Israel’s economic outlook hinges on next government as shekel and stocks slide

Israel’s economic landscape hangs in the balance as the government’s composition following the inconclusive election looms large. The shekel lost nearly 2% against the dollar, the sharpest one-day drop in two weeks and a significant decline on the global stage. The Tel Aviv stock index, which was closed on Tuesday, plummeted around 3%, on track for its steepest drop since June.

Major banks like Bank Hapoalim and Phoenix Financial suffered heavy losses, with Bank Hapoalim shedding 4% and Phoenix Financial plummeting over 5%.

Economists warn that the next government could steer Israel's economic course dramatically. If Prime Minister Benjamin Netanyahu manages to retain power with a right-wing coalition, economic uncertainty could intensify, leading to a weaker shekel, slower GDP growth, and a decline in investor confidence. Such a scenario could deter investment in Israel’s burgeoning high-tech sector and push skilled professionals out of the country, exacerbating economic woes.

Concerns of broader boycotts and international isolation might further dent exports and foreign capital inflows, putting additional pressure on the economy.

Conversely, a government formed by opposition parties with backing from Arab parties could offer a more positive economic outlook. This alternative could spark renewed investor optimism, promote steadier growth, and bolster the shekel and the Tel Aviv stock market. Such a scenario might also help lower inflation, entice more foreign investment, and stimulate trade.

While the election itself isn't expected to directly impact Israel's near-term growth or fiscal path, its outcome could have significant implications in the medium term. Capital Economics notes that the elections might not have a major near-term effect on growth or fiscal trajectory, but could pose considerable challenges over the mid-term.

The International Monetary Fund's July 2026 assessment projected an annual growth rate of 3.5% for this year and 4.4% in 2027, contingent on regional ceasefires being maintained. However, persistent geopolitical uncertainty, high defense spending, and labor shortages continue to pose challenges to the recovery. Ultimately, the success of the next government in curbing uncertainty and reestablishing international economic ties could determine whether the recent market downturn persists or transforms into a rebound.