Israeli Election Stalemate Threatens Public Services and Economic Growth

Israel faces a problematic political deadlock following its latest elections, with polls indicating a likely stalemate and potential for repeated elections, reminiscent of the 2019-2023 period of perpetual transitional governments that hampered economic progress. This political paralysis is expected to have significant repercussions on public services and the Israeli economy.

Daphna Aviram-Nitzan and Roi Kenet-Portal from the Israel Democracy Institute warn that without a government to pass the 2027 budget, the state will operate on a continuing budget. This limits monthly expenditures to one-twelfth of the legally allowed amount, adjusted only for population growth, not inflation. This erosion of funds could lead to a deficit of billions of shekels, disproportionately impacting civilian ministries like education, health, and welfare, which already face budget shortages. The OECD has noted that Israel's civilian spending is already significantly lower than the average in member countries.

The most vulnerable populations will be those in lower income brackets, who rely on state-provided services. The middle class may also face increased out-of-pocket expenses for private healthcare, education, and welfare. This political paralysis could exacerbate the cost of living and deepen social inequalities without tax increases. Social organizations and charities, crucial since the October 7th attacks, could also suffer as a continuing budget restricts new commitments and requires special approvals for essential activities.

Infrastructure investments and new projects may be delayed, impacting the Innovation and Investment Authorities. The OECD has cautioned against broad cuts and urged protection for education and infrastructure investments, areas likely to be affected by the absence of a government to set new priorities. While a continuing budget might curb the deficit in the short term, it could lead to slower growth, reduced tax revenues, and increased interest expenses.

Despite these concerns, the Israeli capital market has shown surprising calm. Credit rating agency Fitch maintained Israel's 'A' rating with a negative outlook in October, warning that political instability could hinder debt reduction and increase financing costs. However, the stock market remains stable, the shekel is strong, and Israel's risk premium has decreased significantly. Rafi Gozlan, Chief Economist at IBI Investment House, suggests investors are anticipating a stalemate, viewing it as preferable to the current government continuing its term. He notes that a change in government could improve Israel's international standing and encourage investment, while the current government's continuation might lead to negative market reactions. The third scenario, a prolonged period of political instability, would hinder decision-making, investment, and long-term planning, potentially leading to slower growth and lower returns.

Ariel Moldovan, Deputy CEO of Pasternak Shoham Investment Management, differentiates between the impact of elections on economic activity and stock performance. He points out that Israel's economy is relatively strong, with inflation under control, interest rates falling, and a strong currency. While political uncertainty is generally disliked by investors, he argues that stock performance is ultimately driven by corporate profits, which have remained strong in sectors like technology and cyber, largely unaffected by government identity. He suggests that short-term market fluctuations are common after elections, but long-term performance depends on company earnings and investor willingness to pay for them. While investors might continue to profit, ordinary citizens facing daily challenges in accessing services and approvals will bear the brunt of the political deadlock.