Twelve economists recently predicted that Israel’s gross domestic product (GDP) will expand 2.8% in 2012. That is a rate that most of the developed world can look on with envy.

Nevertheless, the forecast puts Israel’s pace of growth far below the 5% annual pace of the previous two years. Many economists say Israel faces more downside risks to its growth outlook, especially in the first part of the year, until it becomes clear whether Europe can sort out its debt problems.

There are stimulus measures being taken all over the world, but they will only be felt in the second half of the year.

Thanks to fiscal policies and bank lending that were both conservative, Israel stood aloof of the world financial blow-out of 2008. Economic growth briefly slowed at the end of 2008 and early in 2009, but quickly recovered so strongly that Israel was rare among industrialized economies to experience ballooning home prices over the past two years. Its unemployment rate at the end of 2011 was at its lowest since the 1980s.

But with a second financial crisis threatening—this time originating in European sovereign debt rather than US mortgages—Israel will again have to contend with a downturn not of its own making. And this time, Israel’s parameters are in some cases weaker than they were going into the last global crisis.

“It is uncertain how much growth can withstand further global economic deterioration,” Daniel Hewitt, Barclay’s Capital Israel economist, said in a recent report. His forecast for 2.5% growth in 2012 is the lowest among the economists polled.

While the Israeli government didn’t run up big debts bailing out banks as its counterparts did in Europe and the US, Israel nevertheless now has bigger budget deficits than it did going into the last global downturn at a time when the world’s financial markets are more alert than ever to countries’ fiscal profiles.

Worse still, Prime Minister Binyamin Netanyahu has less leeway than in the past to impose fiscal discipline. The army is demanding more money to cope with the security risks to Israel created by the Arab Spring, while the mass social protests over the summer of 2011 have increased demands from the public for more government assistance for everything from education to more health care.

Netanyahu decided not to cut the army’s 2012 budget. With slower growth expected to cut into government tax revenues this year, there will be little room for increased social spending, including a proposal for longer school days, that were at the heart of a series of recommendations made by a government panel to alleviate income disparities.

Slower growth will feed into higher unemployment, which will only increase the pressure on Netanyahu to act.

Shlomo Maoz, chief economist at the investment bank Excellence Nessuah, said he sees output slowing in the first half of the year, but thinks it will be followed by a strong rebound in the second.

“Israel is relatively immune from global problems, We have increased exports to others countries outside of Europe. Our new export markets—Asia, South America and others—are now close to 50% of total exports.”

Bank of Israel Governor Stanley Fischer has already acted in anticipation of the economy’s more sluggish pace by cutting interest rates by a half percentage point over the past four months to 2.75%. One reason he can act so decisively is that inflation is no longer the threat it was last spring and summer, when it was running at a rate above 4%.
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David Rosenberg is a writer for Media Line. This article was edited to fit the page.