Israeli Economy Faces Post-Election Uncertainty and Fiscal Challenges

The upcoming Israeli elections on Tuesday, October 27, are expected to have significant economic repercussions beyond their political impact. Ronen Menachem, Chief Markets Economist at Mizrahi Tefahot, predicts that the election outcome will influence the economy, businesses, and foreign trade. A stable government is seen as crucial for providing the economic certainty needed for consumer and investment decisions.

Key economic issues facing the next government include the rising cost of living and the state budget for 2027. This budget must outline priorities and foster growth engines, while also presenting a clear plan to contain the deficit and reduce public debt. The geopolitical and security situation will heavily influence the state's financing needs, potentially leading to increased bond issuance, tax hikes, or revised benefits, alongside necessary expenditures for civilian infrastructure and military procurement.

A scenario of indecisive election results could lead to prolonged political instability and further election cycles, exacerbating security uncertainties and hindering economic activity. In such a case, the economy might operate under a continuing budget throughout most of 2027, limiting spending increases. Significant rises in defense spending, as recently observed, would necessitate urgent, broad budget cuts, impacting civilian ministries and potentially lowering future economic output.

Furthermore, an indecisive outcome could weaken the shekel against the dollar, potentially fueling price increases and complicating the Bank of Israel's efforts to lower interest rates. Interest rate levels significantly affect the real estate and high-tech sectors, though the latter is also influenced by global trends. Defense companies might be less affected if global demand for their products remains strong due to the international security landscape.

Fiscal policy will be constrained by a continuing budget, limiting spending flexibility. The sustainability of recent strong revenue streams is uncertain. Limited decision-making capacity could delay crucial long-term government projects, such as infrastructure and education investments. The new government might need to implement fiscal adjustments of 2-3% of GDP to halt the growth of debt-to-GDP ratio, which currently stands at 3.2%, below the 2026 target of 4.9%, but expected to narrow as expenditures rise.

Taxation adjustments, including expanding tax bases and rates, will likely be necessary to meet budget needs. Careful economic planning is required to design taxes that minimize harm to growth-generating activities and offer relief to middle-income households and businesses. Imported inflation will likely erode household purchasing power regardless of the scenario. Election-related uncertainty, indecisiveness, or prolonged coalition negotiations could cause domestic and foreign investors to pause, potentially affecting risk premiums, capital costs, and available funds for investment in economy, society, and welfare. However, Israel's risk premium has historically surprised positively during past challenges. Regulatory policy will also be examined, with a need for clarity and potential easing to provide businesses and consumers with necessary economic outlook.

The economy enters the election period recovering from Operation 'Iron Swords', with low inflation and a strong labor market. Transparent, clear, and responsible economic policy will be vital for navigating challenges like local security tensions and trade difficulties with the EU. The immediate task will be to calm markets and reduce concerns. The upcoming elections are a significant economic event, a critical juncture closely watched by all economic actors.