Bank of Israel Forecasts 5.6% Growth, but Without Israeli Companies' Output Abroad, Growth Is 3.4%

On 21 October, the Bank of Israel kept its benchmark interest rate at 3.25%, following rate cuts in January, May, July and September, as expected by all 15 economists polled by Reuters. Governor Amir Yaron rejected the suggestion that the central bank had waited until after the 27 October parliamentary elections to make its decision, saying it was based solely on economic considerations. Annual inflation stood at 1.6% in September, according to JFeed, below the midpoint of the 1-3% target range. The Bank found that Israel's risk premium had remained at pre-7 October 2023 attack levels and that the shekel had depreciated. What kind of economy will the next government inherit?

• Growth largely generated outside Israel

The Bank's Research Department raised its growth forecast to 5.6% for 2026 and 7.5% for 2027, from 4% and 5.5% in July, according to the Times of Israel. The Bank specifies that most of the upward revision comes from output generated abroad by Israeli companies. Excluding this output, growth stands at 3.4% in 2026 and 5.1% in 2027. The difference-2.2 and 2.4 percentage points, respectively-represents the contribution of output produced abroad to Israel's GDP. According to the Bank, as quoted by Calcalist, this output is generated mainly by multinational companies with foreign owners, and most of the income goes to foreign shareholders rather than contributing to wages and income in Israel. For this reason, the Bank considers growth excluding this output a better indicator of domestic economic activity. In the second quarter, output generated abroad accounted for almost 6% of GDP. Yaron warned that overall growth could give a misleading picture of the pace of domestic economic activity.

The economy grew by 15.4% year on year in the second quarter, following the suspension of activity during the war with Iran, while third-quarter data point to continued growth.

• The cost of living: the issue voters feel most directly

The growth reflected in GDP figures is not the growth voters feel in their everyday lives. According to the Israel Democracy Institute, cited by Al Jazeera, 38% of Jewish Israelis and 46% of Arab Israelis named the economy and the cost of living among the two most important issues influencing their vote. Unemployment is just 2.8%, but food prices rose by 8% between early 2024 and mid-2026, according to consumer rights organisation Lobby 99, outpacing prices overall.

A study by the Aaron Institute for Economic Policy at Reichman University, reported by the Times of Israel in May 2026, shows that a typical Israeli household's consumption basket-including food, housing, electricity, healthcare and education-costs 21% more than in Europe's wealthiest countries: Austria, Finland, Denmark, the Netherlands and Sweden. Compared with Greece, Cyprus, Italy and Spain, the difference is 68%. In 2005, housing in Israel was 31% cheaper than in the wealthier countries in the comparison; it is now 26% more expensive. Food was 26% cheaper at the time but is now 27% more expensive.

• The deficit and public debt

The forecast published by the Bank on 21 October and reported by Calcalist puts the budget deficit at 4.4% of GDP in 2026, down from the 4.9% projected in July, but rising to 4.6% in 2027. Public debt is expected to reach 68% of GDP at the end of 2026 and 66.5% at the end of 2027. The actual deficit over the previous 12 months was lower: 3.2% of GDP at the end of August, according to Globes. Moody's, which maintained Israel's rating at Baa1 with a stable outlook, estimates a central government deficit of 5.3% in 2026 and public debt of around 70%.

In October, Fitch maintained Israel's rating at A with a negative outlook, signalling the risk of a downgrade, and directly linked its assessment to the elections: neither bloc appears likely to reach 61 seats, and a caretaker government lasting for months or another election would make it "difficult to reduce the deficit”, according to the Jerusalem Post.

The historical comparison shows the cost of the wars: before 7 October, Israel's public debt stood at around 60% of GDP, close to the level of other small developed countries, which have since reduced their debt. The Bank warned, according to Globes, that increasing the defence budget without adjustments elsewhere in the budget would widen the deficit and could reignite inflation. Campaign promises, from reservists' pay to housing, must fit within this fiscal constraint.

• Start-ups attract near-record sums

According to CTech Data, Israeli start-ups raised $13.2 billion in the first nine months of the year across 192 publicly announced funding rounds, equivalent to around 85% of the $15.6 billion raised in the whole of 2025. The record remains the $27 billion raised in 2021. In 2025, artificial intelligence and cybersecurity accounted for 40% of funding rounds and around 70% of the capital raised, while funding for AI companies increased from $4.9 billion to $7.9 billion. The largest funding round in the first half of the year was the $1 billion round raised by Vast Data.

The figures differ depending on the source: for the first half of the year, CTech reports $8.4 billion, while IVC-LeumiTech, cited by Globes, puts the figure at $7.6 billion. Figures from different sources are not directly comparable.

• Companies are growing but increasingly hiring outside Israel

The 2026 report by the Israel Innovation Authority, reported by the Jerusalem Post, shows around 400,000 technology employees in 2025, up 2.3% from the previous year. However, research and development jobs fell by around 3,500-the first decline in ten years. At Israeli private technology companies, the share of employees based in Israel fell from 69% in January 2019 to 62% in March 2026, while growth abroad was concentrated in the United States.

The central bank's forecast and the Innovation Authority's report point to the same phenomenon: Israeli companies are growing, but an increasing share of their output and workforce is located outside the country. For the budget, the question is how much of this growth translates into tax revenue collected in Israel. In July, the Bank attributed the lower projected deficit to tax revenues that were higher than expected in the first half of the year.

Defence is not financed solely by Israel's budget. The 2016 US-Israel memorandum provides for a reference annual allocation of $3.8 billion in military aid: $3.3 billion in Foreign Military Financing and $500 million for missile defence. In normal years, this amount covers around 15% of the defence budget, according to the Institute for National Security Studies in Tel Aviv; the share varies from year to year depending on additional packages approved during wars and the size of Israel's own budget. The remainder falls to Israeli taxpayers. Will Israel's domestic tax base be able to finance this share if an increasing proportion of growth is generated abroad?