Israel's new Government gives Reason for Optimism on the Economic, less on the Political Side

July 02, 2021 | Israel

Executive Summary

A Patchwork Coalition with a full Agenda

  1. The eight-party “Change Coalition” ended 12 years of government by Benjamin Netanyahu. However, with a wafer-thin majority in parliament and very diverse positions, domestic politics will remain rocky.
     

  2. While the coalition is reluctant to tackle the conflict with the Palestinians, the economic outlook looks promising: Necessary reforms, a global recovery from the pandemic, and low interest rates spur growth.
     

  3. The recent escalation with Hamas and a more balanced US approach will shift power in the region, as Jordan and Egypt regain influence while members of the Gulf Cooperation Council may face difficulties.

Watch out for

  • A new State Budget, the first in three years, being the big ‘test for the new coalition;
     

  • Benjamin Netanyahu standing trial for breach of trust, accepting bribes, and fraud;
     
  • Implications of the first official visit of an Israeli minister to the UAE on June 29;
     

  • A stronger Arab bloc as leaders of Egypt, Jordan and Iraq met on June 27 to discuss security and economic cooperation.

Key Facts

  • The Bennett-Lapid government holds a majority of 62 Members of the Knesset (out of 120) but includes 27 Ministers;
     

  • Israel’s GDP is projected to grow by 5% in 2021 and 4.5% in 2022, as a result of the reopening of the economy;
     
  • With oil prices at $75 per barrel, Gulf economies are likely to run current account surpluses.

State of Play

From United Opposition against Bibi to Effective Government?

Israel changed its leadership but is waiting for political change to come. After 12 years in office, Benjamin Netanyahu was succeeded by Naftali Bennett. Bennett will lead the new government for the first two years, followed by the new foreign minister and actual mastermind behind this coalition, Yair Lapid. However, this government is unlikely to meet the Israelis’ desire for stability: It is the first time in history that the Prime Minister’s party, Yamina, holds only seven seats in the parliament – Lapid’s Yesh Atid holds 17 seats – and that an Arab party joined the government. The main question is whether unity in opposition to Netanyahu can be turned into effective governance. Most likely, the new government will focus on economic recovery and anti-corruption policies. However, recent fighting between Hamas and Israel demonstrates that the Israeli-Palestinian conflict cannot be ignored. Bennett and Lapid can utilize the political shift to restart negotiations for a long-term solution to the conflict, even though ideological gaps prevail. Meanwhile, the escalation has complicated further normalization between Israel and the signatory countries of the Abraham Accords, Bahrain and the United Arab Emirates.

Key Issues

The Economic Future within Israel Looks Promising

For the Israeli economy and capital markets, the near future looks promising due to three key drivers: The recovery of the global economy, the end of the Covid-19 pandemic (at least for Israel), and the new government's economic reform policies. The current weakening of the Shekel works furthermore in favour of one of Israel’s main growth engines, the export sector. Along with the high-tech industry, it served as a shock absorber during several virus-induced lockdowns. The Bennett-Lapid government is expected to have the new state budget approved before November 2021. After Israel has had no state budget for the past two years, this will bring about additional economic stability and serves as a step out of the current stagnation. Israelis can also be optimistic about reduced levels of nepotism, as anti-corruption was Lapid’s main ticket during the election campaign. While the Likud was infamous for favouritism when it came to the appointment of officials and the distribution of subsidies, the new government started off by wiping the slate clean amongst regional officials and civil servants. Together with the Bank of Israel keeping interest rates low, this allows for an optimistic economic outlook.

 

A major domestic concern, however, is the recent conflict between Israel and Hamas. After the escalation spilled over into mixed neighbourhoods inside Israel, the relationship between Jewish and Arab citizens remains tense and fragile. The new Police Minister, Omer Bar-Lev, has already committed to reforms, including to the police’s treatment of Israeli minorities. However, the conflict has an international dimension too, through its connection to Egypt, Qatar and Turkey, which provide relief for the Gazan people. Qatar is funding parts of Hamas' current administrative expenses and provides assistance to families in need, transferring the money through Egypt with the consent of Israel.

Shifting Regional Power Balances in the Israel-Palestine Conflict

The outcome of the recent clashes demonstrates the limits of Israel’s military capabilities and underscores the need to reach a political solution that is more palpable than the status quo. Several Israeli leaders are supporting an outreach to the Palestinian leadership, rendered possible by Netanyahu’s departure. However, diverging opinions within the coalition and its right-wing support base make this scenario unlikely. Furthermore, whether a two-state solution is salvageable after a dozen years of changing facts on the ground remains open. Finally, the recent escalation severely undermined the Palestinian Authority in the West Bank led by Fatah vis-à-vis Hamas in the Gaza strip and its legitimacy to negotiate for all Palestinians.

 

More broadly, Netanyahu’s ouster shifts the power balance in the region. The new government presents opportunities for countries like Egypt and Jordan. Cairo can play an important role in inter-Palestinian reconciliation, Amman has a critical role to play on final status issues, as it maintains custodianship over the holy sites (which Netanyahu mulled handing over to Saudi Arabia). Moreover, Jordan is vying to rekindle its special relationship with Washington after years of perceived neglect: In fact, King Abdullah is expected to be the first Arab leader to visit the White House later this summer.

 

GCC signatories of the Abraham Accords face an increasingly complicated situation. Leaders justified normalizing relations with Israel as a mean to advance the Palestinian cause. However, the recent fighting fueled public opposition. Meanwhile, Israeli leaders press ahead with normalizing relations, assuming that it will gain them sympathy amongst voters. This week, Lapid took credit for being the first Israeli leader to visit the UAE. Three external factors will further shape the GCC’s outlook on warming ties with Israel: First, rebounding oil prices and the resulting economic recovery renders GCC members less dependent on pursuing economic ties with Israel. Second, the normalization of the US-Israeli relationship is yet to fully transpire. Finally, and most importantly, the future of GCC-Israeli relations hinges on the negotiations between the US and Iran. The initial warming of ties of the GCC and Israel stemmed from the unreliability of the US as a security guarantor against Iran. For their part, Iran will spin Hamas’ steadfastness against Israeli attacks as an indirect victory for the ‘resistance’ that it leads. Israel’s northern frontier and Hezbollah’s reluctance to participate in the fighting, however, suggest that Tehran is still apprehensive of Israeli or US military action. Thus, Israel-GCC military and intelligence cooperation will likely continue covertly.