Israel faces a looming financial crisis if it fails to act, former chief economist warns
Yoel Naveh sees high probability that Israel will be plunged into recession, endangering national security, in next three to five years if it fails to pass responsible 2025 budget
Sharon Wrobel is a tech reporter for The Times of Israel.
Israel needs to act vigorously and with immediate action to formulate a responsible 2025 budget to stave off the risk of a looming financial crisis, that could drag its war-battered economy into a recession and endanger the country’s national security, a former Finance Ministry chief economist has warned.
In an assessment policy paper, Yoel Naveh, the Finance Ministry’s chief economist during a four-year tenure ending in 2018; and Lev Drucker, former senior deputy to the chief economist until 2022, cautioned that if the government fails to address the 2025 budget responsibly by implementing the needed spending cuts, tax hikes, and growth-enhancing reforms, there is a high probability that Israel will be facing a financial crisis in the next three to five years.
“Statements by the prime minister and the finance minister, the lack of discussions on the 2025 budget, and the government’s recent decisions on another breach of the budget framework for the year 2024 show that the government does not understand the scope of the economic problem it faces and instead chooses to ignore the dangers of severely damaging the economy and, as a result, national security,” Naveh and Drucker wrote in the policy paper.
“Failure by the government to take immediate actions to stabilize the economic situation increases the risk of a fiscal crisis which quickly can turn into a financial crisis, the consequences of which will be severe as it will impact Israel’s ability to raise funds for security needs and also affect the private sector,” according to Naveh and Drucker. “Exiting such a crisis will take a long time and severely damage the standard of living in Israel.”
When investors lose confidence in the government’s ability to manage its growing debt it could lead to a fiscal crisis, which has a snowball effect on investments, interest rates are likely to stay higher for longer and credit costs in the economy are mote expensive, which in turn very quickly translate into businesses closing and job losses.
“We believe that official growth projections that the current policies are based on are too optimistic as they assume that everything will go back to normal with the end of the war without any permanent damage,” Drucker told The Times of Israel. “Policymakers must realize that even with the end of the fighting, the economy will not return to the growth path that preceded October 7.”
“There will still be some long-term damage to the growth potential of the economy because of the change in risk perception,” he cautioned.
Faced with credit ratings downgrades and a widening deficit at the same time as ballooning military and civilian spending, as the war against the Hamas terror group in Gaza entered its 12th month, the government has come under increased pressure to maintain fiscal responsibility and credibility, while funding the costs of the fighting.
A lower credit rating makes it more expensive for the Israeli government to raise debt at a time, when it needs billions of shekels to fund the costs of the ongoing war, while investors see more risk to invest in the country, and local war-hit businesses suffer from higher interest rates to borrow money.
“We don’t think that we will see an abrupt end of the war, but rather a gradual decline in the intensity of the security situation throughout 2025, which means that there will be a stabilization, but not the kind of accelerated recovery we saw after the coronavirus pandemic,” said Drucker. “If the government will not act responsibly by providing forward-looking guidance to reduce the debt trajectory in these times of great uncertainty, interest rates will have to stay high for longer.”
“This means credit costs jump for businesses and households, which means purchasing power will go down and investments will fall and these are the two biggest items to growth,” said Drucker.
After almost two months of delays in starting the process for the approval of the 2025 budget, including warnings by the central bank governor, Finance Minister Bezalel Smotrich last week presented an initial framework for next year’s state finances. Part of the 2025 budget plan are broad spending cuts of NIS 35 billion ($9.4 billion), coupled with unpopular measures, which are expected to be difficult to get approval for, including the freeze in tax rates, benefits, and public sector pay.
As a result, the budget deficit target will be 4% of gross domestic product, down from a 6.6% of GDP target in 2024, according to the plan.
“We are not questioning the reasons for the high deficit for this year, but we are urging the government to make the necessary adjustments for next year and, even more important than that, for the years afterwards,” said Drucker. “Deficit levels of above 4% in the long-term are not sustainable.”
“We need to make spending efficient in areas which are not related to defense, because that for sure will be increased,” said Drucker.
Naveh and Drucker estimated that the government will need to make budgetary adjustments of between NIS 30 to NIS 50 billion in the 2025 budget depending on the size of the expected permanent increase in defense spending.
“The goal is to authorize the budget for 2025, but we need to have the political backing,” said Drucker. “We need the prime minister to put his head in the ring and support this unpopular measure.”
As part of the budget 2025 and to catalyze the growth potential of the economy, Naveh and Drucker urged the government to formulate an overall economic plan based on three main components: reducing government spending while changing the order of priorities, increasing state revenues by expanding the tax base, and initiating a wide range of structural reforms that will minimize some of the negative effects that increasing the tax burden will have. The reforms will include increased competition in imports, including the import of services such as insurance, and food products, and the reduction of regulation.
“Without these reforms, we will not be able to offset the inflationary effect of the policy measures which in turn means that the Bank of Israel will keep interest rates higher for longer affecting households and businesses,” said Drucker.
