Israel plans to bring budget deficit below 3% of GDP for 2026-28

Israel's cabinet approved a three-year plan to reduce the budget deficit to below 3% of GDP by 2028, down from an expected 5% this year, with economic growth projected at 4.4% in 2026. The plan aims for deficits of 2.8% of GDP in 2026-2027 and 2.9% in 2028, but the Bank of Israel forecasts higher deficits of 3.5%-4.0% for 2027 and 2028 and advises caution, citing geopolitical and economic risks that could necessitate further adjustments and impact the 2025 deficit target.

Analysis

Israel's cabinet has approved a three-year fiscal plan targeting a reduction in the state's budget deficit from an expected 5% of GDP this year to below 3% by 2028, with specific goals of 2.8% for 2026-2027 and 2.9% for 2028. This move comes after the deficit reached 6.9% of GDP in 2024, largely due to increased defense spending following the October 2023 conflict. The Finance Ministry projects economic growth, impacted by the war to about 1% in 2024, to accelerate to between 3% and 3.5% this year and reach 4.4% in 2026. However, the ministry's statement acknowledges that this plan does not yet incorporate the financial implications of recent military escalations or unfinalized government policy decisions, framing the strategy as a "careful balance between cautious optimism and responsible fiscal steps."

Contrastingly, the Bank of Israel expresses greater caution. Governor Amir Yaron underscored to ministers the critical importance of declining debt levels for maintaining market confidence, noting that risks are currently "higher than usual." The central bank forecasts larger budget deficits of 3.5% to 4.0% for 2027 and 2028, exceeding government projections, and suggests that "additional adjustment measures are likely to be required." Yaron explicitly warned that an escalation in hostilities would likely lead to a breach in the 2025 deficit target and advised against reopening the 2025 budget to raise this target, recommending instead a focus on reducing spending that disincentivizes work or education, increasing certain taxes, and eliminating distortive tax exemptions if further fiscal adjustments become necessary. This divergence highlights significant uncertainty surrounding Israel's fiscal path, heavily contingent on geopolitical stability and its economic repercussions.

Key Decisions for Investors

• Investors should closely monitor Israel's progress towards its stated budget deficit targets of below 3% by 2028, recognizing that ongoing geopolitical tensions and associated defense spending present significant execution risks.
• The divergence between the Finance Ministry's deficit projections and the Bank of Israel's more pessimistic forecasts (3.5%-4.0% for 2027-2028) warrants careful attention, as it may signal future fiscal challenges or the need for additional austerity measures that could impact economic growth.
• Continuously assess geopolitical developments and their direct impact on Israel's fiscal position and economic outlook, as an escalation could derail deficit reduction efforts, breach 2025 targets, and negatively affect market confidence in Israeli sovereign assets.