The return of bombings and terrorism to the streets of Israel has cast a dark cloud over the prospects for the peace process, and for the normalisation of the region's economy. The high security on the borders between Israel and the West Bank, together with the violent images of destruction on the streets of Jerusalem and Tel Aviv, is bound to have an effect on the confidence of investors.
The return of violence could not have come at a worse time for Israel's booming economy, which has recently started to develop the profile of the Tiger economies of the Far East. It is currently in the middle of a sustained period of growth; output expanded in each of the last five years, reaching peak growth of 6.9 per cent last year. Government forecasts have been that, despite high interest rates imposed to curb inflation, expansion would continue at 5 per cent plus this year - although that may now be revised downwards.
The extraordinary period of steady economic growth which preceded the current terrorism has been assisted by both external and internal factors. Externally, the widening of the peace process has meant the Israeli economy has become a more acceptable place for foreign investment, and has also opened market opportunities for Israeli exporters beyond the traditional markets in North America and Europe. Recently finance minister Yitzhak Shochat travelled to the Far East where new trade agreements were signed with countries which previously had no business with Israel at all, including Thailand, South Korea and Vietnam. Trade relations have also been established with China and India, while Japanese investment has been moving into Israel to take advantage of the advanced high-tech sector.
The inflow of foreign businessmen and investment meant that Israel was becoming an increasingly important hub for air transport in the Middle East, a development which could now be put on hold.
In addition, peace has opened the possibility of greater intra-regional trade with Egypt, Jordan, the Palestinian entity and the North African economies seen as promising for developing commercial and tourist relationships. Clearly, the Hamas bombing campaign has called a halt to an improved economic relationship with the Palestinians many of whom earn their living in Israel. With per capital income in Israel reaching $15,500 last year - the equal of Spain, Ireland and New Zealand - the Israeli government has been particularly sensitive to views that it needs to bring its neighbours along, though that is going to be more problematical.
The other critical external factor which has helped to fuel Israel's economic renaissance has been the influx of some 700,000 immigrants from the former Soviet Union since 1989. This wave of immigration has largely been absorbed by the private sector, with an increasing number of qualified technicians finding their way into Israel's burgeoning high-tech sector.
The improvement in the external situation has also coincided with important changes in Israeli capitalism. Even though for the moment Israel has a Labour government, the overwhelming power of the union movement has been gradually dismantled. There has been a concerted effort to open up and liberalise the economy and to remove subsidies. The subsidies have been cut from 11.5 per cent of GDP in 1980 to just 2 per cent in 1994. The eternal battle against inflation (just a decade ago Israeli prices were climbing 440 per cent a year) is being strongly waged by the governor of the Bank of Israel, Jakob Frenkel, who brought the headline rate down to single digits at 8.1 per cent last year.
In his second capacity as the Prime Minister's economic adviser, Frenkel has also persuaded the government to maintain downward pressure on budget deficits which remarkably have dropped to 2.5 per cent of GDP from more than 12 per cent in the late 1980s. The main priority areas in the budget, after defence, are now seen as education and R&D expenditure through the office of the chief scientist Shuki Glaitman.
Putting terrorism to one side, Israel is still not a problem free economy. The trade deficit is in poor shape and the current account is flattered by the $3 billion or so subvention from the United States in the shape of military grants and other assistance. The search for new markets in Asia, previously closed because of the Arab boycott, is driven partly by necessity. The integrity of the banking system and the quality of regulation and supervision on the Tel Aviv stock market are still questionable. That together with a shortage of liquidity is partly why there has been a flight of quality Israeli companies to overseas markets such as Nasdaq, where more than 70 Israel companies worth some $10 billion are listed.
Privatisation has been painfully slow and a large sector of the economy - from banking to Telecoms and power generation - is still firmly in state hands. The promised sell-off of the profitable state airline El Al has been made more difficult by the religious nature of the state, which prevents flying on the Sabbath and makes privatisation politically sensitive. There is a developing battle between environmentalists and those who favour driving growth even faster, over the development of new road and transport structures, including the expansion of Ben Gurion airport and a new 'Peace' airport under joint Jordanian/Israeli control at Akaba in the South of the region. Such projects will be among the first to be derailed should the Hamas bombings destroy the peace process and the new openness of the Israeli economy. If, however, economic expansion and inward investment is sustained, despite the troubles, then this fresh infrastructure will still be needed.
Alex Brummer
Source: Airline Business
