Israeli economy suffers due to conflict

By Andreas Charalambous and Omiros Pissarides

With a GDP exceeding $520 billion, despite its limited population and geographical size, the state of Israel is among the 30 richest countries on the planet. Its per capita income, standing at $55,000, exceeds the respective one of G7 countries, such as Germany, France and Britain, while its future prospects, prior to the commencement of the recent hostilities, were widely viewed as positive, boosted by exports of high-tech products and the utilisation potential of the country’s natural gas reserves.

The recent war with Hamas has, however, altered the situation and Israel’s economy has recorded significant losses. JP Morgan Chase & Co has announced that the economy will shrink by 11 per cent this quarter, while all major rating agencies have issued warnings relating to a possible downgrade of Israel’s sovereign credit rating.

While analysing the consequences of the Gaza war, the following observations can be made.

First, as in most conflicts, the economy has been driven into a sharp and deep decline, due to the immediate and massive impact of the war on economic activity and confidence. Just two weeks after the start of the hostilities, a mere 10 per cent of Israeli industries were fully operational. The mobilisation of 350,000 Israeli soldiers contributed significantly, as they represent almost 9 per cent of the country’s workforce.

Second, the markets reacted negatively. Before the end of the first month of the war, the Tel Aviv stock market had lost 15 per cent, corresponding to $25 billion, while, at the same time, the Israeli currency declined significantly.

Although Israel’s central bank stepped in by announcing unprecedented support packages valued at $45 billion, the decline cannot be contained and the national currency (shekel) is forecasted to suffer its worst annual performance since 2000.

Third, the protracted war is testing the country’s ability for financial endurance. The government of Israel is called upon to manage both the extremely high military costs of the conflict and the simultaneous reduction of tax revenues, the latter being a natural result of the drastic reduction in corporate activity and the collapse of private consumption.

Already, the government has announced a more than doubling of the budget deficit during 2023 and 2024, while the cost of government borrowing from international markets is rising, as Israel’s credit rating is negatively affected.

All the factors above exert a negative impact on business and consumer confidence, both in the short and the long-term.

There are analysts who argue, based on historical experience, that wars are usually followed by periods of economic growth. This is a plausible outcome, in the event that the conflict and atrocities end soon, and normalcy is re-established. At this stage, although the prospect of an end to the war is a likely scenario, the prevalence of long-term political stability in the region appears remote. The hostage exchange and the temporary ceasefire agreements are steps in the right direction.

Andreas Charalambous and Omiros Pissarides are economists