Author: Davit Shatakishvili, Contributing Analyst, American University, Washington D.C.  

 

Israel has one of the most sustainable economies, and is among the highest-tech industry countries in the region. Over the years, despite regional geopolitical challenges, Israel has built a strong, stable and free market economy that has repeatedly demonstrated its resilience to withstand severe crisis periods.

According to the World Bank, Israel is classified as a high-income country. In 2022, the country’s gross domestic product exceeded 522 billion US dollars, which is its historical high. For comparison, its GDP was 24 billion USD in 1980, 60 billion USD in 1990, 136 billion USD in 2000, and 238 billion USD in 2010. These numbers clearly show the rapid pace of development of the country.

Israel started 2023 with a current account surplus, a low ratio of foreign debt to GDP, and high foreign exchange reserves. Despite growing economic activity, the slowdown in global economic growth and tensions surrounding judicial reforms in the country have had a negative impact on investment and economic growth. Since October 7, after the Hamas invasion of Israel, the country’s economy has faced new difficulties. It is interesting to discuss the impact of the war on Israel’s economy, what the forecasts are, and the current economic indicators.

Economic Growth

Last year, Israel’s economy increased by 6.5%, and in 2021, the growth rate was 8.6%. In the first quarter of this year, the country’s economy grew by 2.5%, in the second quarter by 3.3%, and in the third quarter by 2.8%. The Bank of Israel reduced the economic growth forecast indicators for the current and next years, which can be explained by the high uncertainty surrounding the war and the lack of economic decisions coming from the Israeli government. According to their forecasts, the Israeli economy will grow by an average of 2-2% in 2023 and 2024, while growth of 2.3% this year and 2.8% next year was predicted. The Ministry of Finance of Israel also predicts a 2% growth this year, and reduced the next year’s growth rate to 1.6%, which is almost two times less than the previous forecast.

According to a new forecast by the Bank of Israel, the war with Hamas will cost the country 53 billion USD in 2023-2025. While the Governor of the National Bank says it is likely that government spending will increase due to the ongoing security needs, and they also expect an increase in interest payments due to the rise in foreign debt. Based on the National Bank’s expectations, the ongoing war will hit Israel’s gross domestic product by 3% by the end of next year, as the private sector is suffering a severe labor shortage and reduced aggregate demand is hitting the country’s economy hard. However, in general, their expectations are positive, because, they say, the Israeli economy is strong and stable, and knows well how to deal with crises and return to rapid development rates.

Currently, one of the main challenges in Israel remains the labor shortage. According to the latest Labor Ministry report, approximately 760,000 Israeli citizens are unable to work because of the war, which is about 18% of Israel’s total workforce.Given the current war, some of these people are serving in the military reserves, some have had to evacuate from their locations, and in some cases, people who were employed in vulnerable sectors such as the tourism and entertainment industries have had to leave their jobs. The tourism industry accounts for about 3% of the country’s economy, and indirectly provides 6% of total jobs.

Labor shortages affect important sectors such as construction, technology, agriculture and textiles. Particularly noteworthy is the high-tech industry, which accounts for about 20% of the country’s gross domestic product and almost half of the country’s exports. The construction sector was negatively affected by Israel’s cancellation of work rights for Palestinian workers, which caused delays in a number of construction projects. According to the Central Bank of Israel, the labor shortage costs the country’s economy 600 million USD per week.

The Bank of Israel claims the budget deficit will increase to 3.7% of GDP this year, which is almost 1% more than the pre-war level. In 2024, the budget deficit is expected to rise to 5%. Further, due to the increase in Israel’s external debt, the debt-to-GDP ratio, one of the most important fiscal indicators, is projected to increase from 63% in 2023 to 66% in 2024.

 

Inflation

Israel is one of the more stable economies in the region, with consumer prices increasing by an average of just 0.8% over the past 10 years, well below the regional average of 5.4%. However, inflation has become one of the main challenges for the country since 2022, which averaged 4.4% in 2022. As a result, the National Bank of Israel began to tighten the monetary policy. Where the monetary policy rate was 0.1% in February 2022, now it is set at 4.75%.

On November 27 of this year, the Bank of Israel left the monetary policy rate unchanged at 4.75%, as it has been since May of this year, when the refinancing rate increased by 25 basis points from 4.5% to 4.75%.

In August 2023, the annual inflation rate in Israel was 4.1%, which decreased to 3.8% in September, and to 3.7% in October. Despite the slight decrease, it still misses the National Bank’s target of 1-3%. For comparison, in August and September of last year, prices in Israel increased by an average of 4.5%, in October by 5%, and in November by 5.3%.

National Currency

After Hamas invaded Israel in October, the country’s national currency, the Shekel, depreciated to a record low against the Dollar, hitting an 11-year low. After the start of the war, the Bank of Israel announced that it would sell 30 billion USD of its reserves at a currency auction to prevent the collapse of the national currency. According to them, the foreign exchange intervention is aimed at reducing the volatility of the Shekel exchange rate and providing the necessary liquidity for the proper functioning of the financial markets.

Based on the decision of the National Bank, at this stage they will allocate an additional 15 billion US Dollars to protect the Shekel through a currency swap. A currency swap is a form of future agreement between two parties to simultaneously buy and sell a currency at a pre-agreed exchange rate. For example, if a business converts foreign earnings into domestic currency only for the purpose of paying government taxes, and makes other payments in foreign currency, it can purchase a foreign currency swap and fix the future exchange rate in the transaction to reduce the risks of currency depreciation.

In October, the Bank of Israel sold a total of 8.2 billion US Dollars at a foreign exchange auction to protect the national currency. In November, the Shekel became one of the world’s strongest currencies, strengthening by almost 9% against the Dollar. The strengthening of the national currency was also significantly facilitated by the inflow of a large amount of foreign currency from abroad.

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Israel’s economy has faced significant challenges since the Hamas invasion, among them currency devaluation, labor shortages, reduced aggregate demand, and more, not to mention the costs of war, destroyed infrastructure, and increased government spending. Despite the current difficulties, the Israeli economy is not expected to shrink in the current or future years. According to existing forecasts, the country will maintain positive dynamics of economic growth, just at a slower pace. In this regard, it is worth noting that, unlike other countries, the rate of monetary policy in Israel did not increase sharply, which allows the government to take cheap domestic debt. The country was also able to protect itself against a sharp devaluation of the national currency and approach the target rate of inflation. Israel has foreign currency reserves of up to 200 billion USD, which allows it to pursue a stable economic policy while waging war. Due to the uncertainty of the course of the war, it is still difficult to make accurate forecasts, however, considering the current economic indicators, it can be said that the country is quite resilient against the current economic difficulties and will be able to provide the strength to mobilize the necessary military expenses, as well as allocate financial resources to help civilians and restore the infrastructural damage.