Israel: Will Bibi Bring Sharon Down?

Finance Minister Netanyahu's exit may disrupt economic reforms and cause splits in the ruling party, allowing a leadership challenge

By Neal Sandler and Stanley Reed

Finance Minister Benjamin Netanyahu's Aug. 7 resignation in protest of the planned Israeli withdrawal from Gaza is not going to stop the pullout, which is set to begin on Aug. 17. But the charismatic politician's departure from the cabinet creates big problems for Prime Minister Ariel Sharon. Bibi's walkout also raises doubts about whether the economy, which has recovered nicely from the 2000 tech crash and the effects of the Palestinian intifada, will continue its strong performance

Sharon and Netanyahu, a former Prime Minister, together dominate the Likud party. Without Netanyahu's support, Sharon is likely to face difficulty holding the party and the government together. He may be forced to call early elections. If so, Netanyahu, 55, might well take on the 77-year-old legend in a party leadership contest.


  Whether Netanyahu's maneuver will work to his benefit remains to be seen. His departure on the eve of the withdrawal certainly looks opportunistic, if not outright disloyal. Much depends on what happens during the pullout and its aftermath. If it is a disaster, Netanyahu's disassociating himself from the historic step may turn out to have been wise.

Netanyahu's exit has made investors nervous. He took over as Finance Minister in the midst of Israel's worst-ever recession in 2001 and has presided over a remarkable turnaround. Helped by Netanyahu's wide-ranging reforms in everything from pensions to public finances, GDP is expected to grow by more than 4% this year as a result of a surge in exports. Inflation is down to 1.2%, and Netanyahu has brought the usually high budget deficit below 1% of GDP. Even chronically high unemployment has fallen by 2%, to 9%.

No wonder the Tel Aviv Stock Exchange fell 5% on the news of Netanyahu's departure, before recovering modestly on Aug. 8. "The political uncertainty on the eve of the disengagement does not bode well for the economy," says Benny Sharvit, head of research and global markets at Tel Aviv-based Gaon Investment House.


  Sharon quickly replaced Netanyahu with the Prime Minister's close ally, Ehud Olmert, the country's Trade and Industry Minister. Olmert pledged to continue on the reform path, but whether he has Bibi's drive and clout remains to be seen. Netanyahu leaves while in the middle of drawing up the 2006 budget and with major privatizations such as that of Bank Leumi, Israel's second-largest bank, still on the drawing boards.

Netanyahu has endeared himself to business and foreign investors by slashing taxes and putting through large-scale privatizations, including the acquisition of a controlling interest in the national telephone operator, Bezeq Telecommunications Company, by a consortium led by media mogul Haim Saban and Britain's Apax Partners.

But such steps have also created the risk of a backlash. Income inequality is increasing, with more than 20% of the population living below the poverty line, according to a recent study. Some analysts think that further steps toward liberalizing the economy will move to the back burner until after the political situation clears or early elections are held.


  "Netanyahu's departure undermines the implementation of major reforms and could also have a negative impact on the capital markets in the coming weeks," predicts Richard Gussow, senior analyst at Israeli investment bank Excellence Nessuah.

With his move, Netanyahu is taking big risks with the economy and his own political career.

Sandler reports for BusinessWeek from Jerusalem, and Reed is BusinessWeek's London bureau chief