Defense Spending Doubles to 143B Shekels, Pushing Deficit to 4.9% of GDP
Israel's parliament passed a 699 billion shekel ($222 billion) state budget for 2026, reorienting the nation's finances to sustain a prolonged, multi-front war. The budget allocates 143 billion shekels for defense, an increase of more than 120% compared to spending levels before the Gaza conflict began in 2023. This sharp rise in military expenditure, combined with a fiscal deficit target of 4.9% of GDP, will be financed primarily through increased government borrowing and a 3% across-the-board cut to all civil ministries.
The budget's approval averted an automatic dissolution of the government, which would have been triggered if it had not passed by the end of March. Prime Minister Benjamin Netanyahu secured the necessary coalition support by shelving contentious legislative proposals, including a controversial bill on military service exemptions for the ultra-Orthodox, to maintain political unity.
Fiscal Strain Triggers Market Sell-Off and Economic Downgrades
Investor concerns over the deteriorating fiscal position triggered a sharp market reaction. The Tel Aviv 35 index dropped 3.8%, its largest single-day decline in almost a year, erasing all gains made since the conflict with Iran escalated in February. In response to the growing debt burden, Fitch Ratings maintained Israel's 'A' sovereign credit rating but revised its outlook to negative. The ratings agency projects the actual deficit could reach 5.7% of GDP, significantly higher than the government's 4.9% target.
The war's economic toll is forcing widespread forecast revisions. The Bank of Israel is expected to hold its benchmark interest rate at 4.0% as economists slash growth projections from a pre-war forecast of 5.2% to as low as 3%. The extended conflict also fuels inflation worries, creating a difficult policy dilemma for the central bank.
Long-term warfare could lead to a further rise in inflation. At the same time, most major central banks have now moved into a rate hike mode, and the Bank of Israel is unlikely to go against this trend.
— Economists, Bank Hapoalim.
