Israel’s finance ministry has sharply revised down its economic growth forecast for 2024, reflecting the toll the ongoing war in Gaza is taking on the country’s economy. The ministry now expects gross domestic product (GDP) to grow by just 1.1% this year, a significant drop from the earlier estimate of 1.9%. The downgrade, attributed to weaker-than-expected economic data in the second quarter, points to Israel’s slowest economic expansion since 2009, with the exception of the pandemic-induced contraction in 2020.
The war, which began on October 7 when Hamas militants launched a large-scale attack on Israel, has deeply impacted multiple sectors of the Israeli economy. Industries such as construction, agriculture, and tourism have been hit hard, while defense spending has surged to fund military operations. Ongoing skirmishes with Hezbollah fighters in Lebanon have further strained the economy, adding to fears of broader regional conflict.
Economic impact of the war
The Israeli government estimates the cost of the war could reach $66 billion by the end of 2025, a figure that amounts to more than 12% of the nation’s GDP. With the fiscal deficit projected to balloon to 7.8% of GDP this year, up from 4.1% in 2023, the war’s financial burden is mounting rapidly.
The increase in Israel’s fiscal deficit and the costs of military operations have already led to significant market reactions. The country has seen its government bond yields rise relative to U.S. Treasuries, a signal that investors are becoming increasingly wary of Israel’s economic outlook. Furthermore, Fitch Ratings downgraded Israel’s credit rating from A+ to A in the wake of the Gaza conflict, citing the possibility that the fighting could extend into 2025 and warning of the risk that it might escalate into a wider regional war. This marks the first downgrade in Israel’s history, though the country still retains high investment-grade ratings in the single-A range.
Defense spending and fiscal challenges
The heightened defense spending, driven by Israel’s military operations in Gaza and the northern border skirmishes with Hezbollah, has played a key role in the finance ministry’s lowered growth projection. The government’s war expenditures have soared, diverting funds from other sectors and putting pressure on the fiscal balance. The budgetary strains are compounded by a slowdown in tax revenues, particularly from sectors like tourism and construction, which have been severely affected by the ongoing conflict.
Fitch Ratings warned that the persistent uncertainty surrounding the war could further weaken Israel’s economic position, projecting that the debt-to-GDP ratio could rise in the coming years as the conflict drags on. Should the fighting escalate, particularly with Hezbollah, the economic and financial fallout could be even more severe.
Inflation and central bank policy
In addition to slower growth, Israel is grappling with rising inflation. Consumer prices have accelerated, with the latest inflation rate recorded at 3.2% year-on-year, above the central bank’s target range of 1-3%. Despite this, the Bank of Israel is unlikely to lower its key interest rate, currently set at 4.5%, before 2025, given the inflationary pressures.
Andrew Abir, deputy governor of the Bank of Israel, expressed skepticism last month about the possibility of monetary easing in the near future, noting that conditions for a rate cut are unlikely to materialize before the end of the year. The central bank is expected to maintain its current rate to combat inflation, even as economic growth falters.
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International diplomatic efforts
While the war continues to weigh heavily on Israel’s economy, international diplomatic efforts are underway to deescalate the situation. U.S. President Joe Biden, along with leaders from Qatar and Egypt, is working to broker a ceasefire between Israel and Hamas. The White House is reportedly preparing a new proposal to present to both sides, in hopes of breaking the current deadlock in negotiations.
A ceasefire, if achieved, could provide some economic relief by easing the immediate pressures on Israel’s defense budget and allowing for a shift in resources back toward domestic growth initiatives. However, the finance ministry’s revised projections already account for the assumption that the conflict will not escalate into a full-scale war with Hezbollah, a powerful group in Lebanon. Should such a broader conflict materialize, the economic consequences could be even more dire.
Israel’s economic outlook has deteriorated significantly as the war in Gaza continues to strain the country’s finances. With growth projections slashed and defense spending on the rise, the government faces a growing fiscal deficit and heightened concerns from investors. The risk of further conflict, particularly involving Hezbollah, remains a key factor in determining Israel’s future economic trajectory. As diplomatic efforts persist, the immediate challenge for Israel will be managing the dual pressures of rising defense costs and slowing economic growth.
