Date Posted: 18-Oct-2023
Author: Guy Anderson, London
Publication: Jane's Intelligence Review
The outbreak of conflict between Israel and Hamas-led groups on 7 October 2023 has led to the disruption of Israeli life and its economy. Guy Anderson assesses the economic impact of the conflict so far and how the continued disruption may affect the country's economy
Key points
- Israel's dynamic, export-oriented economy is very unlikely to experience long-term damage, but the call-up of reservists by the Israel Defense Forces (IDF) is the principal source of short-term disruption with the potential to hamper commercial activity through workplace absences and reduced consumer activity at home
- The mobilisation of the IDF and the attrition of military inventories will almost certainly come at a financial cost in terms of government expenditure, with the sums involved depending heavily on the direction the conflict takes and the duration of hostilities
- The response of currency and equity markets to the conflict between Israel and Hamas has been limited so far. The Israeli shekel lost ground against the US dollar immediately after hostilities began but remained just 4% below its pre-conflict level by 17 October
Israel's dynamic, export-orientated economy is very unlikely to experience long-term damage as a result of the conflict with Gaza that began on 7 October, although short-term disruption is very likely and there is a roughly even chance of reduced medium-term growth.
The call-up of reservists by the Israel Defense Forces (IDF) is the principal source of short-term disruption with the potential to hamper commercial activity through workplace absences and reduced consumer activity at home. However, impaired trade ties within the Middle East region and beyond have the potential to subdue the trajectory of future export growth.
Economic position
Israel's economy is highly export-orientated and geared towards high value-added manufacturing and services provision. National exports stood at an estimated USD160 billion in 2022, according to the Israel Ministry of Economy and Industry in December 2022; up from USD144 billion in 2021 and accounting for almost a third of all economic activity.
While world markets reacted to the potential disruption to the provision of commodities when hostilities began on 7 October – with an emphasis on the supply of potash from Israel and oil from the region more broadly – Israel's economy is primarily geared towards services such as research and development and information technology. Indeed, services account for more than half of exports, with the primary markets being in Europe and North America.
Call-up of reservists and budgetary considerations
Israel's services sector – and particularly its extensive ecosystem of start-up enterprises – is highly likely to have been disrupted by the call-up of military reservists during the early days of the conflict. Israel called-up 360,000 citizens, accounting for 4% of the population as a whole but 6% of the working-age population. On top of this figure workforces are likely to have been depleted on a temporary basis by those volunteering in civil functions and others who have been displaced by conflict damage or risks of attacks.
Civilian workplace absences owing to the call-up will also almost certainly mean reduced footfall in Israel's shopping malls, with private consumption accounting for nearly half of the country's GDP, according to economics data and analysis company CEIC. Economic activity will very likely rebound, however, when reservists are ultimately demobilised.
The mobilisation of the IDF and the attrition of military inventories will almost certainly come at a financial cost in terms of government expenditure, with the sums involved depending heavily on the direction the conflict takes and the duration of hostilities. Military expenditure is already significant at 3.4% of GDP (USD18 billion) in 2023, given the underlying security environment. However, Israel has the advantage of a strong underlying fiscal position. According to the Israel Ministry of Finance, public debt is modest at a debt-to-GDP ratio of 60% with a minimal budget deficit and a history of relatively strong economic growth.
Impact on international trade relations
At the time of publication, there is a roughly even chance that Israel's long-term economic growth trajectory could be dented both by overt declines in relations with export partners and the cooling of potential ties, some of which have recently developed under the Abraham Accords.
Colombia
One of the higher profile examples of a country's condemnation of Israel's response to Hamas' aggression came from Colombia, where the recently elected president – the left-wing former economist and guerrilla movement member Gustavo Petro – reacted angrily to the siege of Gaza and threatened to suspend diplomatic relations. Petro's intervention followed the signing of a bilateral free trade agreement (FTA) between Israel and Colombia in 2020 – an agreement that saw Israeli goods exports to the South American country almost double to USD139 million between 2020 and 2022, according to the United Nations Conference on Trade and Development (UNCTAD). Israel – which, according to Janes Markets Forecast, had been a significant supplier of military materiel to Colombia with direct exports valued at USD305 million between 2013 and 2020 – responded by suspending security-related sales.
Middle East and the Abraham Accords
Israel's economic relations in the Middle East may also have been complicated by the conflict with Hamas. The United Arab Emirates (UAE) and Israel signed a normalisation agreement in 2020 (under the US-brokered Abraham Accords), which led to a very large increase in bilateral trade and co-operation.
According to UNCTAD, Israel's goods exports to the UAE increased from just USD228,000 in 2019 to USD635 million in 2022; a 287,230% increase that looked likely to increase even further because of an FTA signed in May 2022. By 2022 the UAE accounted for 0.5% of Israel's world exports.
The UAE has taken a cautiously sympathetic line towards Hamas' attacks against Israel by condemning what it described as a “serious and grave escalation”, as cited by Reuters.
Ashkelon
An early target of Hamas was the coastal city of Ashkelon just 9 km from Gaza's northern border. While not a significant port in terms of shipping, it is the home of the northern terminal of the Trans-Israeli pipeline, which runs from the Gulf of Aqaba. An agreement between Israel and the UAE to use the pipeline to transport the latter's oil to the Mediterranean (thus avoiding the transit costs associated with marine transport via the Suez Canal) was one of the early tangible benefits of the normalisation arrangement, according to Reuters. Attacks by Hamas against the pipeline infrastructure threatened to derail this arrangement although future action against Ashkelon is now less likely, given Israel's more recent military action in the north of Gaza.
Saudi Arabia
Saudi Arabia and Israel had reportedly been in extensive discussions towards reaching a normalisation agreement comparable to that between Israel and the UAE prior to the commencement of hostilities. Given the scale of the Kingdom's economy (which is almost twice the size of that of the neighbouring Emirates) such an agreement would have had the potential to make a significant impact on future Israeli economic activity. The conflict has led to the suspension of talks, however, given Saudi concerns regarding Arab opinion. The Kingdom also reportedly rebuffed US calls to condemn the attacks by Hamas.
Market reactions
The response of currency and equity markets to the conflict between Israel and Hamas has been limited so far. The Israeli shekel lost ground against the US dollar immediately after hostilities began but remained just 4% below its pre-conflict level by 17 October. This reflects an immediate intervention by Israel's central bank (with the sale of USD30 billion of foreign reserves to support the domestic currency) and the view of traders that the Bank of Israel's move was likely sufficient.
The reaction of equity investors was more pronounced. The benchmark Tel Aviv 35 index of leading shares fell 8% between the last day of trading before the Hamas attacks and 17 October, but this performance also fell short of a rout.
Comment
At the time of publication, the economic implications of the Israel-Gaza conflict more generally depend heavily on the degree to which unrest can be contained. Janes notes diplomatic efforts were made by the US in particular to reinforce regional stability – a strategy pursued in parallel with the deployment of military assets to the region alongside those of allies such as the UK.
A broader conflict that involves actors and proxies from countries such as Iran, Iraq, and Syria would almost certainly interrupt the supply of oil from a region that accounts for around a third of global production, with price rises that would prove inflationary beyond oil-producing states at a time of pre-existing inflation pressures.
