Economic Challenges: Israel Struggles with Rising Credit Costs and Declining Investor Confidence

Israel's economy has been under the influence of a war for nearly a year, which could escalate into a regional conflict. As borrowing costs rise, the country's financial structure is increasingly under pressure. As of August, the direct war costs in the Gaza Strip amounted to 100 billion shekels, according to the Ministry of Finance. The Bank of Israel projected a total burden of up to 250 billion shekels by the end of 2025. However, these estimates were made before Israel took action against Hezbollah in Lebanon, which will incur additional costs. Credit ratings have been downgraded, exacerbating the economic impacts and potentially having long-term effects. The cost of insuring against an Israeli default has reached nearly a 12-year high, while the budget deficit continues to grow. However, Israel's Finance Minister emphasizes the strength of the economy and states that credit ratings would rise again after the war ends. The war, with its intense military operations, is taking a financial toll, though. The debt level rose to 67% of GDP this year, with the government deficit at 8.3% of GDP, well above the expected 6.6%. Even though Israel's main investors, such as pension funds, are reluctant to divest their holdings in the short term, the investor base has narrowed. Investors are increasingly expressing interest in selling Israeli bonds or refraining from purchasing them due to ESG concerns regarding the warfare. The Norges Bank sold a small portion of Israeli government bonds in 2023. Trang Nguyen from BNP Paribas notes that Israeli bonds are trading with significantly larger spreads than those of similarly rated countries. Israel's domestic bond market remains robust, but foreign investors are pulling out. The share of non-residents in Israeli bonds fell to 8.4% in July, while the supply of outstanding bonds grew by more than a fifth. Equity investors are also scaling back investments. Data from Copley Fund Research shows that international investors have reduced their Israel holdings, particularly after the Hamas attacks in October 2023. Foreign direct investment declined by 29% in 2023 compared to the previous year. Against this backdrop, promoting local investments and government support is becoming more important. In April, the government announced it would invest 160 million USD in venture capital funds to strengthen the technology sector. However, the economic challenges are diverse: displacement, labor shortages, and economic pressure complicate growth. The agriculture and construction sectors are particularly affected, impacting economic growth. While Israel has so far been able to raise funds without difficulty—8 billion USD in international capital markets—the combined effect of rising borrowing costs and increasing expenditures remains a challenge.