Israel’s economy is set to expand at a more moderate pace this year and next year, the Organisation for Economic Cooperation and Development (OECD) cautioned on Wednesday, citing the risk of continued political tensions around the government’s planned judicial overhaul and uncertainty about the global economy.
In the Economic Outlook 2023 report, the OECD lowered the GDP forecast for Israel to 2.9% in 2023 from 3% projected in April, and to 3.3% in 2024 from 3.4% previously. Last month, Israel’s Finance Ministry trimmed its economic growth forecasts and expects GDP to grow at 2.7% in 2023 and 3.1% in 2024 – down from its January estimates of 3% and 3.2%, respectively.
The global economy is expected to grow 2.7% in 2023, slowing from 3.3% in 2022, before picking up modestly to 2.9% in 2024, according to OECD estimates.
“Risks are skewed to the downside, related to high global uncertainty and domestic political tensions,” the OECD remarked in the Israel section of the report. “Heightened security incidents and continued political tensions around the judicial reform could increase risk perceptions, lead to tighter financial conditions, and weigh on business sentiment and investment.”
The OECD pointed out that the “shekel has depreciated in the first five months of the year and the stock market has markedly underperformed global indices.”
In addition, the organization raised concern about the sharp drop in capital raised by tech companies in recent years compared to the high levels seen in 2021 and early 2022. In the first quarter of this year, Israeli tech companies raised $1.7 billion in capital, down 70% from the $5.8 billion in the first three months of 2022, according to a report by IVC Research Center and LeumiTech. The quarter marked the lowest figure in four years. Private investments in the local tech sector peaked in 2021 with investments of a staggering $26 billion, slumping to around $15 billion in 2022.
“A more pronounced slowdown in the global hi-tech sector would also adversely affect growth in Israel,” the OECD said.
The organization said that while higher interest rates are set to slow investment growth, the Bank of Israel will need to maintain “tight monetary conditions” to bring inflation back to the government’s target range.
The Bank of Israel has steadily raised its benchmark interest rate from a record low of 0.1% last April to 4.75% this year in a bid to rein in inflation which, hovering around 5% in the past few months, has fallen short of the target range of 1% to 3%. Meanwhile, a weaker shekel is making imported goods more expensive, which in turn fuels consumer prices, such as the cost of gasoline.
“Elevated inflation will weigh on private consumption growth and exports will be held back by moderate demand growth in trading partners,” the OECD said. “The labour market will slightly cool as growth moderates.”
The OECD cautioned the Israeli government to maintain “fiscal prudence” to avoid adding to inflationary pressures.
“Tax revenues are slowing as GDP growth is moderating and some transitory factors, for instance related to high real estate valuations, are dissipating,” the OECD commented.
The organization described the planned increase in spending in the recently passed state budget for 2023 and 2024 as “moderate,” and expects the budget balance to turn from a small surplus in 2022 to a deficit “slightly above 1% of GDP in 2023 and 2024.”
As part of the 2023-2024 budget, the government approved the allocation of more than NIS 14 billion in coalition funds that will mostly go toward increasing support for Haredi, or ultra-Orthodox, institutions and programs. Finance Ministry officials and leading economists have warned that the allocation threatens to turn Israel into a backward country and damage its labor market and economy.
The concern is that the increase in the allocation of funds to non-official ultra-Orthodox educational institutions, which are not subject to supervision by the Education Ministry and do not teach core studies such as math, science and English, will prevent Haredi children from learning basic skills essential for their integration into the workforce. Israel’s Haredi population, which constitutes about 13.5% of the country’s total population, is expected to grow to 16% in 2030.
The OECD recommended the Israeli government introduce labor market and educational reforms to address demographic challenges and mitigate “wide labor market disparities.”
“Addressing demographic challenges, related to the rising share of population groups with weak labour market attachment, is crucial to maintain future growth and fiscal sustainability,” the OECD warned. “This will require setting appropriate work incentives, better supporting working parents including by expanding child-care facilities in underserved areas, improving skills at all stages of the learning cycle, as well as facilitating mobility towards high productivity jobs and firms.”
Additionally, the organization sees the need for reforms to tackle the rising costs of living, which it said should become more “targeted.” At the end of May, Prime Minister Benjamin Netanyahu set up a ministerial committee to deal with the cost of living, amid persistent inflation and rising public criticism that his government has neglected the matter while focusing on its planned judicial overhaul. Israel’s largest food manufacturers have in recent months announced price increases in the retail sector, led by milk products and products such as bread, instant coffee, sugar, and cocoa.
“Reforms to reduce import barriers and spur competition should continue,” the OECD said.
Looking ahead, the OECD sees economic growth picking up toward its potential
rate in 2024 as inflation abates. The organization expects inflation to gradually slow from the current 5% to 4.1% in 2023 and 2.3% in 2024.