Over the course of a year, Israel’s economy has faced many obstacles and difficulties as a result of the war that Tel Aviv continues to wage in the Gaza Strip, including high borrowing costs, which have begun to impose increasing pressure on the occupation’s financial structure.
Ministry of Finance data indicate that the direct cost of financing the war in the Gaza Strip:
- As of last August, it amounted to 100 billion shekels ($26.4 billion).
- The Bank of Israel estimates that the total cost could rise to NIS 250 billion ($66 billion) by the end of 2025.
- But this estimate was made before Israel’s incursion into Lebanon to confront Hezbollah, or the calculation of a confrontation with Iran, which will increase the total cost.
This caused Israel’s credit rating to be lowered, exacerbating economic impacts that could last for years, while the cost of insuring Israel’s default on its debts reached its highest level in 12 years, and the budget deficit increased.
“As long as the war continues, sovereign debt metrics will continue to deteriorate,” said Sergey Dergachev, portfolio manager at Union Investment.
Although the debt-to-GDP ratio – a basic measure of the economy’s health – reached 62% in Israel last year, borrowing needs have exceeded the limit.
Dergachev explained, “Even if Israel had entered the war in a relatively good economic situation, the matter would be painful on the financial side, and over time it would put pressure on the credit rating.”
Extremist Israeli Finance Minister Bezalel Smotrich – one of those calling for the continuation of the war – says that his country’s economy is strong, and that its credit rating is expected to rise once the war ends.
The costs of the Israeli war are high because:
- Iron Dome air defenses.
- Large-scale mobilization of forces.
- Intense bombing campaigns.
This year, the debt-to-GDP ratio reached 67%, while the government deficit recorded 8.3% of GDP, which far exceeds the previously expected 6.6%.
Although the primary buyers of Israeli Eurobonds, pension funds, or large asset managers tempted by relatively high sovereign debt ratings are likely not to dispose of these assets in a short period, the investor base has shrunk.
Investors privately say there is a growing willingness to dump or not buy Israeli bonds due to concerns about the environmental, social and governance implications of how the war is being conducted.
A spokesman for the Norwegian sovereign wealth fund said that the Central Bank of Norway sold a small stake in Israeli government bonds in 2023 “due to increased uncertainty in the market.”
“Valuations clearly reflect these concerns,” said Trang Nguyen, head of global emerging markets credit strategy at BNP Paribas, adding that Israeli bonds are trading at much wider spreads compared to countries with similar ratings.
When the Ministry of Finance was asked about rising borrowing costs and investors’ concerns about environmental, social and governance standards when preparing this report, it said that the government’s public finances had been “efficiently managed” since the start of the war.
“Israel’s resilient domestic market shows strong demand, and international investors remain confident in our creditworthiness,” the ministry added.
While the bond market in Israel enjoys a large trading volume and is witnessing an active buying and selling movement and expanding rapidly, foreign investors have withdrawn.
The most prominent indicators of the decline in the share of foreigners in bonds:
- Central Bank data show that the share of non-residents in government bonds fell to 8.4%, or 55.5 billion shekels, in July from 14.4%, or nearly 80 billion shekels, in September of last year, and during the same period the volume of bonds in circulation grew by more than a fifth. .
- An official in the Israeli Ministry of Finance (who asked Reuters not to reveal his name) pointed out that Israeli institutions have already been buying more bonds for several months, noting that some global investors sold them due to geopolitical conditions and uncertainty.
- Capital investors are also reducing their investments, as data from Copley Research showed that the reduction in international investors’ pumping of money into Israeli funds accelerated significantly after October 7, 2023.
- Global funds’ ownership of Israeli stocks has fallen to its lowest levels in a decade.
- Foreign direct investment in Israel fell 29% year-on-year in 2023, according to the United Nations Conference on Trade and Development (UNCTAD), the lowest level since 2016.
- While figures for 2024 are not available, rating agencies have cited the unexpected impact of the war on this type of investment as a source of concern, and all of this has increased the need for domestic investment and government support.
Financial burdens facing Israel
- In response, the government pledged last April to allocate $160 million in public funds to boost venture capital financing for the biotechnology sector, which represents about 20% of Israel’s economy.
- The government provides housing for thousands of people displaced by the fighting, many of whom are living in vacant hotels due to the sharp decline in the number of tourists.
- The agricultural and construction sectors face obstacles due to displacement, labor shortages due to mobilization, and Israel’s refusal to allow Palestinian workers to enter.
- The decline in construction activity has been a major factor in dampening economic growth, which fell by more than 20% in the fourth quarter of last year and has yet to recover.
- Data from the three months to the end of last June show that seasonally adjusted GDP remained 1.5% below pre-attack levels, according to Goldman Sachs calculations.
- Israel has recently raised funds to cover its needs. It sold debt on global capital markets this year for about $8 billion, and “Israel Bonds” – the government’s borrowing tool for diaspora bonds – aims to achieve a second annual record exceeding $2.7 billion, but borrowing and spending costs are rising. Economic pressures pose looming challenges.
Roger Mark, an analyst on the fixed income team at Ninety One, said: “There is room for Israel to continue to navigate this crisis, given the large domestic investor base that can continue to finance another large deficit.”
“However, local investors are looking forward to at least some signs of the government’s efforts to adjust public finances and reduce the budget deficit,” he added.
