The war unleashed after the Hamas attack on 7 October 2023 caught a prosperous Israeli economy off-guard: a yearly growth rate of 3%, a limited rate of inflation at 3.2%, a rate of unemployment at 3.2% as well and a current account surplus at 4.2% of the gross domestic product (GDP), the highest in the Middle East alongside Saudi Arabia. Two months later an empirical observation by the governor of the Bank of Israel (BOI), Amir Yaron speaking of a ‘major shock’ proves accurate every day. Padlocked shops, construction sites at a standstill, empty bars, one out of three restaurants closed in Tel Aviv, tens of thousands of displaced Israelis (from the North and from the South), disappearance of US and European tourists, no more international flights at the David Ben Gourion airport, expatriation of 300,000 Israeli holders of foreign passports… A heavy mood prevails and everyone is pretty depressed.
What with the 360,000 reservists called to arms and the 163,000 Palestinians workers banned from entering Israel, over half a million active employees are unaccounted for out of an active population of some 4 million and the effect on business is depressing. According to the BOI, activity will have fallen off by 6% in 5 weeks because of the shrunken workforce. There is a lack of lorry drivers, for example, which disorganised the whole network of domestic transports; farming suffers from the absence of thousands of Asian workers. Many citizens have lost their jobs without being inducted into the army, the number of unemployed has climbed to 264,000 according to the Central Office of Statistics. All in all, 740,000 Israelis have been withdrawn from the labour market in just a few weeks. On 22 November 2023 in Barron’s, a major financial weekly, Daniel Egel, director of the Rand Corporation, predicted a business loss of 400 billion dollars in the ten years to come. ‘It is a long-term threat to the country’s economy,’ he wrote.
Solid lines of defence
This may be an overly pessimistic point of view, at least in the short run. Israel’s economy has solid lines of defence at its disposal. Limited indebtedness (less than 60% of its GDP); it has over 191 billion dollars in currency reserves and its current account surplus (over 20 billion dollars) won’t vanish in just a few weeks. The shekel, the national currency, is holding its own against the dollar and the euro, there are no problems accessing international financial markets, the country’s signature is respected and its financial situation inspires confidence. It is rumoured that a loan of six billion dollars was contracted unobtrusively on Wall Street after 7 October, a private investment in euros, yen and dollars, subscribed to in part by Goldman Sachs. In the event there should arise problems with the markets, the US Federal Reserve could provide liquidity directly to the leading Israeli banks as it already did in 2008, for the central banks of some fifteen countries when the crisis caused the markets to cease functioning normally. The BOI has not raised its interest rate very much and the Tel Aviv stock exchange has fallen by only 4% since 31 December 2022. Since 7 October the drop has been only 1% each week.
The fact is that Israel can finance its war with its own resources plus those provided by the USA. ‘We are in a position to finance the State of Israel, including in the most dire circumstances’ was the opinion expressed by Yali Rothenberg, head technocrat at the Finance Ministry. Leader Capital Markets, the country’s main fiscal advisory firm, estimates Israel’s financial needs for 2023 at 48 billion dollars, a third of which would be shouldered by the USA in the form of military hardware.
Thus no financial pressure can force the government to change its policies, unlike what happened, for example, in the Russo-Japanese war at the turn of the twentieth century which came to an end because the French and Anglo American banks refused to continue giving credit to the belligerents, both at the end of their rope.
The high tech sector, the economy’s driving force, is ultra-performing. With 14% of the country’s jobs, it accounts for over half or its exports, especially in the service area. Over 500 multinational companies are present in Israel, which houses a hundred good high tech start-ups. In the long run, part of this activity may move to more peaceful surroundings but for the moment such is not the case, beyond a brain drain dating from before the war and more or less under control.
Investors are worried, of course. Uncertainty, that arch-enemy of business, is running high. In the hydrocarbon sector, the Tamar deposit stopped its activities for a month before resuming on 9 November. But the most drastically affected country is Egypt which sells Israeli gas to European consumers.
The weak point in the system
The weak point of all this may prove to be the public finances. Before the war, the country’s budgetary deficit was estimated by the Economist Intelligence Unit at 4.6% of the GDP, a rate close to that of several European Union (EU) countries. But it might climb to 10%. The cost of the war has been estimated by Finance Minister Bezalel Smotrich at 270 million dollars per week, what with the upkeep of nearly 400,000 soldiers, the cost of the bombs generously used by the Israeli Air force and often imported from the USA or the UK, and the many losses of income due to the business downturn and drop in domestic consumption. A long dawn-out war or its extension to all or part of the Middle East would increase its cost and cause sharper inflationist tensions, unless the government decides to opt for measures of austerity (tax increases, reductions of public assistance and subsidies…), which are hardly popular, even in peacetime.
It was the opposite path that was decided upon in the amending budget of 13.5 billion dollars for 2023, voted after 7 October and entirely debt-financed. One item of expenditure is particularly worrying: the number of Israelis evacuated from the northern and Southern borders where towns and villages were cleared by government order. Right now, 300,000 displaced persons are housed in the country’s big hotels, deserted by the tourist trade, especially on the Dead Sea and at Eilat, the major harbour town on the Red Sea. How long will they have to remain there? For the moment, the financial front can stand the shock. In the last week of November, the demand for State securities and government bonds was six times greater than those emanating from the Treasury.
There remains a political concern: the ‘package deal’ granted last month to the five parties in the ruling coalition, the ‘special allotments’ for the construction of religious schools or settlers’ villages in the West Bank. Those 3.5 billion dollars are the object of bitter political wrangling between the ultra-Orthodox parties, on the one hand, and far-right parties like the Mafdal on the other. The Finance minister’s religious Zionism is caught in a crossfire.
Nobody is willing to give up this windfall. The ministry’s technocrats were not happy about its bring maintained at all and are demanding it be ended in 2024. Bezalel Smotrich is accused of shirking his responsibilities and imperilling the future of Israeli public finances, though for the time being these are holding their own.
