In a related context, data from the Israeli Ministry of Finance showed that the direct cost of financing the war in Gaza until August amounted to 100 billion shekels ($26.3 billion).
The Bank of Israel estimates that the total cost could rise to 250 billion shekels by the end of 2025. But this estimate was made before Israel’s incursion into Lebanon to fight the Hezbollah group, which will increase the total cost.
This led to Israel’s credit rating being lowered, exacerbating economic impacts that could last for years, while the cost of insuring Israel’s default on its debts reached its highest level in 12 years, and the budget deficit increased.
“As long as the war continues, sovereign debt metrics will continue to deteriorate,” said Sergey Dergachev, portfolio manager at Union Investment.
Although the debt-to-GDP ratio, a basic measure of the economy’s health, reached 62 percent in Israel last year, borrowing needs have exceeded the limit.
Dergachev explained, “Even if Israel had entered the war in a relatively good economic situation, the matter would be painful on the financial side…and over time, it would put pressure on the credit rating.”
Israel’s Finance Minister says that its economy is strong and that its credit rating is expected to rise once the war ends.
The costs of the Israeli war are high due to Iron Dome air defenses, large-scale troop mobilization, and intense bombing campaigns. This year, the debt-to-GDP ratio reached 67 percent, while the government deficit recorded 8.3 percent of GDP, far exceeding the previously expected 6.6 percent.
Although the primary buyers of Israeli Eurobonds, pension funds or large asset managers tempted by relatively high sovereign debt ratings, will likely not dispose of these assets in a short period, the investor base has shrunk.
Investors privately say there is a growing willingness to dump or not buy Israeli bonds 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 the Central Bank of Norway sold a small stake in Israeli government bonds in 2023 “due to increased uncertainty in the market.”
“Valuations are what clearly reflects these concerns,” said Trang Nguyen, head of global emerging markets credit strategy at BNP Paribas, adding that Israeli bonds are trading at much wider spreads compared to countries with similar ratings.
When asked about rising borrowing costs and investor concerns about environmental, social and governance standards when preparing this report, the Ministry of Finance said that the government’s public finances had been “efficiently managed” since the start of the war.
“Israel’s resilient domestic market shows strong demand, and international investors remain confident in our creditworthiness,” the ministry added.
While the bond market in Israel has a large trading volume, is witnessing active buying and selling activity, and is expanding rapidly, foreign investors have withdrawn.
Central bank data show that the share of non-residents in government bonds fell to 8.4 percent, or 55.5 billion shekels, in July from 14.4 percent, or nearly 80 billion shekels, in September last year. During the same period, the volume of bonds in circulation grew by more than a fifth.
A Finance Ministry official told Reuters, “Israeli institutions have already been buying more bonds for several months, and I believe that some global investors sold them due to geopolitical conditions and uncertainty.”
Capital investors are also reducing their investments, as data from Copley Research showed that the reduction in international investors’ pumping of money into Israeli funds accelerated after the Hamas attack on October 7 last year, after it began in May 2023 amid the controversial judicial amendments crisis.
Global funds’ ownership of Israeli stocks has fallen to its lowest levels in a decade.
Foreign direct investment in Israel fell 29 percent year-on-year in 2023, according to the United Nations Conference on Trade and Development — the lowest level since 2016. While figures for 2024 are not available, rating agencies have noted the unexpected impact of the war on such of investments as a concern.
All of this has increased the need for local investment and government support.
The government pledged in April to allocate $160 million in public funds to boost venture capital funding for the vital technology sector, which represents about 20 percent of Israel’s economy.
This is in addition to other costs, including providing housing for thousands of people displaced by the fighting, many of whom live in vacant hotels due to the sharp decline in the number of tourists.
The agricultural and construction sectors face obstacles due to displacement and labor shortages, as a result of mobilization and Israel’s refusal to allow Palestinian workers to enter.
The decline in construction activity was a major factor in reducing economic growth, which fell by more than 20 percent in the fourth quarter of last year and has not yet recovered. Data from the three months to the end of June show that seasonally adjusted gross domestic product remained 1.5 percent below pre-attack levels, according to Goldman Sachs calculations.
Israel has not yet faced any difficulties in raising funds. It sold debt in global capital markets this year for about eight billion dollars. Israel Bonds, the government’s diaspora bond borrowing vehicle, is targeting a second annual record of more than $2.7 billion.
But rising borrowing and spending costs and economic pressures pose looming challenges.
“There is room for Israel to continue to navigate this crisis, given the large domestic investor base that can continue to finance another large deficit,” said Roger Mark, an analyst on the fixed income team at Ninety One.
“However, local investors are looking forward to at least some signs of the government’s efforts to adjust public finances and reduce the budget deficit,” he added.
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