Implications of Continuing the War on Israel's Economy-Three Scenarios

Key Findings:

The publication discusses Israel's critical economic challenges as it navigates the ongoing conflict in the Gaza Strip and the broader struggle against Iran and the “Axis of Resistance." As the conflict enters its tenth month, the Israeli government faces significant decisions that will have far-reaching economic consequences. The country's projected budget deficit for 2024 is expected to be much higher than initially forecast, exacerbated by increased defense spending, reduced economic growth, and potential impacts on foreign investment and Israel's credit rating.

Key Scenarios Examined:

(1) Continuation of the Current Situation:

Israel maintains its current level of military engagement in Gaza, with low-intensity conflicts continuing on the northern front.

Economic Impact: Minimal growth (1% in 2024), a high budget deficit (8%), and an increased debt-to-GDP ratio (70%). The risk premium, indicating investor confidence, could rise to between 1.75% and 2%. The outlook for 2025 remains poor, with ongoing economic strain and internal political and social instability likely to persist.

(2) Escalation in the North:

This scenario envisions a high-intensity, one-month conflict with Hezbollah in Lebanon, potentially spreading to multiple fronts involving Iran and other regional actors.

Economic Impact: The economy could contract by 2% to 10% in 2024, with the budget deficit soaring to 15%, and the debt-to-GDP ratio climbing to 80-85%. The risk premium could spike to 2.5%, making borrowing more expensive. While post-conflict growth could rebound significantly in 2025 (5-7%), the long-term damage to Israel’s economy could be severe, with a substantial rise in debt servicing costs and prolonged recovery periods.

(3) Hostage Deal and Withdrawal from Gaza:

A negotiated settlement that includes a cessation of hostilities in Gaza, possibly leading to calm on the northern border as well.

Economic Impact: Moderate growth (1.5-2%) in 2024, with a budget deficit of 7% and a debt-to-GDP ratio of 68-69%. The risk premium would lower to 1.3-1.5%. A more optimistic economic outlook is expected for 2025, with growth potentially reaching 4.6%, but lingering economic challenges would persist due to ongoing security concerns and the need for rebuilding.

Conclusions:

Long-Term Economic Damage: All scenarios predict long-term economic difficulties, with reduced growth, increased defense spending, and a potential recession similar to the aftermath of the Yom Kippur War.

Budgetary Strain: The need to fund ongoing and future military operations will likely require significant cuts to other government services, including education, health, and infrastructure, which could further harm economic productivity.

Strategic Considerations: The need for careful economic planning is great, particularly if Israel escalates the conflict in the north. The risk of a prolonged, multi-front war is especially concerning.

Recommendations: The government should avoid simply increasing the deficit to cover military expenses. Instead, it should prioritize spending cuts in non-essential areas, explore alternative funding methods, and ensure that any increase in military spending is used efficiently.