Israel’s GDP is booming. Its domestic economy is telling a different story
The economy grew at an annualized rate of 15.4% in the second quarter as activity rebounded from the war. But strip out production by Israeli companies abroad and growth in the first half falls to just 1%, pointing to a far weaker domestic recovery.
The Central Bureau of Statistics (CBS) on Sunday published national accounts data for the second quarter of 2026, showing that the Israeli economy recovered from Operation Roaring Lion and returned to growth. GDP grew at an annualized rate of 15.4% in the second quarter, equivalent to 3.6% growth on a quarterly basis, following a 3.8% annualized contraction, or 1% quarterly decline, in the first quarter.
The strong second-quarter growth partly reflects a rebound from the weak first quarter, which was disrupted by the war. A significant portion of the activity recorded in the second quarter was therefore economic activity that had been postponed during the war. The figures for the business sector are even more encouraging, showing annualized growth of 16.6%.
For a more comprehensive picture of the economy, however, it is useful to compare the first half of 2026 with the second half of 2025. On that basis, GDP grew by 3.2%. This means that if the economy continues during the second half of 2026 at roughly the same pace as in the first half, annual growth would be disappointing and below the 4% forecasts of both the Bank of Israel and the Ministry of Finance. It is still too early, however, to draw firm conclusions about the full-year trend. Business-sector output grew by 4.7% over the same period.
It is also important to examine what is driving growth in the second quarter and the first half of 2026.
The largest contribution in the second quarter came from public consumption, which rose 19.5% on an annualized basis and 4.6% from the previous quarter. This was partly because the state budget was approved only at the end of the first quarter, meaning that government spending accelerated in the second quarter.
That somewhat reduces the significance of the quarter's headline growth figure. Growth driven by government consumption is generally less durable than growth driven by private consumption or business investment. On a half-year basis, however, the increase in public consumption was much smaller and did not constitute the main source of growth.
Private consumption, meanwhile, fell by 0.4% in the first half of 2026 compared with the second half of 2025. That could point to a slowdown in domestic economic activity.
On a quarterly basis, exports recorded a strong rebound, rising 25.2% on an annualized basis. The recovery in fixed investment was more modest, at 6.3% annually, equivalent to 1.5% growth from the previous quarter. On a half-year basis, however, fixed investment was up 10.6%.
But a deeper look at the sources of growth reveals a more worrying picture. A significant portion of the increase in GDP is attributable to production carried out abroad by Israeli-owned companies. This becomes particularly striking when comparing the first half of 2026 with the second half of 2025.
If production by Israeli-owned companies abroad is excluded, growth was only about 1%, rather than 3.2%. In other words, the value of goods and services actually produced within Israel barely increased between the two periods.
This suggests that domestic economic activity is close to stagnation. The second quarter may have more than compensated for the weak first quarter, but when the two quarters are viewed together, the local economy has yet to demonstrate meaningful growth.
The hidden component of Israeli exports
What exactly is "Israeli production carried out abroad"?
Many Israeli-owned companies, including defense, pharmaceutical and hardware companies, manufacture products outside Israel. When an Israeli-owned company produces goods abroad and sells them, the transaction can appear in Israel's national accounts as an export even though the goods never physically cross Israel's borders. This is sometimes referred to as "exports without crossing the border."
Israel still benefits economically from these companies. Their profits can generate tax revenue for the state, and the companies remain part of the Israeli economy. But from a macroeconomic and economic-policy perspective, there is an important difference between production taking place in Israel and production taking place abroad.
A company manufacturing in Israel employs Israeli workers and generates additional economic activity domestically. The state benefits not only from corporate taxes but also from income taxes paid by employees, VAT generated by domestic consumption and, in some cases, property taxes and other local revenues.
Production abroad provides fewer of these domestic benefits.
That distinction matters when policymakers interpret the headline GDP figure. If Treasury or Bank of Israel officials see GDP growing by 3.2%, they might reasonably infer stronger domestic economic activity, a healthy labor market and potentially higher tax revenues.
But if a significant portion of that growth comes from goods produced abroad, its impact on Israeli employment, wages and domestic tax revenues is considerably smaller.
There is, however, another side to the story.
The fact that so much Israeli-owned production takes place abroad may reduce the Bank of Israel's concerns about inflation. A rapidly growing economy operating close to full capacity would normally create upward pressure on wages and prices. But if a significant share of the growth comes from production facilities outside Israel, that pressure on domestic resources is weaker.
This could give the Bank of Israel greater room to cut interest rates if domestic activity remains weak.
Israeli production abroad also provides a form of insurance for the economy and government revenues during periods of shekel appreciation. Companies with established overseas production can continue manufacturing even when the stronger shekel makes production in Israel less competitive. This may help explain how Israeli exports have continued to grow despite the shekel's significant appreciation.
Indeed, some of the increase in production abroad may itself be a response to the stronger shekel, as companies seek to reduce their exposure to rising costs in Israel.
The national accounts therefore tell two very different stories.
On the surface, Israel is returning to growth, with GDP expanding sharply in the second quarter and the first half showing a 3.2% increase. But once production abroad is stripped out, domestic economic activity appears much weaker, with growth of only around 1%.
That has at least three important implications. First, it could give the Bank of Israel more room to lower interest rates because the domestic economy is not overheating. Second, it could mean that the government's tax revenues benefit less from headline GDP growth than the headline figure suggests. And third, it means policymakers will need to look much more closely at what is happening to production inside Israel, rather than relying on headline GDP alone.
