Perfect storm threatens Israel's economy

Bezalel Smotrich  credit: Michal Fattal
Bezalel Smotrich credit: Michal Fattal

The surprise attack by Hamas combined with Israel's socio-political rift could fuel the shekel's further depreciation and cause Israel's risk premiums to jump.

Ministry of Finance director general Shlomi Heisler spoke yesterday with the heads of his departments to coordinate preliminary preparations for the economic fallout of the war launched by Hamas against Israel. The Ministry of Finance says that it is prepared in budgetary terms for all potential situations.

At this time, while armed terrorists are still moving around Israeli towns and villages in the south, and the dimensions of the disaster have not yet fully come into focus, the economic cost of the war Israel is still a secondary concern. However, a war costs many billions of shekels, and beyond the direct effects on the defense budget, this operations could also create headaches for the Ministry of Finance through the challenges caused by the weakening of the shekel and Israel's upcoming credit rating. The situation requires preparedness in the economic arena.

In previous military operations, Israel's credit rating remained unharmed and the shekel was stable. Over the years, foreign investors have learned not to get overly excited by the security situation in Israel, which has not been an obstacle to prosperity in the economy. But it seems that this time there may be a longer and more difficult operation, with the Israeli economy in a sensitive period. Investors are currently shying away from the markets in Israel anyway, due to the government's judicial overhaul. The current concern in the markets right now is of a "perfect storm,", in which the combination of the geopolitical security situation and Israel's socio-political rift, will fuel the shekel's further depreciation and cause Israel's risk premiums to jump. On top of this the fiscal deficit has already been widening every month, which does not leave much fiscal flexibility in the hands of the government.

Next week, rating agency Moody's will publish Israel's latest credit rating. In recent months, the agency has warned several times about the possibility of cutting the rating outlook to "negative," mainly due to the consequences of the judicial overhaul, although in Israel's ratings, the agencies also regularly refer to the potential of a military flare-up. Next month, rating agency S&P will publish Israel's latest rating.

A credit rating cut would increase the cost to Israel of raising debt. This would be especially complicated in the scenario of a protracted, full-scale war, which could require the Ministry of Finance to raise debt to finance the costs of fighting. Usually, at the end of a military operation, the security establishment submits the bill to the Ministry of Finance. Then there are negotiations about how much of the cost will be covered by the defense budget and additional funds are needed from the Ministry of Finance. If necessary, the budgetary source could also come from reserves kept by the Ministry of Finance in various budget sections, including in the budgets of all government ministries.

The direct cost is divided into military expenses, payment of reservist salaries and compensation for damage to property (after the government already deducted about NIS 2 billion from the compensation fund for coalition needs). This, in addition to damage to the economy due to loss of working days or a slowdown in economic activity. In Operation Breaking Dawn in August 2022, a day of fighting was estimated at a cost of about NIS 200 million. However, at that time it was a relatively short operation, with a much smaller reserve scope than was approved for the current campaign.

Published by Globes, Israel business news - - on October 8, 2023.

© Copyright of Globes Publisher Itonut (1983) Ltd., 2023.

Bezalel Smotrich  credit: Michal Fattal
Bezalel Smotrich credit: Michal Fattal
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