With Reuters

Israel is being dragged towards a financial crisis threatening to affect greater parts of the population, warned Bank of Israel governor David Klein.

"It's impossible to be mistaken. We are being dragged towards a financial crisis when the economy is already in a depressed state since the end of the year 2000," Klein said, speaking at the Israel Democracy Institute's annual economics "Caesarea conference", taking place in Jerusalem this year.

The outstanding feature of the first half of 2002 was the way financial markets had acted, he added. "The government bonds market on the one hand and the foreign exchange market on the other hand did not stop signaling that the economy is falling off the track," he said.

Klein said the background to the crisis was the global slowdown, particularly in the United States, the bursting of the U.S. capital markets bubble and the Israel-Palestinian violence. But he also pointed the finger of blame at the Israeli Finance Ministry.

The governor seems to bear a grudge against Finance Minister Silvan Shalom, despite their recent truce. The Finance Ministry reneged on promises made when persuading the central bank to lower lending rates by 2% last December. The result was plummeting confidence in the Bank of Israel and rapid devaluation of the shekel, according to the central bank view. "The background of the financial crisis is known," Klein wrote in a paper distributed at the conference. "While the decision was to replace monetary restraint for fiscal restraint, and reverse the rising trend of the deficit and government debt, what happened in practice was monetary expansion, as planned, coupled with

accelerated fiscal expansion

(emphasis in source). Cooperation between the Finance Ministry and Bank of Israel is important, Klein added, but the real test is implementation. In this respect, Klein says, no changes are evident: the government has not created conditions conducive to restoring economic growth, he wrote. The government deficit targets, now 3.9% of GDP this year and 3% next year, are high, Klein warned. The government should aim to lower those targets, in order to encourage investments. That ill-fated economic package of late 2001 was designed to lower interest rates in all ranges in order to encourage investment. But its flawed implementation actually made the recession worse and stepped up inflation. Blame cannot be aimed at the security situation alone, Klein reproved. Although that certainly poured oil onto the flames, it did not undermine Israel's economic stability. Correct economic management can largely sustain the stability of the financial markets despite the tensions, as was true until year-end 2001, he noted. Klein said economic growth in 2003 was expected to be between nil to 1e%, in line with the Finance Ministry's prediction.