Prime Minister Binyamin Netanyahu’s ideologically eclectic coalition government passed the first major test of its viability in early August, when the Knesset approved an austerity budget for 2013–2014 that includes a range of spending cuts and tax increases. The passage of a two-year spending plan has greatly increased the coalition’s chance of surviving until 2015, assuming there is no need to revise the freshly minted budget.

However, budget negotiations will start anew late next year. At that point, the risk of a crippling impasse will reappear.

First approved by the Cabinet in May, the budget includes a total of $7 billion worth of spending cuts to be implemented between August 2013 and the end of 2014, decisively marking the end of a period of fiscal expansion.  The fiscal plan stipulates an increase in the income tax by 1.5 percentage points, as well as a one-point increase in both the VAT and corporate tax rates.

The plan was initially more ambitious, but Finance Minister Yair Lapid conceded on some points in an effort to minimize the risk of a public backlash against austerity. Despite the cuts, government spending will still rise by more than 5 percent in 2014, and the final budget document did not include a planned tax on home buyers. To avoid strikes by unions, the Finance Ministry postponed wage discussions into 2014, and delayed some of the measures aimed at liberalizing services, such as privatization of ports. 

Lapid defended his plans as a necessary infliction of pain.

Lapid defended his plans as a necessary infliction of pain after the previous administration created a $9.6 billion hole in state finances. However, the attempt to deflect blame failed, and his popularity has plummeted, particularly among his voter base.

The finance minister will have to hope that his fiscal program succeeds in narrowing the deficit without sacrificing too much economic growth in the process. What constitutes “too much” in the minds of an average voter is very subjective. And with poll data indicating that voters are already disappointed with Lapid, any chance of a recovery in popular support may well hinge on an upside surprise in the economic data.

A delay in completing a leadership transition at the central bank is unfortunate, as a strong currency — the shekel hit a two-year high against the dollar in August — threatens the competitiveness of the export sector, which accounts for more than one-third of total GDP. Monetary authorities cut the benchmark interest rate twice in May, to 1.25 percent, its lowest level since March 2010. The central bank has held the rate steady for the last three months, while pledging to buy $2.1 billion in foreign currencies by the end of 2013 in a further bid to ease pressure on the shekel.  

Elsewhere, the Arab League has attempted to breathe new life into the peace process by partially retreating from its long-standing demand that the borders in place prior to the Six-Day War in June 1967 be the basis for any final settlement on the creation of a Palestinian state. However, the prospects for a breakthrough remain dim, owing to the continued expansion of Jewish settlements in the West Bank.

Moreover, peace talks with the Palestinians may become less of a priority amid tumult in Egypt and the threat of U.S. military strikes on Syria, both of which pose immediate security risks for Israel.

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