A long-running domestic political battle over controversial judicial reforms receded into irrelevance on October 7, the date on which Hamas militants based in the Gaza Strip launched a coordinated assault on mostly civilian targets inside Israel that resulted in more than 1,100 deaths and the capture of more than 250 hostages. Under the direction of a special war Cabinet that includes Benny Gantz, a former head of the IDF and the leader of the opposition National Unity, which joined an expanded emergency government, Israel initiated a scorched-earth ground invasion inside Gaza in late October.

Hamas’ deliberate targeting of civilians was likely intended to provoke Israel into responding with a display of force of such ferocity as to offend the sensibilities of the international community, leaving Prime Minister Benjamin Netanyahu’s government diplomatically isolated and under heavy pressure from key regional and global power brokers to revive negotiations with the Palestinians. If that was the plan, it has thus far been only partially successful.

However, the Israeli government is finding it harder to maintain a tenuous diplomatic balance as the prolongation of the military campaign leads to a rising Palestinian death toll. Militant groups such as Hezbollah, facing a test of their credibility as defenders of the Palestinian cause, have stepped up rocket attacks and the risk of direct conflict between Israel and Iran (a sponsor to varying degrees of Hamas, Hezbollah, and Yemen-based Houthi rebels) has risen following an exchange of drone and rocket attacks on each other’s territory in recent weeks.

The Gulf powers and the U.S. are pressing the Israeli government to show restraint in its use of military force and pursue an exit strategy that entails a cease-fire, the release of hostages, and the establishment of a framework for negotiations for the creation of an independent Palestinian state. However, Netanyahu’s agreement to a ceasefire would risk triggering the defection of right-wing coalition partners, the collapse of his government, and an early election that the main governing Likud would likely lose.

The perception that Netanyahu is himself a key obstacle to achieving a cease-fire, the release of hostages, a de-escalation of regional tensions, and improved security has contributed to a significant erosion of popular support for the prime minister and his party. Predictably, Netanyahu, who has enraged his critics by refusing to accept any responsibility for the security failures related to the October 7 attacks, has dismissed public calls for accountability, declaring that the next election will be held as scheduled in 2026, regardless of how events unfold in Gaza.

Netanyahu appears to have decided that his best play is to continue pursuing a military solution in Gaza and hope that some measurable success on the battlefield will help to repair the heavy damage to his political brand by the time he is forced to face the electorate in 2026. But if that is the strategy that Netanyahu intends to pursue, the result is likely to be the reinforcement of the negative forces weighing on the country: the threat of an expanded military conflict, the danger of Israel’s international isolation, a loss of confidence in the ability of political leaders to maintain economic stability, and the possibility of convulsive domestic protests by a frustrated electorate that further compounds the political risks.

The October 7 attacks and the initiation of the military operation in Gaza had an immediate negative impact on the Israeli economy, but signs of a recovery are evident as life for most Israelis returns to a semblance of normalcy, including the return of many reservists to civilian activities. However, the budget deficit swelled to 5.3% of GDP last year and the government is forecasting a larger shortfall amounting to 6.6% of GDP in 2024. Earlier this month, Standard & Poor’s became the second credit rating agency to downgrade Israel’s sovereign credit rating, citing the fiscal risks from increases in defense spending and other budget strains arising from the conflict with Hamas.

The analysis above is taken from the April 2024 Political Risk Letter (PRL). The best-in-class monthly newsletter, written by the PRS Group, provides concise, easy-to-digest briefs on up to 10 countries, with additional recaps updating prior month’s reports. Each month’s Political and Economic Forecasts Table covers 100 countries, with 18-month and five-year forecasts for KPIs such as turmoil, financial transfer and export market risk. It also includes country rating changes, providing an excellent method of tracking ratings and risk for the countries where credit professionals do business. FCIB and NACM members receive a 10% discount on PRS Country Reports and the PRL by subscribing through FCIB.