Economic fallout of Israel’s Gaza Strip operation threatens growth prospects

Matthias Dietrich

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The long-term financial impact of Israel's fighting in the Gaza Strip on the wider economy is coming into sharper focus almost half a year after Hamas launched its 7 October attack on the country.

With Israel’s military response to Hamas’s 7 October attack in its fifth month, there are few indications the fighting – and the strain on Israel’s economy – will ease any time soon.

The Bank of Israel estimated in November that the war would cost about USD53 billion through to 2025 based on forecasts of increased defence and other spending against a backdrop of lower tax revenue.

Israel has not seen this scale of military activity in terms of duration, intensity and cost in recent times. The last conflict that lasted over a month – the 2014 Gaza War, or what the Israel Defense Forces (IDF) called Operation Protective Edge – cost the Israeli economy an estimated ILS7bn (USD1.96bn), not including reservist pay or the cost of air force weapons. In the aftermath, the government cut ILS2bn (USD559m) from all ministries except defence to bring finances back in line.

Personnel costs

The call-up of 360,000 reservists – Israel’s biggest mobilisation since the 1973 Yom Kippur War – is placing considerable pressure on Israeli public finances. The Israeli government estimated that those costs reached USD41 million per day in the early stages of the fighting. Scaling that to reflect the duration of hostilities since then suggests that the extra personnel costs could have reached some USD4.2bn through January.

There are signs that these costs are falling, though. In October, the central bank estimated that 40–50% of reservists are still able to work in their regular jobs. This could lower the IDF’s daily reservist-wage bill to between USD20–24m because reservist compensation is calculated based on their regular salary, with a minimum pay of ILS300.61 (USD82.22) per day for students, the unemployed and those working under minimum salary.

The war has had other knock-on effects on the Israeli economy. Reservists represent about 8% of Israel’s workforce, meaning mobilisation led to a contraction of the labour supply. The resulting indirect economic cost totalled ILS2.5bn (USD684m) in the first five weeks of the operation alone, the central bank said.

Though reservists appear to be returning to the workforce, other shocks to the labour market remain. For example, prior to October 2023, an estimated 75,000 Palestinians from the West Bank and 12,000 from Gaza held Israeli work permits. This is in addition to some 15,000 undocumented workers engaged in trades such as construction and domestic work. Israel froze crossing permits for Palestinian workers after 7 October, and plans to make up shortfalls with foreign labour from the likes of India have yet to come to fruition. This suggests that Israel’s labour difficulties will remain, at least for the short to medium term.

Materiel costs

Israel also faces significant costs from the IDF’s high level of weapons expenditure. The IISS estimates that, prior to the conflict, Israel allocated a third of its defence budget to equipment acquisition and research and development. Israel received an additional USD3.3bn from the United States through Foreign Military Financing allocations.

Although it is premature to estimate the materiel costs of the current military operation, it is likely that future Israeli budgets will increase procurement spending to replenish munitions used and expand stocks. A likely priority is Tamir interceptors, used in the country’s Iron Dome missile-defence system. Israel has used hundreds of them to defend against rocket attacks. However, with an estimated cost of USD40–50,000 per interceptor (based on 2013 figures), replenishing and expanding inventories remain a sizeable commitment.

Reconstruction

One of the biggest question marks remains over how to pay for any post-war recovery, particularly in Gaza, given the scale of destruction. Israel said it would cover the direct and indirect damages of the 7 October attack within a 7-kilometre area around Ashkelon where a considerable number of missiles launched by Hamas struck. That includes loss of turnover for businesses and salary payments for employees. The government has guaranteed a loan fund of ILS10bn (USD2.7bn), as well as grants to businesses that have seen a significant drop in sales.

Estimating the total costs of the fighting is inexact given that there are few indications when it will subside. What is clear is that Israel and the wider region are headed for more challenging financial times as a result of the conflict. Last year, Israel’s central bank lowered its 2024 growth forecast to 2% from 3% and has said it does not expect GDP to recover to pre-war levels for more than a year. However, spending pressures remain. The government raised the national budget by around USD19bn last month and projected a 6.6% deficit for this year, largely to reflect war costs. The three major credit-rating agencies – Fitch Ratings, Moody’s and S&P Global – are reviewing Israel’s A+ rating for potential downgrade in response to the economic pressures.

The ripple effects go beyond Israel and Palestine. On 31 January, the International Monetary Fund revised its estimate for economic performance in the West Bank and Gaza downward by 9% to a 6% drop. It also lowered the growth forecast for the wider Middle East and North Africa region by 0.5% to 2%, considerably below the 5.6% growth achieved in 2022. With concerns about high inflation, the economic impact from the war will have wide-ranging and potentially long-lasting repercussions.