The purpose of this study is to briefly present the projected economic impact of the current war on Gaza, based on the analyses and data published to date by the Israeli press and economic institutions. In this sense, it does not aim to assess the current financial costs and economic impacts of this war, but its prospective consequences, which are expected to extend to all social categories and to affect a number of sectors of Israel's economy in an extremely negative way. Indeed, the economic difficulties as well as the financial costs already facing the current Israeli government as a result of the war are bound to worsen, given the financial and economic crisis, and its effects are likely to continue to be felt after the end of the confrontation.
The current war on Gaza has features that make its consequences substantial and its economic costs high, as can be seen from the following points:
In the first place, Israel entered this war already in an unstable economic situation due to the political crisis over the past year, the downturn in the global economy, rising prices, global monetary inflation, and rising bank interest rates.
A number of economic indicators have declined over the past year, as has the international ranking of Israel's economy, with the risk of downgrading its credit rating.
The war against Gaza is one of the longest the State of Israel has waged since its creation in 1948; it will soon, in this period of February 2024, complete its fourth month, and it is as yet impossible to predict when it will end.
The war began with a military assault on several Israeli towns in the south of the country, which also affected the home front, causing serious destruction to infrastructure and housing, and almost completely paralyzing economic activity in the southern regions for over a month.
On the second day of the war, this first front in the south was accompanied by a more limited one on the northern borders, which, although it did not take on the dimensions of a war, nevertheless led, among other things, to a standstill in civil life and economic activity in the northern municipalities.
For the first time, Israel is in the process of evacuating a large number of Jewish residents from its southern and northern border communities - some 150,000 of its citizens - and transferring them to reception centers, an operation financed out of public funds.
Of course, it is not possible to build a forward-looking vision without briefly outlining the economic costs of the war to date.
The cost of military operations
Military operations have a direct economic and financial impact in terms of costs and losses. Among the main direct costs was the mobilization of almost 360,000 reservists in the early days of the war, meaning that the government bore the cost of mobilization, while the Israeli economy suffered losses resulting from the exclusion of the people concerned from the labor market.
Moreover, the Israeli army used phenomenal quantities of weapons, ammunition and military equipment in the course of these operations, particularly the very expensive smart missiles and Iron Dome rockets. Of course, the army will need to make up the deficit caused by the drawdown in military stocks, which will increase military spending, even after the war. All these factors made the direct and indirect costs of the war on the military economy extremely high, and out of all proportion to what had been seen in previous wars.
According to estimates by the Ministry of Finance, 100,000 reservists cost the state budget 70 million shekels a day. This is a provisional figure, as the additional costs of housing and feeding these soldiers will have to be included; consequently, the final figure should be closer to 100 million shekels per day. There are also indirect costs in terms of lower domestic product, also estimated at close to 100 million shekels per day. Studies therefore estimate the overall cost of these operations at 300 million shekels per day. According to Ministry of Finance estimates, the cost of each day of war, including military equipment, ammunition and costs associated with reservists, would reach one billion shekels.
Estimates by the Bank of Israel and the Ministry of Finance to date put the financial cost of the war on Gaza at nearly 250 billion shekels, a figure that includes military costs as well as the direct and indirect financial impacts of the war, including the cost of relocating citizens who had to be evacuated to other areas, both in the south and north of the country.
These financial and economic costs and losses obviously have a forecast impact on the overall Israeli economy.
Declining economic growth
One of the main negative impacts of the war on Gaza is the anticipated decline in Israeli economic growth. Indeed, since the start of the war, and particularly in the first two months, there has been a decline in consumption, production and investment, as well as a paralysis of the economy, to an almost total degree in the southern region and to a partial degree in the northern region. All this has led to a drop in tax revenues and a decline in economic growth. Conversely, higher war-related public spending is expected to cushion the decline in economic growth somewhat.
J.P. Morgan expects the Israeli economy to contract by 11% in the last quarter of 2023 (on an annualized basis). Data from the Ministry of Finance and the Bank of Israel point to a decline in growth in 2023, from the previously estimated 3% to 1.5%. The 2024 fiscal year would also see a decline in growth, to 3% from the 1.7% initially forecast. Taking into account the demographic increase, this would mean zero growth in 2024.
Rising public budget deficit
A rise in the public budget deficit is anticipated, due to a number of factors: the decline in economic growth and consumption, the fall in public revenues, particularly tax revenues, and the increase in public spending to cover war and reconstruction costs and losses, particularly in the southern areas. According to preliminary estimates, civilian damage in the southern municipalities has reached almost 6 billion shekels (nearly $1.5 billion). In addition, military expenses related to the war and the replenishment of military equipment, armaments and ammunition will have to be financed, necessitating a massive increase in the budget of the Ministry of National Security.
According to Ministry of Finance data and studies, before the outbreak of war, the public budget deficit was expected to rise to 1.3% of GDP by 2023, and to around 1.1% of GDP by 2024. Since the outbreak of war, the deficit is now expected to reach 3 to 4% by 2023, and to approach 6% by 2024.
The ratio of foreign debt to GDP is also expected to approach 70%, compared with 60% in previous years; this is a high rate with which the State of Israel cannot live without suffering consequences for its international credit rating, according to a report published by the Aaron Institute for Economic Policy. This is also a high rate of inflation.
The year 2023 saw a rise in inflation in Israel, reaching an anticipated level of almost 4%. This level led the Governor of the Bank of Israel to raise the bank's key rate several times over the past year to a level of around 4.5%, whereas it had remained stable at around 0.5% for the past decade.
The war on Gaza has had contradictory impacts on monetary inflation. On the one hand, certain factors are pushing inflation down, foremost among them the drop in general consumption and the economic recession that is expected to set in after the war, while on the other, the exchange rate of the shekel against the dollar is expected to continue its erosion, secondly, that the war will lead to a shortage of many agricultural products due to the concentration of many segments of Israeli agriculture in the southern areas, and thirdly, that the price of hydrocarbons in Israel will increase due to the anticipated rise in the world price of oil.
These conflicting factors are likely to exert inflationary pressures in the short and medium term, which is why average inflation is expected to remain relatively high in 2023 and 2024, at around 3%.
It is expected that the Governor of the Bank of Israel will begin to reduce the key rate, if only in small doses, with the aim of alleviating the negative economic impact, dealing with the risk of economic recession, providing Israeli companies with the financial resources needed to cope with the consequences of the war, and easing the burden on citizens. Indeed, at the end of last year, the Governor already decided to cut the key interest rate by 0.25%.
An amended public finance law
In view of this situation, the Israeli government had to decide to increase the public budget by 30 billion shekels in 2023, bringing it to an overall level of 510 billion shekels, an amount financed by an increase in the deficit and recourse to borrowing. Similarly, the Ministry of Finance has completely overhauled the budget for 2024 to adapt it to the war situation, proposing spending restrictions and tax hikes. The Ministry of Finance has proposed a 3% contraction in the overall budgets allocated to the various ministries, as well as an increase in the value-added tax rate from 17% today to 18% from 2025. He also proposed an overall increase of 69 billion shekels in the 2024 budget, taking it to 585 billion shekels, as well as in the public deficit, which would reach 5 or 6% of GDP in 2024 and 2025. Israel's foreign debt is thus expected to reach 70% of total GDP.
The impact of the war on labor markets varies according to the economic sectors concerned. With the outbreak of war, Israel banned Palestinian workers from the West Bank from entering Israeli territory, while most foreign workers left the country. As a result, traditional economic sectors such as construction, infrastructure, traditional industry and agriculture suffered considerable damage. This factor is expected to lead to a decline in the number of housing units built in Israel and a rise in property prices, with a negative impact on construction companies due to the paralysis of a large number of worksites. This will be compounded by a decline in agricultural production and higher prices for fruit, vegetables and other agricultural products.
At the same time, the modern technology and advanced industries sector also suffered damage, due to the mobilization of the reservist contingent, as well as many workers active in this sector, not to mention the exclusion of thousands of Israelis from the job market due to physical or psychological injuries sustained during the war.
Naturally, the impact of the war on the labour market differs in nature and degree according to the economic sectors concerned. On the one hand, as we have indicated, negative consequences can be expected for traditional sectors such as construction, infrastructure, agriculture and traditional industries, due to labor shortages. The war will bring the tourism sector to a virtual standstill for several months, and the modern technology sector will suffer a certain setback. On the other hand, the military industry as a whole should experience a boom, with an increase both in orders, notably from the Ministry of National Security, and in the number of people employed; this increase will add to the worldwide rise in demand for armaments, military equipment and munitions.
It is difficult to predict what the unemployment and employment rates might be for the current year (2024), and the available estimates do not point to a rise in unemployment levels, which can be attributed to the contrasting nature of the impacts depending on the economic sectors concerned.
Based on past experience, the positions of Israeli security institutions and the situation of the various economic sectors, we can assume that the government will authorize the return of Palestinian workers to the Israeli labor market over the coming months, provided there is no further deterioration in the security situation in the West Bank. Indeed, such a decision appears to be the best choice for the economy and the most profitable for the labor market, not to mention the national security considerations that have been put forward by the security establishment in recent months.
The new technology sector: different impacts, both positive and negative
The war has led to a significant drop in investment in the modern technology sector, which represents the locomotive of Israel's economic growth, and has also lowered employment rates in this sector.
A survey carried out two months after the outbreak of war on a sample of 500 start-ups by the "Start-up nation, new initiatives sector" institute, together with the Public Innovation Authority, led to the following findings:
80% of companies contributing to this survey for the first time indicated that they had suffered damage since the start of the war, and 70% saw the operational continuity of their companies' activities negatively impacted, partly due to the mobilization as reservists of some of their employees who occupied central functions in their organizational chart.
Nearly half of all companies report a drop in the productivity of employees who were not mobilized, for various reasons linked to the state of war.
40% said they had suffered economic and financial damage as a result of the war, such as cancellations of investment contracts or difficulties in attracting new investors.
60% reported negative impacts on their sources of financing and investment.
According to another survey of companies operating in the advanced technology sector, nearly 50% are experiencing initial signs of cash flow difficulties, and are struggling to secure new investments.
Estimates suggest that 2024 will be a difficult year for Israel's modern technology sector, with difficulties in mobilizing foreign investment, which accounts for the bulk of the sector's investment, particularly for the more exposed start-ups. The number of employees working in the sector is also expected to decline, as are waves of resignations for reasons related to the war and the global downturn in these sectors. The downgrading of the company's credit rating is expected to have a significant impact on the company's financial situation.
Israel's credit rating downgrade
There is a serious likelihood that Israel's credit rating will be downgraded by international rating agencies in 2024, due to the declining productivity of the Israeli economy and increasing risks.
Moody's has warned that the ongoing military confrontation could lead to a financial weakening of Israeli institutions, particularly those that contribute to policy implementation; Moody's fears a financial upheaval in the aftermath of the war, and the climate of uncertainty associated with the sustained increase, of between 15 and 20 billion shekels, in annual military spending over the coming years. Moody's has also warned that the ongoing military confrontation could lead to a financial weakening of Israeli institutions, particularly those that contribute to policy implementation; Moody's fears a financial upheaval in the aftermath of the war, and the climate of uncertainty associated with the sustained increase, of between 15 and 20 billion shekels, in annual military spending over the coming years.
At this stage, it seems difficult to accurately assess the full economic impact of the war, as well as its consequences for all Israeli social classes, since these effects depend on the evolution of military operations and the duration of the war, not to mention the possibility of the conflict spreading to a second front in the north, a situation that would change the whole picture.
What is certain, however, is that the economic effects of the war between now and the end of December 2024 will be substantial: a slowdown in economic activity, both local and international (exports and foreign investment), a sharp rise in public spending to stimulate consumption, emergency funding to help people who have been evacuated, a fall in public revenues. All these factors threaten economic stability and suggest a deviation from the growth trajectory of recent years.
Added to this is the mistrust of the business sector and major corporations towards the government's economic and financial management. The current government has chosen to tackle the economic impact of the war using traditional economic tools, such as shrinking budgets and increasing the deficit. It has not, however, gone so far as to impose significant income tax hikes, which essentially target the wealthiest strata of society or corporations, nor has it overhauled the allocation of resources, continuing de facto to conform to the economic approaches already in place.
The government has thus decided on a 3% contraction in the budget of each of the ministries for 2024, but has, conversely, kept unchanged all the special budgets provided for in the agreements between the parties in the ruling coalition. This is notably the case for budgets relating to colonization, as well as those dedicated to ultra-religious and Hasidic parties.
The government does not wish to increase public debt significantly and for many years to come, but it continues to respect these agreements. By doing so, it is worsening the future economic situation. All these factors will add to the economic crises, and could prolong their duration long after the war on Gaza is over.
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