Israel

Recovery strengthens but risks persist

Growth is expected to pick up markedly again in 2026, mainly driven by stronger private consumption (around 50% of GDP) and an improvement in investment activity (around 25% of GDP). A decline in inflation toward the Bank of Israel’s 1–3% official target range is set to support consumer confidence and allow for sustained policy rate cuts which will lower borrowing costs for households and corporates. Lower military mobilisation and the gradual normalisation of economic conditions, including the return of foreign workers in agriculture and construction that will boost labour supply—should further sustain consumer spending. After declining in 2023 and 2024, investment is also expected to recover, supported by increased capital spending in the energy (particularly in natural gas), ICT and infrastructure sectors. A sustained improvement in security conditions and a durable ceasefire could also lead to a rebound in tourism revenues (equivalent to roughly 2.5–3% of GDP in pre-crisis years), reinforcing the recovery in domestic demand and strengthening overall growth momentum.

Risks affecting the outlook remain skewed to the downside. Deterioration in the security environment would likely disrupt the ongoing recovery by weakening confidence, slowing labour market normalisation and discouraging corporate investment. Prolonged uncertainty would also delay hiring decisions and weigh on productivity gains. Trade-related risks exacerbate vulnerability. Although pharmaceutical products and semiconductors, which together account for close to 40% of Israel’s exports, are currently excluded from US tariff measures, the exemption may not last. If the US were to impose a 25% customs levy on these sectors, Israel’s effective tariff rate on exports to the US could rise from around 11% to about 22%, which would weaken export competitiveness and weigh on growth prospects.

Elevated import demand will narrow external surplus but budget deficit will remain wide

The current account surplus is expected to narrow due to stronger import demand for consumers and equipment goods in this post-war period. As a result, the merchandise trade balance is likely to remain in deficit, estimated at around 4% of GDP. The services account is expected to stay in surplus, supported primarily by computing services as well as research and development. Improving conditions in the tourism sector should further bolster services exports, helping to maintain a services surplus of close to 6% of GDP. The primary income balance is projected to keep slightly in deficit (around 0.5% of GDP), largely reflecting profit repatriation by foreign-owned firms and interest payments. By contrast, the secondary income balance is expected to remain in surplus (around 2% of GDP), largely reflecting transfers from the diaspora and continued US official support. Despite a narrower current account surplus, Israel’s net international investment position (NIIP) will remain strong. On that score, the surplus of Israel’s external assets over liabilities rose by nearly 7% in Q3 2025 compared with the previous quarter to about USD 260 billion. During the same period, the stock of foreign direct investment in Israel increased by 3.7% to USD 287 billion, while portfolio investment liabilities rose by 2.5% to USD 262 billion. Israel will therefore continue to be a net creditor to the rest of the world. In addition, its international reserves, which stood at around USD 230 billion (approximately 40% of GDP) in November 2025, will continue to provide a strong buffer and underpin the country’s robust external position.

The fiscal deficit is projected to narrow in 2026 as improving growth boosts revenue intake and temporary conflict-related spending is scaled back. Defence spending is expected to be reduced to around 6-6.5% of GDP in 2026 compared with a peak of 9% in 2024. At the same time, easing inflation and lower interest rates should reduce financing costs, and thereby support the budget balance. Consequently, the expected improvement will stem from the recovering economy and the unwinding of exceptional measures, rather than from strict fiscal tightening. Moreover, as defence spending remains high compared with the pre-war period and fiscal consolidation is delayed, the public debt-to-GDP ratio is expected to stay high. However, the risks related to the fiscal position will be low as Israel will keep relying on easy access to domestic and international capital markets to finance the fiscal gap.

Risk of another war

Israeli foreign policy will remain focused primarily on regional security. Israel maintains formal peace treaties with Egypt and Jordan, which provide the framework for diplomatic relations and ongoing cooperation. Relations with Egypt include practical coordination in the energy sector, notably through natural gas production, transit and export arrangements in the Eastern Mediterranean. The peace treaty with Jordan underpins cooperation in areas such as border management, trade and water resources. These bilateral frameworks coexist with a broader regional environment shaped by ongoing security tensions, particularly related to Gaza. Although the ceasefire in Gaza brokered under the US peace agreement has eased immediate tensions, its ability to last is uncertain due to the vague provisions and unresolved political issues, leaving scope for renewed escalation. Relations between Israel, Bahrain, the UAE and Morocco under the 2020 Abraham Accords that normalised the countries’ diplomatic, economic and security ties are expected to remain formally intact. However, the engagement is likely to stay pragmatic as the Gaza conflict and broader regional instability have exacerbated sensibilities and reignited the unresolved Palestinian issue in domestic opinion. Momentum toward normalisation with other Arab countries, especially Saudi Arabia, is expected to remain on hold. Moreover, tension along Israel’s northern border with Lebanon and strikes against Hezbollah, the disarmament of which is still unresolved, also pose downside risks. Relations between Israel and Iran are expected to remain highly strained following escalations in 2025. Although Israel is not directly involved, limited progress in US–Iran negotiations over Iran’s nuclear programme continues to shape Israel’s strategic environment and suggests persistent regional security tensions into 2026. Ties with Türkiye are likely to remain sensitive to developments in Gaza and the broader region (Syria, etc.). The relationship with the US is expected to remain strong, but likely more complex. Differences over the Gaza conflict could create diplomatic tension, while US pressure on regional governance could limit policy room.

Domestically, political tensions will remain high ahead of the 2026 legislative elections to be held by 27 October at the latest. This may complicate policymaking and contribute to social polarisation against the backdrop of unresolved institutional, security and fiscal policy debates. In particular, discord among coalition partners over post-war spending priorities and fiscal measures have delayed talks over the 2026 budget. Under existing rules, failure to pass the budget by the end of March 2026 could trigger a snap election, which would spark further uncertainty over the fiscal policy framework. In addition, any further deterioration in the situation in Gaza or broader worsening of the region’s security landscape could undermine confidence, causing adverse spillovers to tourism activity and private investment. This could weigh on economic momentum through delayed investment decisions and weaker demand.

Last updated: December 2025