Israel’s Economy on the Edge: War Costs Mount as Tenacity Fades and Financial Risks Soar.
Israel’s economy is grappling with profound challenges as the conflict with Hamas, Hezbollah, and other regional actors intensifies. The financial strain on the nation is mounting, with far-reaching consequences for Israel’s long-term economic prospects. The ongoing military engagement, which now encompasses a multi-front conflict involving Gaza, Lebanon, and potential retaliation from Iran, has exacerbated fiscal pressures, raising alarm among economists and analysts about the nation’s capacity to withstand prolonged warfare without sustained damage to its financial foundation.
Mounting Costs and Economic Contraction.
Israel’s Finance Minister, Bezalel Smotrich, has been keen to emphasize the resilience of the country’s economy, accentuating its historical ability to attract investment regardless of geopolitical tensions. However, the current war, described as the most protracted and expensive in the country’s history, stretches that endurance to its limits. The scale of the conflict, compounded by cross-border hostilities with Hezbollah and the looming threat from Iran, is projected to deliver a substantial blow to Israel’s economic output.
Before the Hamas attack on October 7, Israel’s economy was on track to expand by 3.4% in 2024, according to IMF projections. However, recent estimates have revised growth downwards to 1% and 1.9%, a drastic reduction reflecting the deepening uncertainty and disruption across critical sectors. The Institute for National Security Studies at Tel Aviv University has raised concerns that GDP per capita, which had outpaced that of the UK in recent years, will decline, with population growth outstripping economic expansion, leading to a drop in living standards.
Israel’s central bank finds itself in a precarious position. Inflationary pressures, spurred by rising wages and escalating government expenditure to fund the war, preclude the possibility of monetary easing. Despite the need to stimulate economic activity, the Bank of Israel must maintain higher interest rates to rein in inflation, compounding the difficulty of economic recovery. Furthermore, with military and civilian outlays expected to reach 250 billion shekels ($66 billion) through 2025, according to the bank’s earlier estimates, the fiscal outlook remains grim. Analysts now anticipate this figure will swell as the conflict drags on, particularly with fresh incursions into southern Lebanon and persistent airstrikes targeting Gaza and Beirut.
The Growing Deficit and Government Borrowing Costs.
The conflict has already doubled Israel’s budget deficit to 8% of GDP, up from 4% before the war, reflecting the dual pressures of ballooning military expenditure and falling tax revenues. A deepening budgetary shortfall will likely lead to further borrowing, which has already become more expensive as Israel’s credit rating deteriorates. Leading agencies, Fitch, Moody’s, and S&P, have all downgraded Israel’s credit rating, signaling to international investors a heightened risk premium for Israeli bonds. The yield demanded by investors to hold Israeli sovereign debt has risen, reflecting concerns over the country’s ability to manage its swelling fiscal obligations amid continued conflict.
Israel’s economy, heavily reliant on its vibrant tech sector, may face long-lasting structural damage. The tech industry, accounting for 20% of the nation’s GDP, has shown remarkable strength thus far, but prolonged instability threatens to erode that foundation. There are growing fears of an exodus of top talent, exacerbated by the uncertainty surrounding the war and earlier controversies over judicial reforms, which had already sparked moves by some tech firms to register abroad. The consequences for the broader economy could be profound if highly skilled professionals and entrepreneurs begin to leave in significant numbers. Karnit Flug, a former governor of the Bank of Israel, emphasized that even the migration of a relatively small group of elite innovators could cripple the tech sector, which relies heavily on a select few to drive growth and maintain its competitive edge.
Sectoral Impacts: Tourism, Agriculture, and Construction
While the tech sector has managed to weather the storm, other parts of Israel’s economy have been hit far harder. Tourism , a critical source of revenue, has seen a steep decline. The Israeli Ministry of Tourism estimates the war has led to 18.7 billion shekels ($4.9 billion) in lost revenue since last October. Hotels, restaurants, and tour operators are reeling from plummeting occupancy rates, with no clear indication of when the sector might recover. The once-booming tourism industry faces a prolonged downturn as international visitors remain wary of travel to the region.
Agriculture and construction have also been severely impacted, with labor shortages exacerbated by the suspension of work permits for thousands of Palestinian laborers. This has led to a surge in the cost of fresh produce and a sharp drop in housing starts, driving up inflation further and adding to the government’s economic woes. The construction sector, vital for accommodating Israel’s fast-growing population, is now in a state of paralysis, compounding concerns about rising housing costs and social unrest.
Potential for Long-Term Damage
Perhaps most concerning are the warnings that the war may leave Israel’s economy in a permanently weakened state, regardless of the outcome on the battlefield. The Institute for National Security Studies predicts that even in the event of a ceasefire and de-escalation, Israel’s growth trajectory will remain subdued for years to come. The Yom Kippur War of 1973 offers a stark historical parallel: following that conflict, Israel entered a “lost decade” of economic stagnation, driven by spiraling defense costs and a sluggish recovery.
A similar scenario could unfold today as the government faces difficult choices about balancing the budget. Finance Minister Smotrich has already floated the idea of raising taxes and cutting non-defense spending to fund what many expect to become a permanently enlarged military apparatus. Such austerity measures could further depress economic growth, leaving the nation vulnerable to a protracted period of low productivity, sluggish investment, and weakened social cohesion.
The risk of recession looms large, with some analysts fearing a contraction as severe as 10% in Israel’s GDP should the conflict escalate further, particularly if fighting with Hezbollah intensifies and Israeli infrastructure suffers widespread damage. The prospect of a 15% budget deficit, as predicted in a recent scenario analysis by the Institute for National Security Studies, emphasizes the gravity of the situation.
Conclusion: A Tenuous Future
Once a beacon of stability in a volatile region, Israel’s economy now stands at a crossroads. The escalating war, coupled with the ripple effects of credit downgrades, rising inflation, and ballooning defense spending, threatens to undermine years of economic progress. The endurance that Finance Minister Smotrich speaks of will be tested like never before as Israel grapples not only with the immediate costs of conflict but with the long-term consequences of a potentially permanent shift in its economic landscape.
The uncertainty surrounding the war’s duration and outcome weighs heavily on the nation’s economic future. While some sectors, like tech, may retain their ability to bounce back, the broader economy faces a long, hard road to recovery, with lasting implications for growth, living standards, and Israel’s role in the global economic order.
Sources:
https://www.timesofisrael.com/prolonged-gaza-war-hits-israeli-economy-with-unexpected-slowdown/
