The British newspaper The Economist said that the pace of money flight from Israeli banks to foreign institutions doubled between May and July, as investors prepare for the "nightmare scenario" if the war swallows Tel Aviv and occupied Jerusalem.

The newspaper pointed out that investors are not sure of Israel's ability to recover, as the shekel is volatile and Israeli banks are suffering from capital flight.

According to the newspaper, the three largest Israeli banks report a significant increase in the number of customers requesting to transfer their savings to other countries or link them to the dollar, adding that they are resigned to things getting worse.

The newspaper saw in a report that the situation of the Israeli economy has become more difficult compared to the first periods of the war on Gaza, as its gross domestic product grew by only 0.7% between April and June on an annual basis, which is about 5.2 percentage points less than economists expected, according to Bloomberg News Agency.

On September 16, Israeli Finance Minister Bezalel Smotrich was forced to ask lawmakers to approve an emergency increase in the deficit, the second time he has made such a request this year, according to what the British newspaper pointed out.

Smotrich's extravagance and the outbreak of more violent confrontations (southern Lebanon) are a source of concern for investors. On September 23, Israel launched air strikes on the Lebanese border, killing more than 500 people, according to local officials.

This came in the wake of the explosion of pagers and walkie-talkies used by Hezbollah, which killed 39 people, as well as months of rocket attacks by the party on Israeli settlements.

The newspaper pointed out that money has begun to flee Israel, with outflows from Israeli banks to foreign institutions doubling from the same period last year to $2 billion between May and July, at a time when the country’s economic policymakers are more concerned than they have been since the beginning of the conflict.

To the brink

The Economist stated that any economy in wartime is deeply damaged, as the government must finance its armed forces, often through deficit spending, while ensuring that it remains strong enough to pay off its debts when the war ends.

The “nightmare scenario” for Israel, according to the newspaper, is a conflict that spreads to occupied Jerusalem and Tel Aviv, the two main commercial centers, but even a less severe war in which the confrontation is limited to northern Israel could be enough to push its economy to the brink.

The newspaper explained that the unlimited Israeli government spending does not help it. Last March, when the army was hoping to reach a ceasefire by July, the generals estimated that they would need 60 billion shekels ($16 billion, or 3% of Israel’s GDP) above their regular budget, and then a permanent increase of 30 billion shekels ($8 billion) annually to deal with the new security situation.

Since then, as the fighting has continued, deficit projections have continued to rise, and the deficit is now expected to reach 8.1% of GDP this year, which is nearly three times what was expected before the war.

Even a less severe war in which the confrontation is limited to northern Israel could be enough to push its economy over the edge.

The report indicated that Israel’s debt in January reached about 62% of GDP (below the average in OECD countries), which means to investors that Smotrich has little room to maneuver, but if the war continues next year, the financial situation will deteriorate.

The newspaper pointed out that Israeli bondholders want to make sure there is enough room for more military spending, so the acceptable debt ceiling for Israel is lower than that of similar countries, and credit rating agencies are also concerned, with Fitch and Moody’s saying they may downgrade Israel again after doing so once this year.

A Worse Problem

Israeli Finance Minister Bezalel Smotrich, a West Bank settler whose party belongs to the far right in Israel, is making the problem worse, as he is unlikely to ask the military to cut costs.

He has also refused to take other measures to rein in the deficit, either by cutting spending in other items or raising taxes, and Israel’s welfare state continues to expand economically, and the religious population (the Haredim) and the settlers (Smotrich’s allies) have benefited from more subsidies and aid to keep men in their homes, according to the newspaper.

Smotrich has promised to provide $35 billion next year, but he has not said where most of that money will come from.

Work Permits and the Decline of the Construction Industry in Israel

The report indicated that Israel refused to issue work permits to about 80,000 Palestinian workers after October 7, and they were not replaced, and as a result the construction industry declined by 40% compared to the same period last year, which greatly hindered the construction and repair of housing.

At present, the biggest impact has been on inflation, which reached an annual rate of 3.6% last August after accelerating during the summer. If Hezbollah attacks increase, the shortage of construction workers will become a bigger problem, according to the newspaper.

The newspaper saw that investors are not sure about Israel's ability to recover. The shekel is volatile and Israeli banks are suffering from capital flight. The three largest Israeli banks report a significant increase in the number of customers asking to transfer their savings to other countries or to link them to the dollar. However, although inflation is still above target, the central bank chose to hold the previous interest rate at its monetary policy meeting in August for fear of hindering the recovery.

With the scenario of a comprehensive war, military spending will jump to large levels, and the flight of investors may lead to the collapse of banks and the fall of the shekel.

The "nightmare scenario"

As for what the newspaper mentioned as the "nightmare scenario", it is that few investors are preparing for a war that could include all of Israel, including occupied Jerusalem and Tel Aviv.

Under this scenario, economic growth will be severely damaged, perhaps even more than it was after October 7, military spending will jump to record levels, and investor flight may bring down the banks and drop the shekel, forcing the Bank of Israel to step in and spend its reserves.

The newspaper concluded its report by noting that whatever happens, Israeli economists are resigned to things getting worse, and even Smotrich, who is generally optimistic, is now showing a sense of exhaustion, saying, “We are in the longest and most expensive war in Israel’s history.”

Source: The Economist +Al Jazeera