Amid the escalating conflict between Israel and Hamas, there is a growing concern that the extended and potentially widening war could lead to severe economic turmoil in addition to the already devastating human suffering.
For Gaza, an expanded conflict is likely to exacerbate the already dire humanitarian crisis in the region. Simultaneously, Israel is facing a significant setback to its previously robust economy, which was considered an entrepreneurial powerhouse until recently.
The economic prospects for the Palestinian territories were grim even before Israel imposed a blockade on Gaza in response to attacks in early October, creating what the World Health Organization referred to as a “humanitarian catastrophe.” The International Monetary Fund (IMF) had assessed earlier this year that Israel’s blockade of Gaza and increased restrictions in the West Bank were substantial hindrances to growth and private sector development.
Meanwhile, in Israel, the mobilization of approximately 360,000 reservists for military duty is leading to disruptions in various sectors of the economy. Israel’s technology industry, a key driver of its economic growth, has experienced a sudden slowdown. Production at a major Israeli offshore natural gas field has been halted, and the central bank is injecting billions of dollars to prevent the shekel, Israel’s currency, from depreciating further.
This economic downturn comes after a period of uncertainty for Israel’s economy. Last year, The Economist ranked Israel as the fourth-best-performing economy among the countries in the Organization for Economic Cooperation and Development. The nation’s start-ups were attracting significant foreign investment, and the Abraham Accords, which normalized diplomatic relations with several Arab countries in 2020, held the promise of increased economic prosperity. Israel was also establishing itself as a hub for exporting natural gas to Europe and beyond.
However, Israel’s economic momentum began to wane this year when a right-wing government, led by Prime Minister Benjamin Netanyahu, proposed a controversial plan that would curtail the powers of the judiciary. Critics argued that it could undermine the rule of law, leading to widespread protests. Many leaders in the tech industry threatened to leave the country, foreseeing potential damage to Israel’s international reputation and its economy.
The judicial overhaul triggered a sharp 60 percent drop in foreign investment in Israel, eroded the value of the shekel, and caused considerable volatility in the stock market. High interest rates, rising inflation, and concerns about a global economic slowdown further weighed on growth.
The situation is exacerbated by the fact that many of the reservists called up for military service in Israel come from sectors such as technology, education, and law, while ultra-Orthodox men are exempted for religious reasons. This concentration of recruits includes a substantial portion of Israel’s entrepreneurial and economic activity.
This economic turbulence has prompted two credit ratings agencies to issue warnings about Israel’s debt potentially being downgraded. Moody’s recently stated that the current conflict is more severe than previous episodes of violence, with the potential to divert resources, reduce investment, and undermine confidence.
However, some factors are currently working in Israel’s favor. Israel’s overall financial position is stronger today, and the country holds substantial foreign exchange reserves of around $200 billion (close to 40 percent of the GDP). These reserves provide ample capacity to support the economy. In response to the current situation, the central bank has allocated $30 billion in foreign exchange to stabilize the shekel, which has reached an eight-year low.
Israel’s finances are inevitably impacted by any war, and the government can adjust its budget to accommodate the conflict. Israel traditionally allocates over 4 percent of its GDP to military spending, with additional aid from the United States amounting to $3.8 billion annually, mainly for purchasing American weapons.
In the coming days, President Biden is anticipated to request $14 billion in military and security aid for Israel from Congress. Goldman Sachs has advised caution in light of the potential for the conflict to escalate further.
A recent IMF review highlighted the heavy toll on the Palestinian economy and people due to persistent poverty and high unemployment, emphasizing that a turnaround would depend on easing Israeli-imposed restrictions and a political peace settlement.
Israel’s blockade of Gaza following the recent Hamas attacks has led to severe infrastructure damage, widespread shortages of essential supplies, and the displacement of over half of Gaza’s population. If the conflict expands to involve Hamas’s Iranian-backed ally, Hezbollah, in Lebanon, it could exacerbate regional despair.
In Israel, various economic sectors have slowed or come to a standstill. The tourism industry has almost ground to a halt, with cruise ships avoiding Israeli ports and travelers canceling trips. Airlines have suspended flights to and from Israel, including cargo services. Major shipping operations have encountered additional controls by the Israeli Navy, impacting cargo shipments. Moreover, Israel, which relies heavily on imported oil, has closed one of its two main oil ports for safety reasons.
The Israel-Gaza conflict could also impede natural gas investments in the region, hindering the ambitions of Israel and the broader region to become a hub for exporting natural gas to Europe and beyond.
Despite the current economic challenges, Israel’s central bank governor, Amir Yaron, has expressed confidence that the Israeli economy can recover from this difficult period, returning to prosperity.