In the face of war, how much longer can the Israeli economy hold out?

The Israeli economy deemed robust and efficient by the International Monetary Fund, was in a period of relative stagnation when the war against Hamas began. Nearly two months later, the Israeli authorities are still able to contain the shock, but cracks have begun to appear.

"The Israeli economy has been in a very bad way since Oct. 7. The budget deficit has exploded — it reached the equivalent of $6 billion in October, compared to $4.6 billion a month earlier — and every day that passes it loses $250 million," explained financial expert Michel Santi.

On Monday, the Israeli Central Bank (ICB) estimated the cost of the war at $53 billion, Bloomberg reported. "This represents around 10% of Israeli GDP, which is, at least at first sight, quite credible given what the Israeli authorities seem to have spent since the start of the conflict," says Ishac Diwan, Professor of Economics at the École Normale Supérieure in Paris and Senior Researcher at AUB's Issam Fares Institute. "When we measure the cost of this war, we wonder why the parties involved are not in a hurry to make peace," Diwan said.

The shekel and employment

One of the main areas of haemorrhage in the Israeli economy is the exorbitant sums that the ICB has to spend to support the shekel, of which the exchange rate was already at a particularly low level before the Hamas offensive.

According to official Israeli figures cited by Michel Santi, the institution buys back 7 billion shekels a day (nearly $190 million at the current exchange rate) to support the currency. This keeps the shekel at a higher level than at the start of the war, but at $0.27, it is still well within the low range of the past five years.

These efforts come at a cost. In a statement published last Tuesday, the Bank of Israel declared that the country's foreign exchange reserves had reached $191.2 billion in October, compared with $198.55 billion a month earlier, according to Bloomberg. At the start of the war, the ICB announced that it had released a total of $45 billion just to support the shekel.

Secondly, the Israeli economy has been slowing down since the onset of the war, which continues to cost the state dearly. "There are more than 350,000 reservists, most of whom work in the technology sector, the main contributor to Israeli exports. In some companies, the offices are currently empty," explained Santi. Ishac Diwan also noted that many Israelis have had to flee conflict zones, generating both costs for the state and a loss of revenue for the Israeli economy. This economic strain is compounded by the fact that even while the economy was booming in 2022, Israel already had a trade deficit of nearly $40 billion, according to figures from the French Treasury.

The blow to the tech industry has been devastating. In a recent interview for Deutsche Welle, economist Dan Ben-David, lecturer at Tel Aviv University and head of the Shoresh Institute for Socio-Economic Research Dan Ben-David, highlighted that the sector employs only 10% of the country's workforce yet generates almost half of its exports. He sees this dependence as double-edged. "We've put all our best eggs in one basket," Ben-David told DW, adding that a setback in this area would have repercussions for the entire country.

The other sector in difficulty is tourism (accounting for almost 3 percent of GDP and 6 percent of jobs), which has seen its revenues fall by around 70 percent since the start of the war, added Michel Santi. He also noted that the war has had a direct impact on the construction and agricultural sectors, which employ 30,000 and 15,000 Palestinian nationals respectively, whose labour is cheaper. This situation mirrors that of the construction sector in Lebanon, which is dominated by Syrian workers.

"This demonstrates the close link, even if many in Israel don't want to acknowledge it, between the strength of the Israeli economy and the cheap labour, some of which is hired in the Palestinian territories," added Santi.

Risk of long-term deterioration

The consequences of this economic slowdown are impacting growth and government revenues. The Israeli Ministry of Finance has finally revised its growth forecasts for 2023 from 2.7 percent to 2 percent, a level considered too optimistic by some monitoring organizations. Earlier this month, the ministry acknowledged that government revenue had fallen by 15.2 percent in October, mainly due to "tax deferrals and a fall in revenue from the collection of social security contributions."

This expenditure, projected to reach around $44 billion out of the $53 billion estimated by the ICB on Monday, is unlikely to decrease anytime soon. Meanwhile, the $14.5 billion in military aid pledged by the US has still not been released. The US Congress will to resume discussions on the bill this week.

Without even taking into consideration the impact of war on the ground, these imbalances may affect the financial stability of Israel, which has a debt of around $300 billion and almost 10 million inhabitants. This is despite the fact that the debt/GDP ratio was at a sustainable level before the war began, at just over 60 percent of GDP.

In October, two out of the three main financial rating agencies, Fitch and Standard & Poor's (S&P), lowered the outlook for the country's sovereign debt to "negative," which could eventually lead to a rise in the cost of borrowing. The third agency, Moody's, declared in October that it was considering downgrading Israel's debt rating itself for the first time. Additionally, S&P said last week, that the Israeli banking sector was facing a "long-term deterioration in economic prospects and credit conditions."

Risk of boycott

Faced with these risks, the ICB is stalling but is calling on the government to react. It has not yet decided to change its short-term interest rate (which remains at 4.75 percent, its highest level since 2006). However, the institution recently took the view that the amendments to the Israeli state budget prepared by Benjamin Netanyahu's government were not sufficient to finance the war, calling for more cuts in other areas of expenditure.

The ICB's caution is warranted, given the scale of the bill it is expecting to pay. "Israel has a real interest in keeping this conflict as short as possible, even if its reserves are far from exhausted," said Michel Santi. Meanwhile, the Council of Ministers has approved the draft budget, which is pending a vote by the Knesset.

In an analysis published last week and partly based on an interview with the Israeli Ministry of Finance's Accountant General, Yali Rothenberg, Bloomberg considered that the BCI's remaining foreign exchange reserves were sufficient to finance the war for around two years. Several experts in Israel also played down the long-term consequences of the war, claiming that the country's debt/GDP ratio was low enough to give it room to maneuver.

However, Santi considered that, beyond economic and financial losses, the Israeli government’s management of the war and the negative image it has projected by destroying half of the Gaza Strip and killing, according to Hamas figures, more than 15,000 Palestinians — the majority of them civilians — risks penalties on Israeli companies for a long time to come.

This article was originally published in French in L'Orient-Le Jour.