While Israel’s military has had success on the battlefield to the north, south, and east, its finance ministry is having to dodge economic bullets of the state’s own making, with several key indicators heading in the wrong direction.
Israel’s budget deficit is now at 8.3% of gross domestic product (GDP), growth has slowed to 1.5%, big private sector projects are being delayed, foreign investment is down by 4.7%, inflation is up to 3.6%, and there are serious labour shortages. While none are disastrous on their own, together, they spell trouble.
Key to this is the sharp rise in military spending driven by Israel’s multiple offensive actions in Gaza, Lebanon, Syria, Yemen, and Iran. This, in turn, has driven the budget deficit up, while key sectors like technology are struggling with labour shortages, with so many reservists drafted in to fight in Israel’s armed forces.
For many, the mood has changed, and investors are increasingly looking elsewhere. With already-high prices in Israel on the rise, some fear a “lost decade” of anaemic growth that threatens Israel’s long-term stability. Others think Israel’s economy is strong enough to weather the storm, especially given its world-leading tech sector. All agree, however, that its economy faces a crisis.
Feeling the pain
Israel’s wars have caused massive physical damage to its neighbours, but they have also done economic damage across virtually all sectors at home, shaking the country’s financial foundations. Its economy is now under huge pressure.
According to the Bank of Israel, war from 2023-25 could cost Israel more than $55bn, or around 10% of its economy, but economist Yaakov Sheinin, a long-time advisor to Israeli leaders, thinks it could reach $120bn. Israel’s Ministry of Finance puts its daily war costs at $130m, while its Ministry of Tourism reports losses of $5bn over the past year, a fall of 78% since October 2023.
Israeli newspaper Maariv reported that around 48,000 Israeli companies have declared bankruptcy since October last year, when Hamas attacked southern Israel. Another 12,000 are likely to do so by the end of the year. Yet Israelis have not just lost their businesses, with 120,000 still displaced within the country.
The International Monetary Fund (IMF) has revised its growth forecasts for Israel this year, halving its expectations to just 0.7% from an estimate of 1.6% in April. This contrasts with the 3% growth predicted in October 2023.
For 2025, the IMF now thinks Israel will grow by 2.7%, not 5.4% as it previously estimated. Inflation projections have also been revised upward, with a rate of 3.1% for 2024, above the Israeli government's target range of 1-3%.
Treading water
War's repercussions are being felt across most sectors. Before October 2023, Israel's economy was healthy, with GDP per capita rising by 4.8% in 2022, and its tech sector was booming. Given that tech accounts for a fifth of Israel's GDP and more than half of its exports, that was important.
There are now fears of a prolonged downturn on the back of a defence spending increase of $48.4bn and the mobilisation of 360,000 reservists, which has disrupted businesses and intensified labour shortages in critical industries such as technology, construction, and agriculture. The decision to exclude 140,000 Palestinians from working in Israel has further exacerbated the problem.
Rebuilding Israeli infrastructure damaged by the conflict is expected to cost $20bn, which could push the budget deficit even higher. Of more concern in Tel Aviv will be the future plans of several big technology firms, which have suspended operations in Israel, citing security and growing political risks.
Israel is known as the 'start-up nation' for the number of firms it grows from scratch, but foreign investment is an essential requirement for any pipeline, and this is down by 4.7%, threatening many fledgling Israeli companies.
The government was quick to support the economy. A $2.7bn loan fund provided financial assistance to struggling businesses, grants were made to companies suffering significant revenue losses, and workers from India and Sri Lanka were given temporary visas to enter Israel to fill roles vacated by reservists and Palestinians. But analysts agree that these measures have had a limited impact.
Warning lights
The Israeli shekel has been shaken. In October 2023, shortly after Israel ramped up its war in Gaza, the currency's value fell to about 4 shekels (NIS) per dollar, but this has since risen again to around NIS 3.5 per dollar. The Bank of Israel intervened by selling $8bn from its reserves, but the relief is temporary.
Inflation hit a ten-month high of 3.6% in August 2024, driven by defence spending, wage increases, and higher commodity prices, but dropped slightly to 3.5% by the autumn. Interest rates have stayed at 4.5%, which has not helped cash-strapped households but has resulted in bumper profits for Israeli banks, who have had to pay an additional 6% tax on profits for 2024-25.
The impact of a 'brain drain' on Israel's technology sector will be a concern if those with the required skills choose to relocate abroad due to the security and political situation. Even a modest exodus of talent could undermine Israel's position as a global leader in fields like AI and cybersecurity.
One industry that has not suffered from Israel's wars is its defence sector, which has benefitted from increased defence spending. But the prospect of more countries refusing to 'buy Israeli' could be a cloud on the horizon, given that Israel earned $12.5bn from defence exports as recently as 2022.
Bumps ahead
Ministers think Israel will recover once the war ends, Prime Minister Benjamin Netanyahu and Finance Minister Bezalel Smotrich pointing to previous such recoveries (including after the 2014 Gaza war) as evidence of economic resilience. Yet some economists think the situation in 2024 is fundamentally different to conflicts in the past.
For now, the government has revised its growth forecast for 2024 from 3% to just 1.5%, and some think fiscal pressures could now force austerity measures, including tax hikes and public spending cuts. This may weaken consumer confidence, delay recovery, and open the door to economic stagnation, as happened after the 1973 war.
As Israel navigates the turbulence, it is trying to balance military preparedness with economic stability. The government will soon seek to attract investment and economic aid from donors, some of whom may be reluctant to help, given Israel's war conduct and the unprecedented death toll among Palestinian and Lebanese civilians.
A lot will depend on Israel avoiding recession, and the coming months will be pivotal for its economy. With no end in sight to the war in Gaza and with new security concerns in Syria, the markets will be watching closely.
