War on Gaza threatens Israel's already weakened economy

From a devalued currency to a disproportionate impact on the tech sector and a collapse in foreign investment, the problems caused by Netanyahu’s political crisis will be much worse during open conflict

Majalla/Agencies

From a devalued currency to a disproportionate impact on the tech sector and a collapse in foreign investment, the problems caused by Netanyahu's political crisis will be worse during open conflict.

War on Gaza threatens Israel's already weakened economy

Nazareth Seferian

last update on 25 Oct 2023

Israeli Prime Minister Benjamin Netanyahu made his intentions clear on how his military would respond to the 7 October attacks on the country carried out by Hamas.

“Like never before,” he pledged.

“I said that every place from which Hamas operates will turn into ruins. It is already happening today and will happen even more in the future”.

The human cost of this escalation has already been heavy for Palestinians as well as Israelis. There will also be an impact on Israel’s economy, which was already under pressure from the country’s political crisis before its war on Gaza took a further toll.

These are the main economic factors Israel now faces after the start of a war.

Currency and confidence

The Israeli economy was already in trouble before 7 October.

Its currency, the shekel, had weakened from 3.53 to the dollar, reaching 3.84 in the week preceding the attack. In the second half of October, the dollar price in shekels hit 4.06. The Central Bank of Israel announced a $30bn intervention to support its currency.

shutterstock — Its currency, the shekel, had weakened from 3.53 to the dollar, reaching 3.84 in the week preceding the attack.

Economic growth forecasts were already coming down.

For 2022, the value of all the goods and services produced by Israel’s economy – as measured by gross domestic product (GDP) – grew by an impressive 6.5%. By the summer, it was forecast to fall to 3%, and there was widespread public anger at the increased cost of living alongside bitter internal political divisions.

In September, the finance ministry reported that foreign investments were down 60% in the first quarter of the year from 2022. When an Israeli startup is sold to new owners, the average exit transaction dropped by around 80% in the same period.

In September, the Israeli finance ministry reported that foreign investments were down 60% in the first quarter of the year from 2022

Political price for foreign investment

The reasons behind the trend were varied, including the state of the technology sector of the United States economy and the indirect effects of the war in Ukraine. But a significant factor was the internal political turmoil in Israel – not least the controversial attempts by Netanyahu's government to overhaul the judicial system – which unnerved investors.

People hold placards and Israeli flags during a demonstration, as Israeli Prime Minister Benjamin Netanyahu's nationalist coalition government presses on with its judicial overhaul, in Tel Aviv, Israel March 25, 2023.

IVC Research Centre and LeumiTech released data that revealed how fundraising for Israeli technology firms had fallen by more than 65% in the second quarter of 2023 compared to the same period in 2022. Job cuts in the tech sector had increased – Google reduced its team in the country, and Uber terminated operations in Israel.

In an article in Al-Monitor, Omer Moav – former Netanyahu advisor and a professor of economics at Warwick and Reichman University – said: "There is a world slowdown in investments in the high-tech sector, but it is much worse in Israel. And it seems that the reason is the current Israeli government and, in particular, the judicial revolution, or the fear of such a revolution."

All of this suggests that the Israeli economy was on the back foot even before Israel declared war on Hamas. The question is how much further damage to its standing will have been done by conflict.

The reasons behind the downward trend were varied, but a significant factor was the internal political turmoil in Israel – not least the controversial attempts by Netanyahu's government to overhaul the judicial system – which unnerved investors.

Labour force factor hits tech sector

When Israel launched an offensive against Gaza in 2021, the Israeli newspaper Yedioth Ahronoth estimated that each day of bombing caused the country $37mn in direct economic losses.

The scale of the current conflict may make that amount look modest.

The New York Times has reported that around 360,000 reservists have been called up for duty in a military campaign expected to feature a ground offensive in Gaza. Given the average younger age in the technology sector workforce, it is likely that the sector is bearing a disproportionate share of these numbers.

AFP — Israeli army soldiers patrol an undisclosed area in northern Israel bordering Lebanon on October 15, 2023.

According to Avi Hasson, CEO of Start-Up Nation Central, an Israeli nonprofit that connects startups with investors, that may have massive implications for the country's economy. In an interview with Bloomberg Television, he said:

"The business plan of Israel is high tech, to put it in a short sentence. About 18% of our GDP is driven by high-tech, about half of our exports… A certain percentage of the workforce has been enlisted to reserve duty. We estimate that number to be about 15% of the workforce in high-tech."

In another interview, Eran Yashiv – an economics professor at the London School of Economics and Tel Aviv University – said:

"The economic cost for Israel in this context is two-fold. On the one hand, you lose the output produced by these people… on the other hand, you have to finance their mobilisation into the war effort, which is obviously costly."

A certain percentage of the workforce has been enlisted to reserve duty. We estimate that number to be about 15% of the workforce in high-tech.

Avi Hasson, CEO of Start-Up Nation Central

Spending more on war

Governor of the Bank of Israel Amir Yaron is at the forefront of dealing with how the war will affect the country's economy.

In a video call with IMF and World Bank officials, he said that the situation would most likely require budget adjustments from the Israeli Government.

The New York Times reports that Israel spent more than $23bn last year on the military, with this budget usually worth over 4% of GDP. The US provides around $3.8bn in annual aid and President Joe Biden committed an additional $8bn in military and security aid for Israel a few days after the war started.

The central bank is faced with the choice of reducing interest rates to help bolster the wartime economy or to keep them elevated to support the currency. An announcement from the Bank of Israel on whether to keep rates at 4.75% will be forthcoming soon.

Israel's central bank on Monday held its interest rate at its first meeting since the attack by Hamas, likely in an effort to keep depreciation of the shekel in check, despite the war inflicting new uncertainties on the country's economy. https://t.co/RPX3pk5WHQ
— WSJ Central Banks (@WSJCentralBanks) October 23, 2023

Professor Yashiv was not optimistic about Israel's currency: "I don't see the Shekel strengthening by very much. The possibility of that is remote at this stage. But I think the uncertainty is over how far the depreciation will go."

According to some reports, the central bank is expected to lower interest rates by 0.5%. Israel's CTech website expects such a move.

It is likely to be based on a scenario in which the war lasts up to six months and is limited to the country's south but is a high-intensity conflict. This baseline analysis expects damage to the Israeli economy at the same level as during the Second Lebanon War.

But the unknown factor in 2023 is the large number of reservists that have been mobilised, which will have implications beyond those seen in the comparison war.

The Bank of Israel expects the economy to shrink in the year's final quarter and is looking at a GDP drop of 1% or around 20bn Shekels.

Goldman Sachs told clients it expected Israeli financial authorities to "remain cautious due to potential risks for the conflict to escalate further."

The Bank of Israel expects the economy to shrink in the year's final quarter and is looking at a GDP drop of 1% or around 20bn Shekels.

Clouded outlook, but some diplomatic hope

For all the analysis being carried out and the forecasts issued on costs, no observer can be certain of what will happen. The clash between Israel and Hamas can potentially develop into a bigger regional conflagration or even a global war.

AFP — French nationals leaving Israel for France, wait to check-in at Ben Gurion International Airport near Tel Aviv on October 14, 2023.

When The New York Times asked how Israel's economy would be impacted, Avi Hasson of Start-Up Nation Central said, "In terms of economic impact, I think it's too soon to tell." But he was aware of the war's threat to the progress recently made in a rapprochement between Israel and the United Arab Emirates and Saudi Arabia.

In an interview to Bloomberg Television, Hasson said:

"It's obvious that this war poses a challenge to this relationship. Obviously, these are troubling times in that respect. It's much harder now to conduct that sort of business. All of these governments in the region have internal public opinion to manage."

But he ended with a note of optimism for these cross-border partnerships:

"I think it will take time to go back to where we were, but the forces are too strong to stop progress and innovation from achieving collaborative prosperity."

Given the expectation that this will be a long war, Israel is not yet aware of its full impact on the economy. It has been resilient in the past, but with different conditions could come a different outcome.

+ / -