Israel’s embattled but resilient economy

I spoke recently with a friend, Sgt. Maj. Amichai, who was home for a short break after nearly two months of reserve duty in the Israeli army. Amichai owns a small tourism business in Jerusalem, renting Segways and other vehicles, called SmartTours. It relies heavily on domestic and international tourism.

Shortly after Hamas attacked southern Israel on Oct. 7, Amichai decided to temporarily close up shop. Tourism was cratering, but that wasn’t the only reason. Like him, most of his employees were called up for reserve duty. He continues to check voicemail, but only a few potential customers have contacted him over the past two months.

SmartTours is being sustained by the government’s wartime aid program of grants and subsidized loans for small and medium-size businesses. Amichai’s landlord also agreed to delay rental payments. While grateful for this support, Amichai remains concerned about the post-war period: impending loan and rent deadlines, employees eager to return to work, expected lower levels of tourism and leisure-activity demand. With the Covid-19 pandemic still in recent memory, he knows that the transition back to where the business was on the eve of the war will be bumpy.

Amichai’s experience is not unique. The macro-economic fallout of the war is already evident. 

The Bank of Israel anticipates that by the end of 2025 the war will have resulted in about $43.6 billion in direct costs to the economy and $9.3 billion in indirect costs (lost tax revenues). The budget deficit is expected to increase to 3.7% of gross domestic product in 2023 and 5% in 2024, up from prewar budget deficit forecasts of 1.3% and 1.5%, respectively. The war’s total cost through 2025 is estimated to be around 11% of Israel’s 2022 GDP.

Forecasts of Israel’s economy going forward will be subject to more uncertainty than usual.

The bank has downgraded expected GDP growth to 2% for each of 2023 and 2024, down from the prewar forecast in July of 3% growth for each year. Even so, these updated forecasts reflect a somewhat optimistic scenario whereby the war’s intensity begins to diminish in early 2024 and remains predominantly focused on one front—namely, mopping up operations against the remnants of Gaza’s terrorist groups. However, this outlook could change with any miscalculation or deliberate escalation of the skirmishes with Hezbollah on the northern front. 

Survey data from the Central Bureau of Statistics portray a stark reality since Oct. 7: unemployment spiked from 3.6% to 9.6% in October. But the effects are being felt differently by sector. 

In the food and drink service sector and the construction sector, revenue dropped for most firms by over 50% in November. The former dropped because of lower demand and the latter mainly because of employee absence. The construction industry relies heavily on Palestinian and other foreign workers. The West Bank has been on an effective shutdown, and foreign workers who rotate back to their home countries are not being replaced in the same numbers since the war began. 

In contrast, high tech services and finance were less impacted, with only 3% of firms reporting similar revenue reductions in November, highlighting the disparate effects of the war on the Israeli economy. Growth in the high-tech sector, a main driver of the Israeli economy, surged during the pandemic and decelerated in 2023, owing more to global developments than anything related to the war. The industry has, in addition, seen nearly all of its pandemic-era external funding fade away over 2023, leaving it at levels comparable to those in 2019. 

Pre-Oct. 7, Israel’s economy had been recovering well from the Covid pandemic, with GDP growth since mid-2021 above its long-run trend. Unemployment was low and the debt-to-GDP ratio was near its pre-pandemic level of 60%, roughly the median of OECD countries (the Organization for Economic Cooperation and Development comprises the 38 most advanced economies in the world). The Consumer Price Index had peaked in January 2023 at 5.4% and was decelerating towards the Bank’s target range of 1% to 3%, hitting 3.7% in October. Over the entire period of rising global inflation coming out of the pandemic, Israel was consistently below the median of OECD countries and often in the bottom 10%. 

The biggest economic concern prior to Oct. 7 stemmed from internal politics, a controversial judicial reform in the Knesset which drove some of the shekel’s depreciation against the U.S. dollar and caused the below-global-trend performance of the Tel Aviv 125 stock index. Nevertheless, Israel’s economy was solid on the eve of the war. The value of the shekel plunged relative to the dollar in the weeks after Oct. 7 but has now recovered—appreciating 8% from mid-November to mid-December—to where it was earlier in 2023, though still down from 2022. The domestic battle over judicial reforms is on pause as the country turns to fight external enemies, but has not gone away.

Looking ahead to 2024, uncertainties persist: disputes over budgets amplified by war needs, uncertain tourism revival, stability of Israel’s credit rating, potential military budget hikes and the trajectory of inflation, to name a few. Yet, history shows Israel’s economy bouncing back fairly quickly, dating back to at least the Second Lebanon War of 2006. 

This ability to bounce back is ultimately what keeps Amichai determined to not give up on his business. At the same time, he noted the difficulties in dealing with the volatility of a tourist customer base in a country like Israel where every few years military conflicts arise and demand for his services falls.

Despite the magnitude of the conflict this time when compared with the four previous wars with Hamas, Amichai is confident that tourism will return in some form during 2024. Yet, in the same way the pandemic accelerated certain changes such as remote work, he recognizes that it has become essential to adapt to the reality of owning a small business in Israel tied to tourism and leisure.

Amichai’s next move, which tells us a great deal, is diversifying into security services, where high demand can be expected for the foreseeable future.

Source: JNS

Originally published by The Jerusalem Strategic Institute.