Israel plans to raise about $60bn in debt this year, freeze government hiring and increase taxes as it almost doubles its defence spending to support its war in Gaza, according to a senior finance official.

Israel’s more than four-month conflict with Hamas has taken a severe toll on the economy, which shrank almost 20 per cent on an annualised basis in the last quarter of 2023.

The hit came as the government mobilised a record 300,000 reservists; tens of thousands of people were displaced in the north and south of the country; and consumer spending slumped. About 150,000 Palestinians workers have also been prevented from entering Israel from the occupied West Bank.

But Yali Rothenberg, the finance ministry’s accountant general, told the Financial Times that he expected the economy to begin to recover as large numbers of reservists are demobilised and consumer spending picks up.

“The economic fundamentals are there,” he said. “If you look at the high-tech sector, it’s there. If you look at the infrastructure investment, it’s there. If you look at the private consumption, it’s there.”

Rothenberg said a critical factor in restoring the health of Israel’s economy was the demobilisation of reservists. He said that the number still serving was about a fifth of the 300,000 called up after Hamas’s October 7 attack that killed 1,200 people, according to Israeli officials, and triggered the war.

That number was expected to drop to between 30,000-40,000 by the end of March, he added, saying the conflict was “de-escalating”.

“This is the scenario which is budgeted,” Rothenberg said.

The government is, however, threatening to expand its offensive in Gaza to Rafah, a southern city where more than 1mn people already displaced from their homes have sought sanctuary, despite international warnings that an assault in such a densely populated area would be devastating.

The Israeli offensive has killed more than 29,000 people, according to Palestinian health officials, devastated huge swaths of the strip and forced more than 85 per cent of the 2.3mn population from their homes.

And despite demobilising thousands of reservists, Israel has said it expects to maintain a security presence in the strip for the foreseeable future. The office of Prime Minister Benjamin Netanyahu on Friday released a plan for postwar Gaza that envisages Israel maintaining a sizeable security buffer within the enclave.

There are also concerns that almost daily clashes between militant movement Hizbollah and Israeli forces across the Lebanese-Israeli border could escalate into a full-blown conflict.

It is against this backdrop that the government plans to raise defence spending this year by 55bn shekels ($15bn), an 85 per cent increase on the prewar defence budget. That would push defence spending to about 20 per cent of the 2024 budget, the finance ministry said, up from 13.5 per cent before the war. The draft budget for 2024 is being reviewed by committees in the Knesset and is expected to be passed next month.

“We think there will be increased defence spending in Israel for the coming years,” Rothenberg said. “This is why we took the fiscal steps right now.”

He added that a committee of experts from outside the government had been established to advise on future defence spending.

State revenue for 2023 came in at 12bn shekels below forecast, while the government increased spending by about 26bn shekels because of the war. That included an additional $4.7bn on defence as the finance ministry issued special permits to allow the government to operate outside the budget immediately after Hamas’s October 7 attack.

In a bid to balance the books, the ministry plans to increase value added tax from 17 per cent to 18 per cent in 2025, while this year and next it will increase taxes such as those on smoking and banking, freeze government hires and defer public sector wage increases.

Moody’s this month lowered Israel’s sovereign rating from A1 to A2 over concerns about the war in Gaza, its indefinite duration and the broader impact on the economy. The rating agency also lowered Israel’s debt outlook to negative due to the risk of the conflict spreading to the country’s northern front. 

Last month, Israel’s central bank governor urged the government to rapidly curb spending, warning that its market “credibility” depended on it making budget adjustments, including cuts to expenditure and increases to revenue.

Israel’s government is forecasting a budget deficit of 6.6 per cent of gross domestic product this year, and predicts that growth will drop from 2 per cent in 2023 to 1.6 per cent this year.

After the war broke out, it borrowed about 81bn shekels, pushing the debt-to-GDP ratio to about 62 per cent, its highest level in about eight years.

The ministry expects that ratio to rise by another five or six percentage points this year as it looks to tap domestic and international markets to raise about 250bn shekels. However, it forecasts that debt-to-GDP will remain below 70 per cent.

Rothenberg, who has been meeting investors in New York and London, said most of the debt would be raised locally, but added the ministry was looking “intently” at the dollar market, saying “everything was on the table”.

“Investors really want to own some Israeli paper, they think it’s an opportunity and people recognise the de-escalation,” he said.