In the midst of the ongoing conflict with Hamas, Israel faces a formidable fiscal challenge, with the Finance Ministry projecting daily expenses of approximately $270 million and a staggering fiscal burden of $48 billion for the fiscal year 2023-2024. As the Israeli military intensifies its efforts against Hamas, the Finance Ministry’s accountant general department is working tirelessly to manage and update real-time financial forecasts, meticulously logging the costs of every aspect of the conflict, from missile interceptors to daily reservist deployments.
Despite the recent development of a potential four-day pause in the fighting due to a hostage deal with Hamas, the economic toll of the war remains significant. Leader Capital Markets, a prominent financial advisory firm in Israel, estimates the war’s cost to be around $270 million per day, contributing to the substantial fiscal price tag for the upcoming fiscal year.
Leader Capital Markets suggests that Israel will likely bear two-thirds of the total costs, with the remaining portion covered by the United States. To finance this considerable financial burden, Israel is poised to borrow extensively, marking a challenging period for the nation’s financial landscape. Yali Rothenberg, the Finance Ministry’s accountant general, acknowledges the risks associated with managing Israel’s $300 billion debt stock but expresses confidence in the nation’s ability to secure financing, even in more extreme scenarios.
The economic shockwaves resulting from the conflict have prompted the Israeli government to shift its economic gears rapidly. While international debt has been issued in various currencies through private placements facilitated by Wall Street banks like Goldman Sachs Group Inc., the government is primarily relying on the domestic market to absorb the majority of its financing needs. Since October 7, the Finance Ministry has already sold 18.7 billion shekels of local bonds, a significant increase compared to the monthly average of just over 5 billion shekels recorded through September.
Demand for Israeli securities has remained robust, reaching over six times the amount offered in recent auctions. Moody’s Investors Service estimates that the government’s gross borrowing needs will account for around 10% of economic output this year, up from 5.7% in 2022. Domestically, interest rates in Israel have risen less compared to many developed economies, making it relatively economical for the government to borrow within its borders. The yield on Israel’s 10-year shekel bond, while slightly increasing since the conflict’s onset, remains lower than that of similar-maturity US Treasuries.
Notably, the Israeli currency has rebounded after initial losses when the war began, thanks in part to unprecedented interventions by the central bank. As the conflict compelled the government to increase fiscal spending, October witnessed a budget deficit more than seven times larger than the previous year, resulting in a gap equal to 2.6% of the gross domestic product (GDP). Rothenberg anticipates a cumulative budget shortfall of about 9% over the next two years.
Bloomberg Economics suggests that while the financial costs are unlikely to be prohibitive for Israel, the country’s $191 billion foreign-exchange reserves could fund the war for approximately two years. Further assistance from the United States, coupled with borrowing from financial markets, aims to fill the financial gap. The resolution of the conflict, however, is expected to hinge more on diplomatic and military developments rather than economic considerations.
Finance Minister Bezalel Smotrich has proposed an amended budget for the remainder of 2023, featuring a spending increase of 35 billion shekels, primarily financed by debt. Additionally, Israel must address an estimated 15 billion shekels of lost revenues in 2023 and replenish a government tax-compensation fund, depleted by 18 billion shekels to cover expenses following the outbreak of the war.
The majority of bond issuance occurs domestically, accounting for over 80% of the total. Despite potential challenges in foreign markets, Israel faces a less welcoming market abroad, with the cost to insure sovereign bonds against default doubling since the conflict began.
To alleviate unease in the financial markets, the accountant general department has intensified outreach efforts to rating agencies, foreign and local market makers, providing real-time data and explaining unfolding developments. Efforts are also underway to facilitate inflows into the high-tech industry by engaging potential investors and companies seeking capital.
Despite being a country at war, Israel has historically experienced significant economic rebounds following military operations. The financial strain has prompted increased scrutiny from major rating agencies, leading to a negative outlook. However, Israel has managed to avoid a first-ever downgrade thus far.
As Israel grapples with the financial challenges presented by the conflict, a critical budget debate unfolds, focusing on the fate of discretionary spending allocated to the five parties forming Benjamin Netanyahu’s government. The reluctance to divert or eliminate this funding has sparked controversy, raising concerns about potential impacts on the government’s credibility.
Rothenberg emphasizes the need to reassess priorities as Israel drafts a new economic plan for the upcoming year. With shifting dynamics since October 7, he asserts that special allocations should be on the table, reflecting the changing world and the need for a strategic approach to navigate through these unprecedented challenges.
