Analysis
How Iran’s fate could shape Israel’s economic revival—or ruin
Victory may bring prosperity, but a drawn-out war could trigger fiscal collapse.
The Iranian ayatollah regime has been threatening Israel for 46 years, and in recent decades has become the ultimate geopolitical threat to Israel and the central variable in the risk premium of its economy. Therefore, to begin making economic assessments and estimates, it is important to consider two different scenarios following an attack on Iran, which would yield radically different results.
1. The first scenario is the optimistic one, and there is room for optimism given the performance of the IDF and the Mossad, the support of the U.S., and the tacit agreement of most Western countries, who, just a few hours ago, had turned their backs on us in light of the war in Gaza. There is broad agreement that the Israeli military move in Iran was necessary and vital.
If the Iranian threat is removed, then a new era could begin that would jumpstart all the key macroeconomic parameters of the Israeli economy, first and foremost, growth through one key component: investments. Perhaps even more important is the expectation of a decrease in the deficit and debt, and an almost immediate improvement in Israel's credit rating. As mentioned, the Iranian threat is the main factor driving Israel's risk premium. Therefore, if the "head of the snake" disappears, no matter why or how, Israel's defense spending is expected to decrease in the long term, or at least not increase as assumed by the Nagel Commission.
We must not forget that the disappearance of the Iranian threat would follow the elimination of threats from Hamas, Hezbollah, and the Assad regime in Syria. Without Iran, and with the end of the war in Gaza, the way would open for peace agreements with Arab countries. This is the scenario that most closely resembles a "new Middle East."
A decrease in the risk premium would also lower the interest rate on government debt, which reflects that premium. It’s true that Israel’s CDS (credit default swaps) jumped by 14.5% last week (when fears of war were already in the air, but no one yet knew when, or to what extent). But if Iran "disappears" from the threat map, they will drop. Not to the level seen prior to October 7 (around 50 basis points), because the government, and its judicial overhaul with all its implications, is not going anywhere. But as noted, there are Israeli CDSs with Iran and all its ramifications, and there are those without.
In such a scenario, a short-term event that includes a loss of GDP in the coming days is “likely” if growth accelerates later in the year and compensates for the period of intense warfare. But there is still a major missing piece in the equation: what happens in Gaza. If the Netanyahu–Smotrich government insists on occupying the Strip, everything written above becomes irrelevant: the costs of occupation, essentially defense expenditures, will prevent any reduction in defense budgets. Consequently, neither the debt nor the interest burden will shrink. Growth will continue to be slow because Israel, as a small, open economy, will face deepening international ostracism.
2. The second scenario is the problematic one. A longer war that leaves Iran and the ayatollah regime enraged and engaged in a war of attrition against Israel, a kind of Iran–Iraq-style campaign that drags on, exhausts resources, and necessitates sustained high levels of security spending.
In this scenario, the risk premium does not decrease, nor does the deficit or the debt. The state’s surprisingly strong tax revenues may help only in the short term. In this context, it’s important to remember that the government has already depleted all budget reserves, and the Treasury’s stated deficit of 4.9% is illusory. This war is not budgeted. If we’re looking at a prolonged campaign like the “Swords of Iron” war, the outcome is catastrophic, both in terms of growth, investment, and fiscal stability.
Not only could Israel’s credit rating fall further, but such a downgrade would complicate Israel’s ability to raise capital on international markets and force even more severe cuts to civilian spending, which is already dangerously low in the long term, about 3 to 4 percentage points below the OECD average. This must also be accompanied by tax increases, despite decent economic performance in 2025. Such measures could push the Israeli economy toward a fragile and dangerous tipping point.
And if Netanyahu continues to pursue the ideological fantasies of Ben Gvir and Smotrich in Gaza, it's hard not to foresee a collapse through the fiscal channel.
