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TheStreet Open House

How Is Israel’s Economy Affected by the Current War?

NEW YORK (TheStreet) -- Israel and Hamas continue to fight on as the latest Middle East conflict continues amid intermittent cease-fires.

Israel's military objective continues to be to destroy Hamas' tunnels and rocket launchers and bring a period of sustained quiet to the country.

Read More: 10 Stocks Carl Icahn Loves in 2014

From the Israeli perspective, this latest conflict is proving to be expensive in many ways. The Israeli defensive operation has been met with increasing resistance from the international community, with urgent calls for an immediate ceasefire. The longer the conflagration continues, the greater the likelihood that Israel will face growing economic and political isolation.

Tourism to Israel has dropped off significantly and will likely remain low in the aftermath of the war.

Israel's central bank made comments to the effect that 0.5% may be shaved off the economic growth forecast for the year. A financial consultant to the former Governor of the Bank of Israel alluded to the need for sound economic policy to guide the Israeli economy moving forward. Foreign investors tend to shy away from countries under attack and this will become a factor moving forward.

Last week the Bank of Israel reduced the benchmark interest rate from 0.75% to 0.50%. This has been done in an attempt to provide momentum to the Israeli economy in the midst of the war effort. Israeli financial analysts expect that the current Gaza operation will likely have the same effect on the economy as the 2006 Lebanon war. The net effect of that conflict was a modest decline of 0.5% of gross domestic product.

The Israeli economy suffers directly from reductions in productivity every time missile alert sirens send the country's residents into bomb shelters. The economic costs of the war are estimated upwards of $2.9 billion, and already the war has soaked up 1.2% of the GDP. In the event that quiet prevails after a ceasefire is reached, the Israeli economy is resilient enough to withstand the costs of this operation.

History reflects that the Israeli economy surged at a rate of 6% prior to the 2006 Lebanon war and then slowed down to 2.9% prior to this current conflict. The tourism sector is going to be particularly hard hit, and if a third intifada ensues the economic costs for Israel could be crippling. Since a big chunk of Israel's workforce is enlisted in the IDF, productivity declines are widespread and costs are mounting.

The IMA (Israel Manufacturers Association) has already listed a figure of $240 million in losses as a result of the war effort.

The Israeli economy is generally perceived to be solid with top-performing companies like Tnuva, MA Industries, Elbit Systems (ESLT) and others. Government orders for Elbit Systems have spiked by 6.1% since the current war got underway. Elbit Systems shares trade around $62 in the U.S. and are up 3% for the year to date. Based on the current uptick, it is clear that the defense establishment will be granted a bigger budget and it will likely exceed the targeted rate of 3% of GDP for the current year.

For 2015, it is expected that the defense budget will target 2.5% of GDP. Elbit Systems stock is currently trading at its most expensive P/E ratio in over five years. However, Elbit is a global company so it is unlikely that there will be a marked increase in volumes from this war. The company derives a great deal of its growth from the Israel Defence Forces, but international revenues are providing more of the company's income base.

Read More: Follow the Money (Supply): Why Stocks Are in Trouble

 Israeli Finance Minister Yair Lapid is confident that taxes will not be raised in 2014, and a war chest of $1.6 billion will be used for compensation related to civilian damages.

At the time of publication, the author held no positions in any of the stocks mentioned, although positions may change at any time.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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