The International Monetary Fund said Israel’s economy has shown unusual resilience through three years of war, but warned that the country’s growth path has been significantly damaged and that long-standing labor market gaps have become a macroeconomic risk.
In its annual review of the Israeli economy, the IMF said GDP remains about 9% below the trajectory it was expected to follow before the war. The fund cut its 2026 growth forecast to 3.5%, down from a prewar forecast of 4.8%, and projected a more moderate recovery of 4.4% in 2027.
The IMF said annual inflation is expected to rise from 1.9% in the first quarter of 2026 to 2.5% in the fourth quarter, mainly because of energy prices, before easing toward 2% in 2027. Core inflation and expectations remain around the midpoint of the target range, while the strength of the shekel is helping offset some price pressures.
The report also warned that fiscal pressures are intensifying. Israel’s government deficit is expected to widen to 6.2% of GDP in 2026, up from 5.2% in 2025, while public debt is forecast to rise to 70.1% of GDP and reach about 74% by 2031.
The IMF called on the government to reduce the deficit to about 2.5% of GDP within three years. Because civilian spending is already low, the fund said the adjustment should rely mainly on revenue measures rather than spending cuts.
Among the options it listed were merging Israel’s two lowest income tax brackets, raising VAT by another 2 percentage points and reducing exemptions, including benefits for advanced training funds and the VAT exemption on tourism services. The IMF also pointed to the possible cancellation of VAT exemptions on fruits and vegetables, a reassessment of tax benefits under the Law for the Encouragement of Capital Investment, and the return of taxes on products with negative social effects, such as sugary drinks and disposable utensils.
According to the fund’s calculations, raising VAT by two percentage points alone could generate revenue equal to about 0.8% of GDP.
But the IMF said Israel’s economic challenge cannot be solved by tax hikes alone. The report devoted significant attention to structural weaknesses in the labor market, warning that low employment rates among Haredi men and Arab women, along with persistent skills gaps, have shifted from a social issue into a genuine macroeconomic threat.
Draft protests in Bnei Brak
(Photo: AP Photo/Oded Balilty)
According to the IMF, the employment rate among Haredi men is about 55%, meaning roughly half are not employed, compared with a government target of 65% by 2030. Among Arab women, employment stands at about 45%, compared with a target of 53%.
The fund recommended expanding core curriculum studies, strengthening vocational and technological training, and reducing financial incentives that discourage labor force participation.
The report also warned that Israel’s high-tech sector, the main engine of the economy, faces new risks from the global AI boom. The IMF said Israel is among the countries best positioned to benefit from the AI revolution, but preserving that advantage will require further investment in science education, human capital and digital infrastructure.
That position, the report suggested, is not guaranteed. A sharp correction in the global AI market could harm Israeli exports, foreign investment and employment because of the country’s deep integration in the sector’s global value chain.
The overall message of the report is that the risk of an imminent economic crisis has receded, but three years of war have altered Israel’s economic balance. The central threat is now the gradual erosion of the country’s growth potential if it fails to expand its workforce, rebuild fiscal buffers and keep investing in long-term growth engines.