By Nick Mann | 2 August 2012

Israel’s deficit targets are at risk despite the austerity package approved this week by the country’s coalition Cabinet, Fitch Ratings warned yesterday.

In a note, the ratings agency said ministers’ support for Finance Minister Yuval Steinitz’s proposals to increase revenue and cut spending was ‘positive’. But the country was unlikely to meet its budget deficit target of 2% of gross domestic product. Its 2013 target was also at risk, Fitch said. This was increased from 1.5% to 3% of GDP last month.

Among the measures backed by the Cabinet on Monday were a 1% rise in VAT from September 1 – taking it up to 17%; increases in income tax; and efforts to chase down large companies with outstanding tax bills.

Together, the finance ministry expects these measures to add £2.3bn to the government’s revenues next year, which will be further boosted by a 5% cut in departmental budgets this year and a 3% cut in 2013.

Israeli Prime Minister Binyamin Netanyahu said the measures were needed to protect the country's economy and jobs. 'We need to act responsibly, with determination and in time,' he told the Cabinet.

Against a background of falling revenues and a slowing economy, Fitch said ‘the renewed effort at fiscal consolidation is a positive development’.

It added: ‘Bank of Israel governor Stanley Fischer, who previously warned against any loosening of fiscal policy, has welcomed the package. A commitment to fiscal tightening could give the Bank of Israel, which left rates unchanged at 2.25% last week, room to ease monetary policy further, potentially supporting the Israeli economy.’

But the deficit target for 2012 was still ‘unrealistic’, it said. Israel’s A-rating with a stable outlook was last affirmed by the agency in April when it forecast a budget deficit of 3.7% this year as growth slows. While the new measures would be equivalent to around 1.8% of GDP, their main impact would be felt next year, Fitch explained.

Government debt last year amounted to 74.2% of GDP and Fitch said that it would have to fall significantly to improve the country’s rating.

‘A positive rating action on Israel would require the debt/GDP ratio to fall nearer to the government's 60% target. Conversely, a prolonged rise in the ratio and/or sustained fiscal easing would prompt a negative rating action.’

The austerity package will have to receive Parliament’s backing next week before it can be implemented.