Prospect of Prolonged Israel-Gaza War Adds Economic Havoc to Human Toll

As the fighting between Israel and Hamas risks bursting into regionwide chaos, the prospect of a long and potentially widening war could pile economic havoc atop a devastating human toll.

For Gaza, a broader conflict would almost certainly deepen the already worsening humanitarian conditions in the territory. And Israel faces a fresh blow to a resilient economy that until recently had been hailed as an entrepreneurial powerhouse.

The outlook for the Palestinian economy was already dire before Israel declared a siege of Gaza in retaliation for the Oct. 7 attacks, creating what the World Health Organization called a “humanitarian catastrophe.” An assessment this year by the International Monetary Fund said Israel’s blockade of the Gaza Strip and increased restrictions on the West Bank were significant obstacles to growth and private sector development.

In Israel, as many as 360,000 reservists are leaving their jobs and businesses to mobilize for military duty, bringing parts of the economy to a standstill. Israel’s technology industry, a driver of growth, has abruptly slowed. Production at a major Israeli offshore natural gas field has been shut down. The central bank has committed billions of dollars to prevent Israel’s currency, the shekel, from collapsing.

The conflagration caps a troubling period for an economy that had been riding high, ranked by The Economist last year as the fourth-best-performing economy among the countries in the Organization for Economic Cooperation and Development. Israel’s start-ups have attracted billions in foreign investment. The Abraham Accords, which were signed in 2020 and established diplomatic relations between Israel and several Arab countries, opened a path toward more economic prosperity. Israel is also developing a hub for exporting natural gas to Europe and beyond.

But the economy started to stumble this year after a right-wing government, led by Prime Minister Benjamin Netanyahu, advanced a contentious plan to rein in the power of the judiciary that critics said could potentially weaken the rule of law, inciting millions of Israelis to protest in the streets. Many tech leaders have threatened to leave the country over the judicial overhaul, saying it would undermine Israel’s standing, and warned of an economic downdraft.

The overhaul set off a 60 percent plunge in foreign investment in Israel, and it has hastened an erosion in the shekel’s value and wide swings in the Israeli stock market. High interest rates, rising inflation and expectations of a slowdown in the global economy were also weighing on growth.

The government’s zeal in pursuit of judicial change generated uncertainty among investors, and “caused money to move out,” said Dan Ben-David, the founder of the Shoresh Institution for Socioeconomic Research and a professor at Tel Aviv University.

“Going into this, we already had an economic problem,” he said. “And then came the Hamas attack.”

Aggravating the shock, Mr. Ben-David added, is that many of the reservists being called to serve in the military are tech entrepreneurs, teachers, lawyers and other secular Israelis, while ultra-Orthodox men are excused for religious reasons. That has concentrated the pool of recruits around people who make up the bulk of Israel’s entrepreneurial economic activity.

Two credit ratings agencies this week warned that Israel’s debt could be downgraded. On Friday Moody’s said that the conflict was “more severe than the episodes of violence in the last few decades,” creating the risk of a diversion of resources in the economy, decreased investment and a loss of confidence.

And the Fitch ratings agency warned on Tuesday of the “heightened risk of a widening of Israel’s current conflict to include large-scale military confrontations with multiple actors, over a sustained period of time.” Just six months ago, Fitch cited Israel’s “strong economic growth.” A ratings downgrade could force Israel to pay higher interest when it borrows.

Goldman Sachs said in a note Monday that the risks to Israel’s financial and economic stability appeared to be lower, for now, than during previous major conflicts because Israel’s overall finances were stronger today and the country had a large stock of foreign exchange reserves.

The Bank of Israel has about $200 billion in foreign exchange reserves — close to 40 percent of the country’s gross domestic product — which its governor, Amir Yaron, told I.M.F. and World Bank officials in a video call on Sunday provided ample capacity to support the economy. Since the conflict, the central bank has earmarked $30 billion in foreign exchange to support the shekel, which has fallen to an eight-year low.

The central bank is facing a quandary: Reduce interest rates to help bolster the wartime economy, or keep them elevated to support the shekel. The bank is scheduled to announce its decision on Monday.

Any war is likely to affect Israel’s finances, Mr. Yaron said, but the government could make budget adjustments to adapt to the conflict. Israel regularly spends over 4 percent of gross domestic product on the military — amounting to $23.4 billion last year — and receives an additional cushion in the form of $3.8 billion in annual aid from the United States, used mainly to buy American weapons. In the coming days President Biden is expected to ask Congress for $14 billion in military and security aid for Israel.

Goldman told clients in its note that it expected Israeli financial authorities to “remain cautious due to potential risks for the conflict to escalate further.”

The economic situation for Palestinians on the Gaza Strip and in the West Bank has been notoriously worse.

An annual I.M.F. review in August described the heavy toll to the Palestinian economy and people from persistent poverty and high unemployment. The outlook remained “bleak amid a volatile political and security situation,” the I.M.F. concluded, adding that any turnaround would hinge on the “easing of Israeli-imposed restrictions on movement, access and investment,” as well as a political peace settlement.

Israel’s siege of Gaza after the Oct. 7 Hamas attacks has destroyed infrastructure and led to dire shortages of food, water, gasoline and other essentials, and the displacement of about half of Gaza’s more than two million Palestinians. An expansion of the conflict to include Hamas’s Iranian-backed ally, Hezbollah, in Lebanon would be a development that some feared would multiply the regional despair.

In Israel, activity in many sectors of the economy has slowed or ground to halt. The tourism business has come to a near standstill, with cruise ships avoiding Israel’s shores and people canceling visits. Major airlines have halted flights to and from the country, including for cargo. On Monday, UPS said it had stopped flying to Israel. Sea freight operations have faced additional controls by the Israeli Navy, affecting cargo shipments. Israel, which relies heavily on imported oil, has shut one of its two main oil ports for safety reasons, analysts said.

Tech companies and start-ups reported that many of their younger employees had been mobilized. Nvidia, the world’s largest maker of chips used for artificial intelligence and computer graphics, said it had canceled an A.I. summit that was scheduled to take place in Tel Aviv. Retailers, including H&M and Zara, have shut stores in the country.

The Israel-Gaza conflict could also slow natural gas investment in the area, analysts said, hurting the ambitions of Israel and the wider region, which have recently received a lift from Chevron to become a hub for exporting natural gas to Europe and elsewhere.

Mr. Yaron, the central bank governor, said on Sunday that the Israeli economy had “known how to function and to recover from difficult periods in the past, and to return to prosperity rapidly.”

Even so, Mr. Yaron said, with many reserve soldiers at the front lines and civilians in shelters because of rocket attacks, there will be an effect on real economic activity. And war, he added, was “likely to persist in the coming period.”