An International Monetary Fund report on the Israeli economy, published today by the spokesman of the Bank of Israel, reached a mixed verdict. While several economic indicators show a steep decline from the fourth quarter of 2000, the report says, others show "surprising resilience".

The IMF analysts point at remarkable stability in exchange rates, inflation, and market-based inflationary expectations.

The analysts recommend that the macroeconomic policy mix should aim to maintain stability, while striving to ease the cost of the downturn. The upshot would be to mix support of economic activity through measured monetary loosening while maintaining fiscal discipline.

The IMF delegation predicts subdued growth of 1.5% to 2%, but notes high uncertainty factors both at home and abroad.

On inflationary prospects, the IMF analysts note that the cumulative interest rate cuts by the Bank of Israel add up to a substantial figure. But because inflation expectations have sharply fallen, real interest rates have declined only moderately and remain high at 6%. Assuming that inflation expectations stabilize, the analysts note, future interest rate cuts by the central bank should translate into real rate declines, which should support the economy over time.

But the environment is still fragile, the analysts warn. The war on inflation has been long, price stability is new and indexation is still widely practiced.

The IMF is reportedly concerned that the Israeli government will breach deficit restrictions it set itself, as it expands spending on security.

On Israel's exchange rate regime, the IMF recommends abolishing the exchange rate band. At the least, recommend the analysts, the band should be modified to ensure that its lower boundary does not constrain the central bank's pursuit of stable prices.

Maintaining discipline

Israel's credibility has been enhanced by responsible fiscal behavior in recent years. But that could change.

One problem is the expensive private bills raised by members of Knesset. Another is the intifada.

The fund fears that the new circumstances created as fighting between Israelis and Palestinians continues will induce the government to spend more on defense without concurrently reducing spending in other areas.

Keeping the deficit strictly at the 1.75% of GDP target would clearly signal the markets that the government is committed to fiscal discipline, say the analysts.

The analysts recommend leaving wiggle room in the event that state revenues fall short of expectations, in order not to exacerbate the economic downturn.

The IMF urges the government to formulate a medium-term fiscal plan covering five to ten years, to prepare the public for the steps that need to be taken. It notes mounting concern about the social and economic costs of income inequality in Israel, but meanwhile praises the government for its commitment to tax reform.

The report said that tax reform should address two key problems: the high tax burden at some income levels, and the asymmetric tax imposed on different forms of capital income, which results in distorted investment flows and creates an unjust tax system.

Labor travails at the central bank

Meanwhile, the Bank of Israel's own work is still being disrupted by the three-month and counting labor dispute. Governor David Klein will not be announcing the nominal rate of interest for May. He claims that central bank employees are withholding essential information.

Sources close to the negotiations between the central bank's workers and management today said that the talks have progressed markedly.

The sources surmised that an accord can be reached within days, maybe even before the Shavuot (Pentacost) holiday, which falls on May 27 to 28.

The two issues under dispute relate to automatic promotions (read: pay raises) and the numbers of tenures at the bank.

Labor representatives claim that the central bank has materially changed the structure of tenures at the bank. The reps demand that the bank officially redefine its list of positions.

For its part, the management does not like the labor panel's amended list of positions, mainly because it involves a great deal of promotions. The central bank management fears a steep rise in wage costs, which would certainly arouse a quarrel with the Finance Ministry wages department.