Israeli Prime Minister Benjamin Netanyahu’s cabinet approved a revised state budget for 2024 that became bogged down in political wrangling and unnerved investors worried about the government’s fiscal path during the war against Hamas.
A 70 billion-shekel ($19 billion) surge in expenditure and an estimated drop of 36 billion shekels in revenues will push this year’s deficit to 6.6% of gross domestic product, a shortfall that would be among the widest for Israel this century. Defense spending alone will go up by 55 billion shekels.
The National Unity Party led by Netanyahu’s political rival Benny Gantz, who joined the government after Hamas’s Oct. 7 attacks, voted against the budget during a session on Monday that was delayed by disagreements.
Finance Minister Bezalel Smotrich said on X after the vote that “we are changing the order of priorities” to show “there is a government that stands behind” every reservist, soldier and their families.
The approval was the culmination of a standoff pitting critics across the Israeli finance establishment against a right-wing ruling coalition unwilling to pay the political price with its survival in question.
As the cabinet vote approached, a letter signed by 200 of Israel’s top business leaders and chief executive officers called on the government to avoid “damage to Israel’s national and economic strength,” asking it to consider the risk of a possible credit rating downgrade. It’s a view echoed by Dov Kotler, head of one of the country’s two biggest banks.
“National priorities must change,” Kotler, Bank Hapoalim’s CEO, said in a rare interview. “Anything that supports defense and growth stays, anything else gets thrown out.”
The central bank has also been warning the government’s fiscal response to the war that began just over three months ago could provoke a backlash from investors. It’s pointed to the possibility of an increase in bond yields and currency devaluation, along with a drag on future economic growth.
That concern is already starting to materialize against the backdrop of fears over a wider conflict in the Middle East.
The shekel is among the world’s worst performers against the dollar in the year to date with a loss of almost 4%. The cost to insure Israel’s sovereign bonds against a default is up by more than 12 basis points since late December.
Fiscal Adjustments
“We need to be sure that leadership is acting in our best interest,” said Eyal Ben Simon, CEO of Phoenix Holdings Ltd., one of Israel’s largest institutional investors that oversees over $110 billion in assets. “As a financial investor, 2023 was difficult and could be an example of what happens if we do not act properly at this crossroad.”
The Finance Ministry’s 20 billion shekels of adjustments fell short of what’s been urged by the central bank, a change it argued was necessary to ensure that public debt as a share of economic output starts declining after 2025.
Gantz’s party said the government’s budget proposal “doesn’t invest enough in growth engines and doesn’t reflect the necessary fundamental change of priorities.” The budget needs parliament’s approval by Feb. 19.
The fiscal program backed by the cabinet offers a mix of measures such as tax hikes and spending reductions — including a 5% cut to ministry budgets — to help cope with a steep increase in expenditure to 582 billion shekels this year.
But it spared many of the controversial outlays on religious institutions and other political causes advocated by Netanyahu’s ultra-Orthodox and far-right allies, whose support he needs to remain in power.
In an effort to avoid deep cuts in various government ministries, the cabinet voted to raise social security fees, the health tax and the value-added levy.
Other key highlights of Israel’s budget
Expenditure will surge by almost 70 billion shekels this year, which includes 13.5 billion shekels for civilian expenses resulting from the war
VAT will rise from 17% to 18% in 2025 and is set to generate 7.2 billion shekels annually
Israeli banks’ tax on profits will go up to 26% from 17% for two years only, bringing in 1.4 billion shekels per year
Dividends will be collected from government enterprises like defense companies Rafael and Israel Aircraft Industries, yielding 2 billion shekels
The government plans to cut by 15% its funding of various programs, some aimed at fighting violence in Israeli Arab communities
The discussions around the budget thrust Netanyahu’s Likud party into a tricky political calculation as it sags in the polls. While trying to preserve an emergency unity government, it can’t alienate the religious and nationalist allies that helped put it into office a year ago.
New elections are possible as early as the first half of 2024 as calls grow for the prime minister and other elected officials to take responsibility for the Oct. 7 attacks that saw 1,200 people killed and over 100 taken hostage.
Netanyahu’s compromises were on display Monday with a decision to scale back by less than a third what are known as “coalition funds,” an 8 billion-shekel discretionary allocation set aside for the five parties comprising the ruling government.
The funding has become especially contentious after the start of the war since it’s in part intended for West Bank settlements and religious schools that don’t teach math and English.
What’s Next
After the budget deal, questions now center on how the central bank might respond and if Israel’s credit rating will suffer as a result.
The strain on Israel’s finances has already put the government in the spotlight of the three biggest credit assessors, though Israel has so far avoided what would be its first-ever rating downgrade.
Bank of Israel Governor Amir Yaron has meanwhile said “a risky fiscal policy” could be a factor for interest-rate decisions, following a cut earlier this month.
Researchers at the central bank have raised their war-bill forecast for 2023-2025 to 255 billion shekels, of which nearly two-thirds consists of defense expenditure, alongside rising interest payments on government debt.
Besides what the central bank called a “transitory increase” in the budgetary costs from the war, Israel faces a more permanent burden that would total about 30 billion shekels from 2025 onward.
“The business of government is about prioritizing,” Andrew Abir, the central bank’s deputy governor, said in a recent interview. “Any government has to make some form of prioritization around the sums of spending or, on the other hand, the taxation it raises.”
LINK: Israel War Budget Approval Exposes Rifts, Leaves Markets on Edge – Bloomberg
