The ongoing Gaza war has significantly impacted Israel’s economy, exacerbating existing financial challenges. The conflict has disrupted key sectors, including tourism, agriculture, and manufacturing, leading to widespread economic instability. The tourism industry, which is crucial for Israel, has seen a sharp decline as the conflict deters visitors. Agricultural exports have also been hit hard due to security concerns and logistical disruptions. Other parts of the economy have taken a significant hit. In the final quarter of last year and in the weeks after the war began, Israel’s gross domestic product (GDP) shrank by 20.7 percent (in annual terms). The slump was driven by a 27 percent drop in private consumption, a drop in exports and a slash in investment by businesses. Household expenditure snapped back at the start of the year, but has since cooled.

Moreover, the costs of military operations and the need for reconstruction efforts in affected areas are straining the national budget. The government has increased defence spending to address security needs, diverting funds from other critical areas such as social services and infrastructure development. This reallocation of resources could have long-term consequences for Israel’s economic growth and public welfare.

Israel also imposed strict controls on the movement of Palestinian workers, forgoing up to 160,000 workers. To tackle those shortages, Israel has been running recruitment drives in India and Sri Lanka with mixed results. But labour markets remain undersupplied, particularly in the construction and agriculture sectors. According to the business survey company CofaceBDI, roughly 60,000 Israeli companies will close this year due to manpower shortages, logistics disruptions and subdued business sentiment. Investment plans have, in turn, been delayed.

Bruised public finances: Fitch expects Israel to permanently increase military spending by 1.5 percent of GDP compared to prewar levels, with unavoidable consequences for the public deficit. Last week’s rating report noted that “debt (will) remain above 70 percent of GDP in the medium-term”. The report emphasised that public finances have been hit, and that “we project a deficit of 7.8 percent of GDP in 2024 (up from 4.1 percent last year)”. Israel’s far-right Finance Minister Bezalel Smotrich has publicly disagreed, and expressed confidence that it will fall back to 6.6 percent this year.In addition to these direct economic impacts, the conflict has heightened investor uncertainty, leading to fluctuations in the stock market and a potential slowdown in foreign investments. Businesses are facing challenges in maintaining operations amid the instability, with some having to close temporarily or cut back on production.

The ongoing conflict also poses a challenge for Israel’s recovery from the COVID-19 pandemic. The pandemic had already weakened the economy, and the war has further delayed the recovery process. The combination of military spending, disrupted economic activities, and the need for post-conflict reconstruction creates a complex financial landscape that the Israeli government will need to navigate carefully.

The human toll [of a wider war] could be significant. There would also be huge economic costs, says Omer Moav, an Israeli economics professor at the University of Warwick.

“For Israel, a long war would come with high costs and greater deficits,” he said.

In addition to undermining Israel’s debt profile, Moav said that prolonged fighting would incur “other costs”, like labour shortages and infrastructure damage, as well as the possibility of international sanctions against Israel. “Israel is currently ignoring the fact that economics may lead to greater [societal] damage than war itself,” said Moav. The government is not behaving responsibly. Does it want to avoid the costs of war, or does continued conflict serve political interests?

Looking forward, the Israeli government faces the dual challenge of managing the immediate economic fallout from the conflict while also addressing the long-term needs for rebuilding and restoring investor confidence. The conflict’s resolution and subsequent peace will be crucial for stabilising the economy and ensuring a sustainable recovery. However, until a lasting solution is found, the economic toll is likely to persist, affecting the livelihoods of many Israelis and the overall economic outlook for the country.