Israel is facing an escalating economic crisis amid the ongoing two-year war on Gaza, as the Knesset has definitively approved raising the targeted deficit ceiling in the 2025 budget to 5.2% of GDP, up from 4.9%.

According to Reuters, the decision came due to the need for additional funding for military spending, amounting to 31 billion shekels (9.35 billion USD).

Military Spending Burdens Public Finances

A report by Calcalist newspaper explained that out of the 31 billion shekels, 29 billion shekels (8.75 billion USD) will be allocated directly to the security sector, at a time when public finances are under severe pressure.

The newspaper noted that this spending expansion will lead to an overall 3.35% cut in ministry budgets starting next year. The proposal also includes a deduction of 481 million shekels (145 million USD) from allocations previously designated for religious school teachers, after funds for educational reforms were frozen.

Despite divisions within the coalition, 55 lawmakers voted in favor of the decision against 50 opposing, according to Reuters. Calcalist pointed out that religious parties’ positions varied; the “Yahadut HaTorah” party opposed it, while “Shas” supported it, considering the funds necessary for “existential needs such as purchasing ammunition and reservists’ salaries.”

Tight Monetary Policy Amid War

Meanwhile, the Bank of Israel kept its benchmark interest rate at 4.5% for the 14th consecutive meeting, confirming – according to Reuters – that it is in no hurry to ease monetary policy despite inflation falling to 2.9% in August from 3.1% in July.

The report added that the economy contracted by 4% year-on-year in the second quarter of 2025, reflecting ongoing pressures from the war.

Out of 12 analysts surveyed by Reuters, 9 expected interest rates to remain steady, while 3 predicted a 25 basis point cut, but economic uncertainty led the central bank to postpone any changes.

2026 Budget Crisis and Election Possibility

According to Calcalist, discussions on the 2026 budget remain stalled and will not be approved before December 31, raising fears of government dissolution if not ratified by the end of March 2026, potentially opening the door to early elections in June.

The newspaper added that the final decision rests with Prime Minister Benjamin Netanyahu, who links the fate of the budget and election timing to the results of his Monday meeting with US President Donald Trump.

Far-right parties such as Otzma Yehudit and Religious Zionism have attacked what they call “Trump’s 21-point plan” to end the war, threatening to withdraw from the coalition if Netanyahu adopts any of its points.

With no practical solutions in sight, the Israeli economic scene grows increasingly fragile amid growing international isolation.