the government's target inflation target, between 2% and 3%, considering the circumstances of the Israeli economy on a month-to-month, and even day-to-day basis.

Still, you decide whether to cut the interest and by how much. What figure do you have in mind?

According to the calculations of the Bank of Israel, the interest rate most consistent with the inflation target for the year is 6.5%, not the current 7.5%. This is why further reductions are necessary. Again, I point out that we are aiming for an interest of 6.5% consistent with the inflation target of 2.5%, up to 3.5%, under the current market conditions.

The upcoming cuts will remain small. I am not in favor of accelerated interest cuts, of 0.5% a month or more. I am not ready to gamble on economic stability by introducing cuts too soon. Haste makes waste.