Israel Defence and Security Report Q2 2009

Israel is still in a highly insecure environment. Internally, its occupation of the Palestinian territories has led to a prolonged campaign of violence against both military targets and non-combatants within its own territory. Further non-state groups resident in other countries such as Lebanon also target Israeli forces with regular violence. Finally, a variety of external threats exist among Arab and neighbouring countries, most notably Iran, that have refused to formally recognise Israel's existence as a state.

A final peace settlement between Israel and the Palestinian Authority (PA) still seems highly unlikely.

Hamas remains a threat to the stability of the region (including neighbouring Egypt), and we would expect US President Barack Obama to support any Israeli efforts to forcibly remove the group. He supported the Israeli campaign against Hizbullah in 2006. The President’s website states of that conflict: ‘Obama is an original cosponsor of the Senate resolution expressing support for Israel, condemning the [Hizbullah] attacks, and calling for strong action against Iran and Syria.’ In fact in spite of the ceasefire agreed in June and meant to run until December 2008, the Israeli armed forces were still exchanging fire and rockets in Gaza towards the end of the year.

Israel's defence industry has become the leading sector in the country's economy. It benefits from large amounts of support from the government in the form of contracts, and the country possesses a welltrained and well-armed military. There is, however, an ongoing debate amongst the state’s leaders as to whether defence spending should be curbed, maintained or increased. Most recently, reports in Israeli newspaper Haaretz note that Defense Minister Ehud Barak has openly questioned moves to slash defence spending in 2009. Mr Barak is quoted as saying that ‘sound, responsible leadership can not support cuts in the defense budgets in light of the threats posed by Iran, Hezbollah, and Hamas’. Barak has also reacted strongly against an ultimatum delivered by Finance Minister Roni Bar-On. Mr Bar-On had argued that fiscal rectitude demanded making cuts to either defence or social welfare programs. In response, Barak stressed the importance of a no-compromise approach that sought to find ways to invest in both.

On broader political matters, the issue of greatest note pertains to the formation of government.

Netanyahu faces some serious challenges, even from within his own party, to form government following the February 10 elections. The latest update on this front is that by April 3, Netanyahu must have secured the support needed to form government.

Growth in the economy will slow dramatically in 2009 due to falling demand for Israeli exports, sluggish consumer spending and negative investor sentiment. Increased government spending should spare the economy from recession, however, with annual growth expected to come in at 1.3%.

We have slashed our growth forecasts for Israel in 2009 in light of the sharp deterioration in the global economic outlook since our last Business Forecast Report. We are now forecasting real GDP growth of just 1.3% for the coming year, rising to 1.9% in 2010 and 2.1% in 2011. Even when external conditions improve, we believe that the days of 5+% annual growth, enjoyed since 2004, are over and Israel's growth patterns will in future resemble those of developed states such as the US or Western Europe. In the short to medium term, the risks to our forecasts are weighted to the downside. Globally, the bad news just keeps on coming and a deeper or longer than expected downturn in the US would have a knock-on effect on the Israeli export sector and on foreign direct investment.