Should the fighting in its neighbourhood persist into 2025, Israel’s finances are likely to worsen. Bondholders are growing anxious, seeking reassurance that Israel has the fiscal capacity to sustain its war expenditure. As a result, they are setting lower thresholds for acceptable debt levels compared to similar countries.

Investors are increasingly sceptical about Israel’s ability to bounce back. The shekel remains volatile, and Israeli banks are reporting growing capital flight, with many customers moving their savings abroad or linking them to the dollar. Inflation has risen above target, but the central bank has chosen to keep interest rates steady, fearing that rate hikes could derail a fragile recovery.

Israel’s tech industry, once the crown jewel of its economy, is particularly vulnerable. This sector, which has traditionally been a driver of Israel’s rapid economic growth, is expected to see a significant downturn. The mobilisation of tech professionals has disrupted productivity, and investor confidence has plummeted, with both domestic and international capital flowing towards safer markets. The Mediterranean island of Cyprus (where one of the present columnists, Raghavan, was High Commissioner until a few years ago), just a 45-minute flight from Tel Aviv, has become a popular destination for Israeli tech companies seeking stability, as it offers attractive tax incentives and a safe haven with high quality of life.

While Israel’s tech sector has the potential to eventually recover due to its global reputation for innovation and its strong ties to the US and Europe, the duration of the conflict and the government’s ability to stabilise the economy will play a crucial role in determining long-term recovery.

Fears of fiscal spiral

Prime Minister Netanyahu’s financial commitments to his ultra-Orthodox coalition partners are exacerbating concerns, raising fears of a fiscal spiral where Israel’s high earners bear an increasing tax burden. Defence spending, already set to double to 9 per cent of GDP, risks pushing the economy into a “lost decade”, similar to the economic stagnation India experienced after its 1965 and 1971 wars.

The war’s cost, projected to reach 250 billion shekels ($67 billion) by 2025, adds to Israel’s economic woes. While US military aid remains essential, it will not be enough to cover Israel’s ballooning expenses. The deficit, currently at 7.8 per cent of GDP, is likely to grow, burdening future generations with higher debt repayments.

Domestically, Israel’s economic challenges go beyond macroeconomic indicators. The construction sector has slowed by nearly a third, agricultural output has dropped by 25 per cent, and tourism — though a smaller part of Israel’s economy — has been devastated. Gaza’s economy has been decimated, with trade halted and infrastructure destroyed, leaving thousands dependent on aid. Israel will ultimately bear the responsibility for rebuilding Gaza, and even with international assistance, this will be a significant burden on its economy.

Israel is facing mounting economic pressures that may soon outweigh its battlefield successes. Without a swift resolution or ceasefire, Israel’s economic outlook appears increasingly bleak, with long-term consequences not only for Israel but for the wider region. The war may have started in Gaza, but its impact is now spreading far beyond.

Implications for India

What does this mean for India and its relations with Israel? Given the steadily developing relationship between India and Israel, the economic strains on Israel could have implications for India as well. Tens of thousands of Indian citizens work in Israel, primarily in construction and industry. However, they cannot replace the jobs of Palestinians, as India maintains a strong empathy and relationship with the Palestinian population and is deeply concerned about the plight of innocent civilians trapped in conflict.

For all intents and purposes, Israel must wind down its wars, begin the reconstruction of Gaza, and restore normalcy to both its own economy and the Palestinian territories.

Raghavan is a former Director of CBI and a former High Commissioner of India to Cyprus. Goyal is a geopolitical risk strategist