Israeli tanks operate amid the ongoing ground operation of the Israeli army against the Palestinian Islamist group Hamas
Israel will triple its fiscal deficit next year as military spending soars © Reuters

The Israel-Hamas war is exacting a terrible toll in human life and suffering. Its financial implications for Israel are more muted. A fiscal deficit will widen next year as military spending soars. But the country can finance most of its needs. That helps support the shekel, sovereign bonds and the stock market.

Military spending will rise substantially from about 5 per cent to 7-8 per cent of gross domestic product. Israel will triple its fiscal deficit next year to pay for this added outlay.

Investors in Israeli bonds require an additional risk premium as a result. The yield on Israeli 10-year bonds has climbed since September and the yield spread with equivalent global benchmarks has opened up by perhaps 40 basis points. Credit default swap prices have risen but not by enough to cause any alarm.

Israel has little dependence on external lenders. Credit rating agencies such as S&P and Moody’s have placed its bonds on negative watch. Yet it should be able to finance its swelling military budget locally, thinks Capital Economics. Only about 15 per cent of its bonds are held by foreign investors.

Israel’s currency, the shekel, has strengthened slightly against the dollar since hostilities broke out. That may reflect support from the Bank of Israel. Still, if a country’s currency offers a barometric reading of market pressure, the shekel price is good news.

The stock market also offers reassurance to foreign investors willing to invest in Israel at a time of acrimonious debate over the policies of its government. MSCI Israel, an index of its largest companies, had already drifted to historically low valuations — the forward price/earnings ratio is under 10 times.

A mechanically negative reaction to the war has put temporary pressure on Israel’s markets and currency. Bonds have fallen in price, though mostly in line with other global fixed income. So far, Israeli securities have remained steady and should track world markets upward next year unless the conflict escalates.

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