Israel's Gaza War: The Economic Fallout

Factory shutdowns near the Gaza Strip are indications of how a prolonged conflict could tip Israel's slumping economy into a serious tailspin
An Israeli soldier fires tear gas toward Palestinian protestors on Dec. 29, 2008 during a demonstration against the Israeli bombardment of the Gaza Strip. Abbas Momani/AFP/Getty Images

Located in the kibbutz of Kfar Aza, just a kilometer from the border with the Gaza Strip, chemical company Kafrit Industries (KAFR) operates one of the dozens of factories ordered to shut down until further notice by the Israeli government, just after its air force carried out massive air strikes on the Hamas-controlled territory. Even before the latest escalation of violence began on Dec. 27, the producer of additives used in the plastics industry had to deal with intermittent Palestinian rocket fire. But lately Kafrit Industries—like most Israeli companies—has been more concerned about the impact of the global recession.

Now, the worst Israeli-Palestinian military flare-up in years has taken center stage. "Up to now we've been able to meet all of our commitments, but the security situation has now made operating our business even more challenging," says Avi Zalcman, chief executive of Kafrit. Luckily for the company, it has plants in Germany and China that can at least partially offset the loss of production in Israel. But others like RMH Lachish Industries (LHIS), a producer of agricultural machinery based in nearby Sderot, are less fortunate. "One hundred percent of our production is for export, and we've already had to cancel orders," says Gershon Goldberg, CEO of Lachish.

The impact on the Israeli economy is only starting to be felt. So far, plant closures have been limited to nonessential facilities within 4.5 kilometers (2.8 miles) of the Gaza border. Farther afield—though still within range of Palestinian rocket fire—companies like Intel (INTC), which employs 2,000 workers at a semiconductor facility in Kiryat Gat, are continuing to operate at full capacity.

Eyes on the Deficit

The shutdown of plants near Gaza is a relatively minor part of the broader impact on the Israeli economy of renewed warfare. Israel's Manufacturers Assn. pegs the current loss of production at $1 million a day. And though it's still too early to assess the final cost of the military operation, unofficial estimates have put the price tag at $25 million to $50 million a day. "The cost will run up sharply if reserves are called up for a ground operation and if the conflict goes on for more than a few weeks," predicts Leo Leiderman, chief economist at Israel's Bank Hapoalim (POLI.TA).

Jittery traders worried about geopolitics drove the price of oil up by as much as 12% on Dec. 29, to $42.20 per barrel before it settled back below $39. But the reaction of Israel's financial markets has so far been fairly muted. The shekel has barely budged against the U.S. dollar in recent days (though it has weakened vs. the euro), even despite a 75-basis-point interest rate cut, to 1.75%, by the central Bank of Israel late on Dec. 29 that's intended to spur the economy.

Stocks, too, aren't faring badly. After initially dropping on Sunday in response to the Israeli air strikes on Gaza, the Tel Aviv stock market recovered part of its lost ground on Dec. 29. Analysts say the real test for local financial markets will be the impact of the military operation on the budget deficit.

"If the deficit increases sharply, this could have a very negative effect on the shekel and the stock market," says Michael Sarel, chief economist at Harel Insurance & Finance (HARL.TA), one of Israel's leading financial companies.

Even without the new conflict, Israel's budget deficit in 2009 was projected to be at least 5% of gross domestic product, up from an expected 1.6% in 2008, due to a sharp decline in tax revenues and plans for increased spending to counter the slowdown. The high cost of a lengthy military operation could lead to a further mounting of the deficit.

A Vulnerable Economy

Over the years, the Israeli economy has learned to adjust to various levels of hostility. However, unlike the situation in 2006, when the economic boom was only briefly interrupted by the 40-day war in Lebanon against Hezbollah, the economy is now significantly more vulnerable. After five years of rapid economic growth averaging around 5% annually, the boom came to a screeching halt in the third quarter of 2008 as the global recession hit the local economy.

The bad news continues to pile in. Industrial production fell by 3.5% from August to October, while consumer spending was down by 4.2% in the same period and export growth has fallen off. Even unemployment, which fell to 6% in the third quarter—its lowest level in years—is on the rise. Thousands of workers have been laid off in recent weeks from the country's high-tech industry, which accounts for more than 40% of Israel's industrial exports and has been hit by the global downturn.

Most experts have been forecasting 2009 economic growth at no more than 1%. But those projections were made prior to the latest escalation of violence. They could prove overly optimistic if the violence continues and Israel gets bogged down in a lengthy operation in the Gaza Strip. The impact would be even worse if the fighting widened into a regional conflict.

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