Israel’s growth forecast looks strong, but its debt problem isn’t going away
The OECD projects robust recovery, yet Israel continues to run elevated deficits for a fourth consecutive year.
When reading the OECD forecast published on Wednesday, one cannot help but feel a certain sense of relief. After long months of war, security uncertainty, and geopolitical upheaval, the organization paints a picture that appears almost encouraging. The Israeli economy is expected to grow by 3.3% this year, 0.5 percentage points above the global average, and accelerate to 5.6% in 2027, nearly double the growth rate projected for the world economy. Private consumption is expected to recover, the construction sector is forecast to expand rapidly, inflation is expected to remain under control, and the Bank of Israel is even projected to continue cutting interest rates.
In fact, this is one of the most optimistic reports published about Israel since October 7. The OECD assumes that the Israeli economy will recover relatively quickly from the recent shocks and return to a strong growth trajectory. But precisely because the report is so optimistic, it exposes a deeper problem: the real story is not growth, it is the deficit.
Even under the relatively favorable scenario outlined by the organization, a scenario that assumes economic recovery, moderating inflation, a return of demand, and an easing of security tensions, the government deficit is expected to reach 5.3% of GDP in 2026 and decline only to 4.2% in 2027. This would mark the fourth consecutive year in which Israel has run deficits well above the levels that prevailed before the war. The result is evident in the data: the debt-to-GDP ratio is expected to rise to approximately 71% this year and remain around 70% next year. That compares with roughly 60% on the eve of the current government's term.
This is arguably the most important figure in the report because it suggests that Israel’s problem is no longer cyclical, it is structural. A 5% deficit during a deep recession, high unemployment, and collapsing economic activity could be justified as a temporary response to a crisis. But that is not the scenario the OECD describes. It describes an economy that is growing, with low unemployment, stable inflation, and private consumption expected to surge by 2027. Yet even in that environment, Israel does not return to the deficit levels that characterized the economy before the war.
Rebuilding the Fiscal Buffers
This is the central point: the key debate about the Israeli economy is no longer whether it will grow, but whether it can continue growing without rebuilding the fiscal safety cushions that have largely been depleted.
The OECD’s answer is clear. Its primary recommendation to the government is to rebuild the fiscal "buffers" that enabled Israel to navigate previous crises successfully. The organization calls for faster debt reduction, preserving the revenue measures introduced in the 2025 budget, and reducing spending once security conditions allow. This may be the most important sentence in the entire chapter on Israel.
Israel’s economy differs from many other OECD countries. Unlike Switzerland, Denmark, or Germany, Israel operates in an unusually volatile security environment and is exposed to geopolitical shocks far more frequently. As a result, it requires greater fiscal flexibility. For years, maintaining these buffers was one of Israel’s greatest economic strengths.
On the eve of the COVID-19 pandemic, Israel’s debt-to-GDP ratio stood at around 60%. That relatively low level gave policymakers room to respond aggressively when crisis struck. The same logic applied in the years that followed, when strong post-pandemic growth helped stabilize the economy. Those buffers allowed governments to increase spending during emergencies without immediately undermining investor confidence. But buffers are not an unlimited resource. They can be used only if they exist, and once they are used, they must be rebuilt.
This is where the most interesting gap emerges between the OECD report and the message delivered just hours earlier by Bank of Israel Governor Amir Yaron. Both institutions describe essentially the same reality. Both highlight the remarkable resilience of the Israeli economy. Both point to recovering activity, relative financial-market stability, and renewed investor confidence.
.Yaron’s presentation showed declining risk premiums, a strengthening shekel, a recovering stock market, and improving confidence indicators. But while the OECD focuses on the growth outlook, the Bank of Israel is focused on a different question: what happens during the next crisis?
For a country like Israel, that is not a theoretical question.
Budgetary Pressures Ahead of Elections
The OECD itself outlines two very different scenarios. The optimistic scenario assumes continued security stability and even deeper regional integration, leading to stronger growth. The downside scenario assumes renewed fighting or prolonged instability in the Middle East, resulting in weaker economic activity and a worsening fiscal position.
In other words, even the OECD’s optimistic forecast is built on an implicit assumption: Israel will need the capacity to respond quickly to future shocks.
That is precisely why the deficit matters more than growth. A country can sustain a large deficit during wartime. It cannot sustain one indefinitely if it knows future conflicts are likely.
This is the dilemma, or, as Governor Yaron has called it, the “trilemma,” facing future Israeli governments. Security needs have risen dramatically. Civilian spending remains relatively low compared with other OECD countries and requires expansion. At the same time, capital markets and rating agencies continue to expect a credible path toward fiscal consolidation and lower debt.
The argument that "the economy is strong, therefore we can continue spending" misses the point, and may even be dangerous. Precisely because the economy is strong, this is the moment to rebuild reserves.
Notably, the OECD praises the current government in only one significant area: the fiscal adjustment package included in the 2025 budget, including the VAT increase, additional revenue measures, and broader consolidation efforts. These measures did not emerge in a vacuum. They followed multiple credit-rating downgrades, a sharp rise in Israel’s risk premium, and sustained pressure from the Bank of Israel and the Finance Ministry’s Budget Division.
Viewed in that context, the package is not evidence that the problem has been solved. It is evidence that the problem has finally been acknowledged. Solving it remains a far more difficult task.
These issues become even more important as Israel effectively enters an election period. Discussions about politically motivated tax cuts, unfunded spending commitments, and new fiscal promises are already beginning. The Knesset has not yet dissolved, yet the budgetary pressures are already visible.
The critical question, therefore, is not what happens in 2027. The OECD has already provided a relatively optimistic answer to that. The real question is what happens after the next election.
Will the next government continue rebuilding the fiscal buffers recommended by both the OECD and the Bank of Israel? Or will it interpret the expected return to growth as evidence that Israel can continue living indefinitely with deficits of 4%-5% of GDP?
That is no longer a forecasting question. It is a policy question.
And precisely because the OECD is so optimistic about Israel, its warning becomes much harder to ignore. If even under a favorable scenario the deficit remains elevated and debt continues to climb, that suggests the challenge is no longer just the war.
It is fiscal policy itself.
