Economic Strain in Israel Amid Ongoing Conflict

By Libby George, Karin Strohecker and Steven Scheer
LONDON/JERUSALEM (Reuters) – Israel’s economy has, for nearly a year, endured the upheaval caused by war, which threatens to escalate into a regional conflict. However, increasing borrowing costs are beginning to strain the nation’s financial framework.

War Funding Costs

The direct cost of funding the war in Gaza through August reached 100 billion shekels ($26.3 billion), according to the finance ministry. The Bank of Israel estimates that this total could soar to 250 billion shekels by the end of 2025, a figure that does not account for Israel’s recent military actions in Lebanon against Hezbollah.

Credit Ratings and Economic Metrics

These developments have prompted credit rating downgrades, which could have long-lasting economic repercussions. Currently, the cost of insuring Israel’s debt against default stands at a 12-year high, coinciding with a rapidly increasing budget deficit.

Sergey Dergachev, a portfolio manager at Union Investment, commented: “As long as the war continues, the sovereign debt metrics will continue to worsen.” Last year, Israel’s debt-to-GDP ratio was at 62%, but borrowing needs are now escalating. Dergachev noted, “Even if Israel has a relatively good base, it will still be painful on the fiscal side, eventually pressuring the rating.”

Government Perspective

Despite these concerns, Israel’s finance minister asserts that the economy is robust and credit ratings are expected to improve once the conflict ends. The war’s costs are significant, driven by the Iron Dome air defenses, extensive troop mobilization, and intensive bombing campaigns. In 2023, the debt-to-GDP ratio hit 67%, while the government deficit reached 8.3% of GDP, above prior expectations.

While core buyers of Israel’s international bonds, such as pension funds and major asset managers, are not likely to divest quickly, interest in purchasing Israeli bonds is waning, with some investors expressing concerns about the ESG implications of the ongoing conflict. For instance, Norges Bank sold a small holding in Israeli government bonds in 2023 due to market uncertainties.

Declining Foreign Investment

Data indicates a decrease in foreign investor participation in Israel’s bond market, with non-residents holding 8.4% (55.5 billion shekels) of bonds by July, down from 14.4% (almost 80 billion shekels) in September of the previous year. Alarmingly, ownership of Israeli stocks by global funds is at its lowest in a decade, with a 29% year-on-year drop in foreign direct investment in 2023, the lowest since 2016.

Local Investment Needs

This situation highlights an urgent need for local investment and government support. In April, the government committed $160 million to bolster venture capital in the tech sector, which represents about 20% of Israel’s economy. Additional expenditures include housing for thousands displaced by the conflict.

The war has also significantly impacted agriculture and construction, key contributors to economic growth. Goldman Sachs reports that Israel’s economy contracted by over 20% in the fourth quarter of last year and remains 1.5% below pre-war GDP levels as of the end of June.

Future Prospects

Despite these challenges, Israel has successfully raised around $8 billion of debt in international capital markets this year. Its diaspora bond vehicle targets record fundraising of over $2.7 billion in annual hauls.
AIthough local investors continue to support funding amid rising costs, their expectations for government consolidation efforts are growing.

($1 = 3.8055 shekels)