The escalating military operations by the Israel Defense Forces (IDF) in Gaza cast a spotlight on the country’s deepening economic challenges, as the conflict enters its seventh week. Amidst this continuing turmoil, a team of Israeli technocrats known as the 'government’s CFO' are responsible for navigating the emerging economic complexities.
Leader Capital Markets, a top financial advisory firm in Israel, reports that the war costs the economy around $270 million every day (citing Israel’s Finance Ministry). It estimates a total fiscal impact of 180 billion shekels ($48 billion) for 2023-24. Israel bears two-thirds of these costs, and the United States of America covers the remaining one-third.
Fiscal Strategy and Debt Management
Israel's economic plan, heavily reliant on substantial borrowing, is crucial in sustaining its most challenging armed conflict in 50 years. In this complex scenario, Yali Rothenberg, the Finance Ministry’s Accountant General, plays a pivotal role in overseeing the management of the country's $300 billion debt profile, a significant part of which is attributed to this conflict. Prime Minister Benjamin Netanyahu’s government strategy, designed to endure several months of combat, includes additional financial buffers to mitigate the economic impact of the prolonged military engagement.
“We are moving forward with a base case scenario that references several months of combat and have worked in additional buffers. We are capable of financing the State of Israel even in more extreme scenarios than the current fighting,” Rothenberg told the press.
Domestic and International Financing
After the crisis, the Israeli Finance Ministry raised its domestic bond sales to 18.7 billion shekels ($5 billion) since 7 October, exceeding its usual monthly average of slightly more than 5 billion shekels ($1.34 billion). Although increasing, the country's domestic interest rates remain lower than many advanced economies.
Demand for Israeli government securities has been strong, with demand at recent auctions coming in at more than six times the supply. Moody’s estimates the government's gross borrowing needs at about 10 percent of its economic output for this year, up from 5.7 percent in 2022.
Despite increasing domestic interest rates, Israel's borrowing costs remain lower than many developed economies. Although the yield on Israel's 10-year shekel bond has been higher since the beginning of the Israel-Palestine conflict, it was recently at 4.2 percent, still below that of similar US Treasury bonds. The Israeli currency has regained its post-war losses and is trading robustly against the dollar, mainly because of the central bank's unprecedented interventions.
Fiscal Challenges
The Israeli government's fiscal strain is increasingly apparent, as evidenced by the October budget, which shows a deficit more than seven times larger than in 2022. Israel’s Finance Minister Bezalel Smotrich has proposed an amended budget for the remainder of 2023 to tackle this. This revised budget includes a substantial spending increase of 35 billion shekels ($9.4 billion), primarily financed through debt. Additionally, Israel faces the challenge of compensating for an estimated 15 billion shekels ($4 billion) in lost revenues for 2023. Furthermore, the government needs to re-stock a tax compensation fund, which was emptied of 18 billion shekels to cover expenses after the war began.
A significant portion of the financial response involves bond issuance, with more than 80 percent of the total funding coming from domestic sources. This strategy is intended to shield the Israeli economy from the volatility of foreign investment flows. Despite these efforts, Israel is encountering a less welcoming international market. The cost of insuring Israel’s sovereign bonds against default has roughly doubled since the onset of the war, indicating increased skepticism and risk perception among international investors.
Gauging Israel’s Financial Health
The conflict has doubled the cost of insuring Israel's sovereign bonds against default, reflecting increased market apprehension. Consequently, Israel's Accountant General Department is actively engaging with rating agencies and market makers to sustain investor confidence and stabilize its position in international markets.
Israel has raised $5.4 billion outside domestic efforts since the conflict began by leveraging international support, including selling more than $1 billion in bonds through a US-registered entity and other privately negotiated deals.
Despite a negative outlook from major rating agencies, Israel has avoided a credit rating downgrade. Rothenberg highlights the necessity of controlling the budget deficit for long-term fiscal stability. He acknowledges the importance of managing the debt-to-GDP ratio, expected to exceed its current level of around 60 percent.
Internally, the Israeli government is embroiled in contentious debates regarding allocating discretionary spending. Critics contend that the government's hesitance to adjust or redirect these funds threatens its credibility, particularly in the changed fiscal environment since 7 October.