Israel’s economy has shown remarkable resilience amidst the ongoing war, which threatens to escalate into a broader regional conflict. However, the country’s financial stability is now being strained by rising borrowing costs and growing war-related expenses.
According to Israel’s finance ministry, the direct cost of funding the war in Gaza up until August reached 100 billion shekels ($26.3 billion). The Bank of Israel estimates that the total cost could soar to 250 billion shekels by the end of 2025, but this projection was made before Israel’s recent incursion into Lebanon to combat Hezbollah forces, which will undoubtedly push expenses even higher. These escalating costs have led to credit rating downgrades, amplifying the economic consequences that could affect the nation for years to come. Additionally, the cost of insuring Israel’s debt against default is now approaching a 12-year high, while the national budget deficit continues to swell.
“As long as the war continues, the sovereign debt metrics will continue to worsen,” remarked Sergey Dergachev, portfolio manager at Union Investment.
Though Israel’s debt-to-GDP ratio—a critical indicator of economic health—was a relatively stable 62% last year, the country’s borrowing needs have now increased significantly. Dergachev noted that while Israel started from a strong economic base, the long-term fiscal impact of the war will be “painful” and could lead to further pressure on its credit rating.
Despite these challenges, Israel’s finance minister has expressed confidence in the country’s economic strength, predicting that its credit ratings will rebound once the war ends. The costs of maintaining the Iron Dome missile defense system, mobilizing large numbers of troops, and conducting extensive airstrikes have contributed to Israel’s debt-to-GDP ratio climbing to 67% this year. The government deficit, meanwhile, has surged to 8.3% of GDP, far exceeding the 6.6% that was previously expected.
Israel’s international bond market, a key source of funding, has begun to feel the effects of these pressures. Investors, particularly those with environmental, social, and governance (ESG) concerns, are showing increasing reluctance to buy Israeli bonds. Some, like Norway’s Norges Bank, have already reduced their holdings in Israeli government bonds, citing “increased uncertainty in the market.”
“What you do see reflecting these concerns is obviously the valuations,” said Trang Nguyen, Global Head of Emerging Markets Credit Strategy at BNP Paribas. Israeli bonds are now trading at significantly wider spreads than those of similarly rated nations, reflecting the heightened risks.
Despite the rising costs and investor concerns, Israel’s finance ministry insists that the country’s financial position remains strong. “Israel’s robust domestic market demonstrates strong demand, and international investors remain familiar with our credit,” the ministry stated, highlighting the growing depth and liquidity of the domestic bond market.
However, central bank data indicates that foreign investors have become more cautious. The share of government bonds held by non-residents dropped from 14.4% in September 2022 to 8.4% by July 2023, even as the overall amount of outstanding bonds increased by more than 20%. The ministry acknowledged that some global investors had offloaded their Israeli bonds due to geopolitical concerns, but added that Israeli institutions had been stepping in to buy more.
Beyond bonds, equity investors are also retreating from the Israeli market. Data from Copley Fund Research shows that international investors have been reducing their exposure to Israeli equities, a trend that accelerated following the Hamas attacks in October 2023. Ownership of Israeli stocks by global funds is now at its lowest point in a decade.
Foreign direct investment (FDI) has also been affected. UNCTAD reported a 29% year-on-year decline in FDI into Israel in 2023, marking the lowest level of investment since 2016. While 2024 data is not yet available, ratings agencies have warned that the unpredictability of the ongoing war could further deter foreign investors.
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In response to these challenges, the Israeli government has ramped up domestic investment initiatives. In April, it pledged $160 million in public funds to support venture capital in the technology sector, which accounts for roughly 20% of the country’s economy. This comes in addition to increased spending on housing for those displaced by the conflict, many of whom are now being accommodated in hotels that have been left vacant by the sharp decline in tourism.
The war’s impact on Israel’s agricultural and construction sectors has been severe, with worker shortages exacerbated by military mobilization and the exclusion of Palestinian laborers. These disruptions, combined with the war’s direct costs, contributed to a more than 20% decline in economic growth during the fourth quarter of 2023. Although there has been some recovery, GDP remains 1.5% below pre-attack levels as of June 2024, according to Goldman Sachs.
Despite these headwinds, Israel has continued to raise significant amounts of money in international markets, selling $8 billion in debt this year. Its diaspora bond vehicle, Israel Bonds, is on track to set a second consecutive annual record with sales exceeding $2.7 billion.
However, the longer the conflict drags on, the more challenging it will be to manage the rising borrowing costs and economic pressures. “There is room for Israel to continue muddling through,” said Roger Mark, an analyst with the Fixed Income team at Ninety One, “but local investors are looking for at least some signs of consolidation efforts from the government.”
