Israel is not done with its budget reforms, warned Finance Minister Silvan Shalom on Wednesday. The country cannot afford to continue spending such huge amounts on defense, he said.

Speaking at the Israel Democracy Institute's annual economics "Caesarea conference", taking place in Jerusalem this year, Shalom said that the security establishment received a massive NIS 7 billion increase in its budget this year. But such levels of financing cannot be sustained.

"We have reached the crisis point," he said. "We need to talk about reform in the defense establishment. Today the defense establishment makes decisions on long-term projects independently. This cannot continue. The prime minister will have to make the final decision."

Defense Minister Benjamin Ben-Eliezer told the conference, however, that the defense ministry still had a shortfall of NIS 2-3 billion despite the additional funds, and that its deficit continues to grow.

Ben-Eliezer said that the NIS 2.5-billion cost of constructing a security fence along the "seam line" between Israel and the Palestinians was "worth every shekel, both from a security and an economic standpoint".

Israel holds the world record for the percent of budget spent on security, Shalom rebutted, at about 20%. The sheer weight of the burden is disrupting government activity in all other areas, he said.

The finance minister estimated that the hostilities are costing Israel 3.5% to 5% of its national product each year, and added that it was unclear if Israel could continue to function under such conditions in the long-term.

Shalom and Prime Minister Ariel Sharon on Tuesday lowered the government's estimate for economic growth in 2003 to just 1%. The revised estimate means the treasury must cut the 2003 budget by NIS 8-9 billion instead of NIS 7 billion, as planned.

The treasury actually believes growth next year could be as high as 2.5%, but following consultations with external economists, it decided to base the budget on the more conservative estimate of 1%.

Shalom said Wednesday that the treasury intends to present the 2003 budget for government approval before the end of July. The budget cuts will exact a heavy social cost, he warned.

Ben-Eliezer: Israeli economy can't bear burden of confrontation

"The Israeli economy cannot bear the burden of an active military confrontation over the long term," Ben-Eliezer told the conference. "If Israel continues to live in a state of war over years, through no fault of its own, it will not be able to rehabilitate its economy."

The Labor Party chairman stressed that although Israel will not compromise on fighting terror, cleraly terror cannot be answered solely through military tactics. A political solution is needed, Ben-Eliezer said. To that end, Israel needs to sit at the negotiating table with the Palestinians, he said.