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Bank of Israel Governor Prof. Amir Yaron delivered remarks during the cabinet meeting on the State Budget for 2026. The following are his remarks:
In the past five years, the Israeli economy has had to contend with two major economic crises – the COVID-19 pandemic and the war. A key factor in the economy’s successful handling of these crises was the strong economic conditions at the onset of each, particularly the fiscal buffer reflected in the relatively low debt-to-GDP ratio, which stood at around 60% before both crises. The central message of my remarks is to emphasize the strategic importance of maintaining a fiscal buffer in the Israeli economy as a foundation for effective management of future crises.
The war, which has continued now for more than two years, has placed a heavy burden on Israel’s economy and on the state budget. Its effects are evident in the decline of GDP—mainly due to reduced labor supply—and in the significant increases in government expenditures and public debt. Nevertheless, given the tragic events of October 7 and two years of warfare, the economy has demonstrated remarkable resilience and strength. Against this backdrop, the achievements on various fronts and the moderation of hostilities since the ceasefire in Gaza mark a milestone that calls for the beginning of fiscal consolidation toward lower deficits and a reduction in the debt-to-GDP ratio.
Israel entered the war in a robust economic position, the result of many years of positive economic developments and responsible fiscal and monetary policy. The economy recovered rapidly from the COVID-19 pandemic, and the debt-to-GDP ratio declined swiftly thanks to prudent fiscal management and solid growth, which enabled the rebuilding of fiscal buffers ahead of the next crisis. This reinforced market confidence in Israel, built over years of proven ability to respond quickly to crises and return promptly to normal activity and responsible fiscal policy.
Even now, financial markets continue to show confidence in the Israeli economy, supported by the government’s fiscal responsibility and the achievements in the war. This confidence has been strengthened by significant fiscal consolidation measures adopted in the 2024 budget and, in particular, in the 2025 framework. These steps helped moderate the sharp rise in the debt-to-GDP ratio required to finance the war and signaled a commitment to reduce it once hostilities subside. Now that the fighting has eased, it is time to demonstrate to the markets that this commitment is being fulfilled. It is important to remember that while risks have diminished—as reflected in the decline of the risk premium—the possibility of renewed escalation cannot be ruled out and remains a key consideration in economic policy planning and in the need to create an adequate fiscal margin.
The budget proposal presented today for government approval provides a reasonable framework that still allows the initiation of fiscal consolidation. A deficit target of 3.6% of GDP, as proposed, will enable a modest reduction in the debt-to-GDP ratio in 2026, assuming the high growth rate that is expected as hostilities continue to subside. It is essential that the government approve the proposed deficit target and adopt the necessary measures on both the revenue and expenditure sides to achieve it. This is a challenging task given the many current needs, and I call on all ministers to act responsibly to meet this goal and justify market confidence in the Israeli economy and in the government’s economic policy. This responsibility is particularly crucial in light of geopolitical uncertainty, significant budgetary demands, and uncertainty regarding some revenue sources. Reducing the deficit and adopting policies that support a sustained decline in the debt-to-GDP ratio will help lower the cost of debt financing in the economy.
A specific revenue source in the proposed budget, amounting to approximately NIS 10 billion, is of a one-off nature. Therefore, the current budget proposal, which includes permanent tax reductions, may lead to an increase in the structural deficit—even if it is balanced this year—and make it harder to reduce the debt-to-GDP ratio in the coming years. According to Ministry of Finance estimates, the plan to widen income tax brackets is balanced against the expected increase in property tax revenues (from land for construction) once fully implemented. However, at least in 2026, the combination of these programs will be deficit-generating by several billion shekels, since the property tax proposal will be implemented gradually. In addition, the proposal to raise the VAT exemption threshold on personal imports will reduce revenues by NIS 1 billion and create distortions in the tax system. It is therefore particularly important to maintain fiscal balance through offsetting measures, such as the introduction of VAT on tourism.
Alongside the 2026 budget, it is important that future budgets continue to support a decline in the debt-to-GDP ratio. Recent discussions on a multiyear defense budget trajectory have indicated a high and sustained level of expenditures. Such a level of defense spending, combined with current civilian expenditure paths and existing tax rates, does not support a reduction in the debt-to-GDP ratio and may even lead to a significant and persistent increase, potentially approaching 80% of GDP toward the end of the period—even if GDP grows at or above potential. Therefore, if the government adopts such a trajectory, it must also approve corresponding adjustments in other expenditures or revenues to ensure that the debt-to-GDP ratio continues to decline steadily toward the desired level of around 65% of GDP by 2030. This will allow us to rebuild the fiscal safety cushions that proved so valuable in stabilizing the economy during the pandemic and the war.
Some may argue that there is no need to strive for fiscal buffers or that too much emphasis is placed on reducing the debt-to-GDP ratio over time. This is not the case. Israel’s risk environment and the frequency of crises differ from those of comparable countries, and maintaining market confidence during times of crisis can be very different when the debt-to-GDP ratio is around 60% compared to when it exceeds 70% and is rising. At the end of 2022, and again recently, we saw how sensitive markets can be to fiscal expansions in countries such as the United Kingdom and Japan.
So far, I have focused mainly on the proposed budget framework, which is important to approve. The accompanying Economic Arrangements Bill also includes several positive measures. The dairy market reform is expected to reduce central planning in the market, thereby increasing average efficiency in dairy farms and helping lower the cost of living in this area. The bill also includes other positive steps, such as promoting government digitalization, expanding the use of cloud technology, and developing digital infrastructure across the economy. Additional measures include promoting the construction of long-term rental housing and improving administrative data for labor market analysis. The introduction of VAT on tourism is another step that reduces economic distortions while helping to lower the deficit in the future. We welcome these measures.
Conversely, one of the decisions included in the budget documents effectively cancels the implementation of the five-year plan for the Arab society, transferring most of the remaining budgets for 2025–2026 to the Ministry of National Security and the Shin Bet, as part of the government’s decision to combat crime in Arab communities. This move results in extensive budget cuts in education, employment, transportation, construction, urban planning, and local authorities, halting government activity in these areas. The Bank of Israel opposes the proposal to harm Program 550 due to its proven positive effects on education and employment in the Arab community, as well as its significant potential contribution to overall economic growth by narrowing employment and productivity gaps between the Arab population and the rest of society.
The materials submitted to the government also include several proposals related to the financial sector, and I would like to address this topic briefly. In general, the financial system is a vital component of economic activity, serving as the bridge through which savings are channeled into investment. An efficient and competitive financial system enables smoother and more effective resource allocation, which is reflected in real economic activity and growth.
Various reforms and legislative initiatives we are currently advancing are, in my view, poised to bring about a transformation in Israel’s financial system, enhancing efficiency and competition.
The proposed Economic Arrangements Bill already includes two significant financial reforms. The reform to ease licensing for small banks is expected to pave the way for the establishment of additional banks in the coming years—particularly those with strong financial backing and existing customer bases—which will increase competition in the credit and deposit markets. It will be important to carefully consider the appropriate supervisory framework for the holding companies of these banks. Since the issue of supervision involves complex aspects, including financial stability and regulatory coordination, I recommend conducting a thorough review before proceeding with legislation.
The legislation to establish a business credit database at the Bank of Israel is expected to end the monopoly of the bank where a business maintains its account over the relevant credit information. This will allow additional lenders to compete for providing credit to businesses, improving their conditions. However, for the business credit database to achieve its purpose, it must include all relevant information for credit assessment, and the process of incorporating such data must be swift, efficient, and effective.
In particular, it is essential to allow credit bureaus and relevant lenders to develop models for assessing borrower quality by granting them access to all relevant information in both the business and retail databases—naturally, in anonymized form. Moreover, the process of determining which data sources report to the database and defining the specific data they provide should not be overly bureaucratic. The correct and efficient approach is to leave these powers with the professional authority operating the database—the Bank of Israel. I have noticed that critical amendments requested by the Bank of Israel for inclusion in the legislative text were not incorporated. To ensure that the legislation indeed leads to the establishment of an efficient and effective database for the benefit of the economy, I ask that these amendments be included in the version approved by the government.
Another significant step we have led in the financial system is the transition of the Tel Aviv Stock Exchange to trading from Monday through Friday—aligning with trading days in global exchanges. This move is expected to make the Israeli stock exchange more attractive to major international indices, and contribute to increasing trading volume and market depth.
In addition, other important financial legislative initiatives are currently under consideration by various government and Knesset bodies. The securitization law, approved in its first reading and expected to reduce financing costs for nonbank credit providers, is still awaiting further advancement in the Knesset. The factoring legislation, which could help small businesses improve liquidity by removing barriers to invoice assignment, is still in early drafting stages. I call on all relevant parties to act decisively and swiftly to advance these legislative processes.
Furthermore, I expect that the legislation concerning finality in the payments system will be advanced, and that a memorandum will be published soon. This amendment is urgently needed both due to Israel’s commitments to the international CLS clearinghouse and substantively to prevent disorder in the Israeli payments system in cases where a participant in the ZAHAV (RTGS) system requests reversal or cancellation of a clearing transaction.
All these steps complement the reforms we have led in recent years that strengthened customer bargaining power, including the establishment of the retail credit data system, open banking, and increased transparency in interest rates on loans and deposits. Our research shows that these reforms have improved customer conditions and reduced the cost of consumer credit and mortgages.
In conclusion, alongside these issues, I wish to reiterate the importance of reviewing the budget to identify sources that can be redirected toward growth-supporting investments in infrastructure and human capital. In particular, it is advisable to reduce budget allocations that create disincentives to join the labor market or to pursue education that enhances earning capacity. Such budgets harm long-term growth and living standards, and their negative impact will increase over time. The issue of military recruitment also carries economic implications. The use of reserve duty as a substitute for expanding the regular army is costly—both fiscally and due to lost workdays and disruptions in the civilian labor market. Likewise, granting exemptions to population groups with low labor market participation increases the burden on the working population, raises fiscal costs, and hampers economic growth.