Written by Libby George, Karen Strohecker and Stephen Shear
LONDON/JERUSALEM (Reuters) – For nearly a year, the Israeli economy has weathered the chaos of a war that threatens to turn into a regional conflict, but rising borrowing costs have begun to put pressure on its financial structure.
The direct cost of financing the war in Gaza until August amounted to $100 billion ($26.3 billion), according to the Ministry of Finance. The Bank of Israel believes the total could rise to NIS 250 billion by the end of 2025, but that estimate was made before the Israeli incursion into Lebanon to fight Hezbollah, which will add to the tally.
This has led to a credit rating downgrade, amplifying economic impacts that may reverberate for years, while the cost of insuring Israel’s debt against default is near a 12-year high and its budget deficit is growing.
“As long as the war continues, sovereign debt metrics will continue to deteriorate,” said Sergey Dergachev, portfolio manager at Union Investment.
Although Israel’s debt-to-GDP ratio, a basic measure of economic health, reached 62% last year, borrowing needs have ballooned.
“Even if Israel has a relatively good base, it will still be painful on the financial side,” Dergachev said, adding: “And over time, this will put pressure on the rating.”
The Israeli Finance Minister said that the economy is strong, and that the country’s credit rating should rebound once the war ends.
The cost of the war is high due to Israeli air defenses, Iron Dome, large-scale mobilization of forces, and intense bombing campaigns. This year, the debt-to-GDP ratio reached 67%, while the government deficit reached 8.3% of GDP, much higher than the previously expected ratio of 6.6%.
While the primary buyers of Israel’s international bonds – pension funds or major asset managers attracted by its relatively high sovereign debt rating – are unlikely to offload the assets in a short time, the investor base has narrowed.
Private investors say there is a growing interest in unloading Israeli bonds, or not buying them, due to concerns about the environmental, social and governance implications of how the war is being conducted.
A spokesman for the Norwegian sovereign wealth fund said that Norges Bank sold a small share of Israeli government bonds in 2023 “due to increased market uncertainty.”
“What you see reflecting these concerns is clearly valuations,” said Trang Nguyen, global head of emerging markets credit strategy at BNP Paribas, adding that Israeli bonds are trading at much wider spreads than similarly rated countries.
Asked about rising borrowing costs and ESG concerns from investors for this story, Israel’s Finance Ministry did not immediately respond to a request for comment.
Although Israel’s domestic bond market is deep, liquid and expanding rapidly, foreign investors have retreated.
Central bank data show that the share of non-residents fell to 8.4%, or NIS 55.5 billion, in July from 14.4%, or nearly NIS 80 billion, in September last year. During the same period, the volume of outstanding bonds increased by more than a fifth.
“Israeli institutions have actually been buying more over the past few months, and I think some global investors sold bonds because of geopolitics and uncertainty,” said a Finance Ministry official, who requested to remain anonymous.
Stock investors are also downsizing. International investors’ downgrades of Israel’s funds, which began in May 2023 amid disputed judicial reforms, accelerated after the October 7 Hamas attacks, data from Copley Fund Research showed.
Global funds’ ownership of Israeli stocks is now at its lowest levels in a decade.
Foreign direct investment in Israel fell by 29% year-on-year in 2023, according to UNCTAD – the lowest level since 2016. While 2024 figures are not available, rating agencies have cited the war’s unexpected impact on such investment as a source of anxiety.
All of this has amplified the need for domestic investment and government support.
The government in April pledged $160 million in public money to boost venture capital funding for the critical technology sector, which represents about 20% of the Israeli economy.
This adds to other costs, including housing thousands of people displaced by the fighting, many of them in vacant hotels due to a sharp decline in the number of tourists.
Displacements, labor shortages due to mobilization, and Israel’s refusal to allow Palestinian workers to enter are hindering the agricultural and construction sectors.
The latter has been a major factor in dampening economic growth – which fell by more than 20% in the fourth quarter of last year and has yet to recover. Data from the three months to the end of June show seasonally adjusted gross domestic product remained 1.5% below pre-attack levels, Goldman Sachs calculations show.
Israel has not yet faced much difficulty in raising funds. It sold about $8 billion of debt on international capital markets this year. Its diaspora bond vehicle, Israel Bonds, is targeting a second annual record of more than $2.7 billion.
But higher borrowing costs, coupled with higher spending and economic pressures, loom large.
“There is room for Israel to continue to flounder, given the large domestic investor base that can continue to finance another large deficit,” said Roger Mark, an analyst in the fixed income team at Ninety One.
“However, local investors are at least looking for some indication of consolidation efforts by the government.”
($1 = 3.8055 shekels)