Isranomics

Israel’s economy faces new challenges in 2023

by | Dec 15, 2022 | Economy | 0 comments

In the face of the upheaval of the last few years, from the Corona crisis to the war in Ukraine, Israel’s economy exhibited resilience compared to most other countries. However, Israel has a glaring vulnerability, which should concern policymakers in light of the global economic downturn and the recession that has already begun among the leading economies.

According to available data, it appears that the recent growth has been driven by cheap debt. A close to zero cost of borrowing encouraged an increase in debt-taking by corporations and households. According to Bank of Israel figures, private sector loans surged by 16% in just one year (through mid-2022), making it the quickest rate on record. At the same time, the volume of bank credit to construction companies and entrepreneurs jumped at twice the average rate. Now, when the cost of borrowing is close to zero, taking on debt is permissible (in some instances, it is even encouraged) when the borrower can easily repay the finance at a very low rate. However, things begin turning around quickly when interest rates start going up. And this is exactly what has been happening since April of this year, when Israel’s central bank had to step in and hike rates in order to address the issue of high inflation.

Current data demonstrate that Israeli consumer debt growth reached levels not seen in recent history. From 2019 to this year, it increased at the third fastest rate in the world, after China and South Korea. And with the Bank of Israel’s interest rate moving from 0.25% to 3.25% within eight months, mortgage repayments and loans are becoming more expensive, while the risk of bad loans for banks continues to grow.  A potential financial upheaval due to the rising cost of finance is something that concerns not only property buyers but also property developers, as it is considered one of the most leveraged sectors in the economy. According to data, the bank credit to construction companies increased at a high rate of 30% in just one year.

Having said all that, there is hope that things will begin improving next year. The reason being is that every increase in interest rates is intended to slow down the pace of consumption and slow down inflation. Hence, experts believe that the rate of inflation will moderate in 2023 as a result. However, it is likely to affect economic growth. The Bank of Israel forecast confirms it, as it expects the economy to expand at around 3% in the coming year, following very strong growth of 6% throughout 2022. According to the bank’s projection, inflation will recede to a more acceptable level of 2.5%, compared to the current rate of 5.1%. Worth noting, that the prior GDP forecast that was published back in July, projected a growth of 3.5% for next year.

The OECD, on the other hand, is somewhat less enthusiastic than the Bank of Israel. They forecast the economy to grow at a 2.8% annual rate, with inflation reaching 3.3%. The cause for the slowdown is a fall in tax revenue from two of the economy’s key sectors, high-tech and property development, as both are expected to deal with rising interest rates. However, in the case of high-tech, there is an additional challenge in the form of a series of redundancies that have gripped the industry in the US and around the world and are already exhibiting signs of spillover into Israel. As a result, a substantial slowdown in the high-tech industry may have a detrimental influence on the overall economy. Because of this, a severe slowdown in the high-tech sector may have an adverse influence on the economy as a whole.

On the bright side, this year Israel managed to accumulate budget surpluses worth around NIS 28.9B, which was not seen since 1986. The country managed to do it as a result of higher tax revenue than it initially projected. But the current status quo is unlikely to continue, as the incoming government has already announced plans for increased expenditure. Therefore, the consensus among some experts is that Israel will have to deal with an increase in the budget deficit at around 4% of the GDP in the coming year.

While the size of the deficit during the next twelve months is anyone’s guess due to a number of factors, the incoming Prime Minister is inheriting a healthy account balance. It will be up to him and his government’s policies to ensure that the economy continues to produce results in the near future.

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