Since the outbreak of war with the Hamas terror group on October 7, institutional investors have transferred a staggering NIS 151 billion ($40 billion) out of Israel, according to a bombshell report by the Hebrew financial daily Calcalist. This monumental capital flight highlights the severe economic ramifications of the ongoing conflict, which have sent shockwaves through Israel’s financial markets and eroded investor confidence at a critical time.

Eroding Confidence and Escalating Risks: A Perfect Storm for Capital Outflows

The war with Hamas, coupled with fears of potential escalation to Israel's northern front and an increasingly precarious fiscal situation, has spurred large insurance companies and investment funds to redirect substantial sums abroad. These institutions, which oversee the long-term savings of millions of Israelis—including pension and provident funds—are now prioritizing overseas assets over domestic investments. This shift is a clear signal of waning confidence in the Israeli government's ability to stabilize the economy, curb the ballooning deficit, and tackle soaring inflation.

Initially, in the early days of the conflict, local institutions responded by increasing their exposure to the Israeli market, demonstrating a brief surge of economic patriotism. However, since April, this trend has sharply reversed. As faith in the government's economic stewardship dwindled, so did domestic investment, with funds increasingly seeking the relative safety of foreign markets.

Major investors have transferred $40 billion out of Israel since start of war – report https://t.co/X6AI3uFzdm via @timesofisrael

— Joel Pollak (@joelpollak) September 17, 2024

A Dramatic Shift in Investment Strategies: By the Numbers

Calcalist’s analysis reveals a striking shift in asset allocation. Local institutions managing provident funds saw their average exposure to overseas assets surge from 51.7% at the beginning of October 2023 to 56.3% by the end of July. Meanwhile, financial institutions overseeing pension funds increased their foreign exposure from 47.6% to 50% over the same period. This rapid reallocation underscores the urgency with which investors are fleeing perceived domestic risks in favor of more stable international opportunities.

Economic Headwinds Intensify Amidst Conflict and Policy Challenges

Israel's economic growth has been dealt a heavy blow as the conflict drags on, with data showing a sharper-than-expected slowdown in the second quarter. The Central Bureau of Statistics revised its growth estimate for the April-June period to an annualized 0.7%, down from the initially reported 1.2%. This deceleration is largely attributed to the ongoing war, which has not only disrupted economic activity but also fueled inflationary pressures, complicating the policy landscape for the Bank of Israel.

Half of start-ups in Israel had investments cancelled due to war https://t.co/EM80AzZR5V

— Christopher (@chrisusanz) September 14, 2024

Despite the sluggish growth, the Bank of Israel finds itself in a precarious position, unable to cut interest rates to stimulate the economy. Persistently high inflation, a tight labor market, and expansive government spending to fund the protracted conflict have tied the central bank's hands. Unlike their counterparts in the U.S. and the European Union, Israeli policymakers face the prospect of delaying interest rate cuts further into the future.

According to Barclays economist Zalina Alborova, the path of high inflation combined with geopolitical and budgetary uncertainties could push any monetary easing into the latter half of 2025, at the earliest. The grim economic outlook is further underscored by Israel's stubbornly high inflation rate, which hit 3.6% in August—well above the government’s target range of 1% to 3%. This inflationary surge is driven by supply chain disruptions, soaring costs of travel and fresh produce, and climbing housing expenses.

Remember who the free world is up against, how this war started, and who is still driving it (Netanyahu & Israel have agreed to 3 U.S. ceasefire-for-hostages proposals; HAMAS has refused each time). Again, remember who started this and what they are. Don't get it twisted. https://t.co/GhJm7wHUf1

— Heather Robinson (@HE_Robinson) September 16, 2024

Looking Ahead: Navigating an Uncertain Future

As Israel grapples with the dual challenges of war and economic instability, questions loom large over the future of its monetary policy. Central bank officials, having kept the benchmark interest rate steady at 4.5% for five consecutive meetings, express little optimism about rate cuts in the near term. With inflationary pressures showing no signs of abating, the Bank of Israel faces a delicate balancing act—managing price stability without exacerbating the economic slowdown.

The ongoing capital flight serves as a stark reminder of the economic stakes at play. As investors continue to seek refuge abroad, Israel’s financial markets will need to navigate these turbulent waters with caution and resilience. The road ahead is fraught with challenges, but stabilizing the economy will be crucial to restoring confidence and ensuring long-term growth amidst the storm.