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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Key Takeaways
- **Protracted Political Uncertainty:** The fragmented election results point to a prolonged period of coalition negotiations, raising concerns about policy paralysis and its potential dampening effect on investor sentiment and the Israeli Shekel (ILS).
- **Fiscal & Economic Policy Risks:** A transitional or unstable government could delay critical budget approvals, infrastructure investments, and economic reforms, impacting Israel’s growth trajectory and potentially its sovereign credit rating.
- **Elevated Geopolitical Risk Premium:** The specter of a constitutional crisis or an escalation with Iran, especially under a caretaker government, could significantly increase Israel’s risk premium, affecting bond yields, foreign direct investment, and sector-specific asset valuations.
Israelis voted in a historic election on Tuesday, the first since Hamas’s October 7 2023 attack, in what many viewed as a referendum on Prime Minister Benjamin Netanyahu’s divisive rule. Beyond the domestic political ramifications, global markets and investors watched closely, understanding that the outcome would dictate the stability of Israel’s economy, its fiscal direction, and its geopolitical posture in an increasingly volatile Middle East. The Shekel (ILS) and Tel Aviv Stock Exchange (TASE) indices, such as the TA-35, typically react sharply to shifts in political certainty, making this election a high-stakes event for asset managers and analysts alike.
Turnout rose to the highest level in more than two decades and was well above the previous election in November 2022, a strong indication of what the country’s citizens saw as the high stakes of the vote. For markets, high turnout often signals deep public engagement, which, in the absence of a clear mandate, can amplify the political noise and introduce further volatility.
What do the results show?
According to exit polls released late on Tuesday, neither Netanyahu’s far-right coalition nor the bloc of Jewish opposition parties, centred around Gadi Eisenkot’s Yashar party, was on course to win an absolute majority — signalling a potential deadlock. This fragmentation immediately flagged a red alert for investors, as political uncertainty typically translates into a higher risk premium for sovereign debt and increased currency volatility. A hung parliament could lead to prolonged negotiations, delaying crucial policy decisions and impacting market confidence, as seen in previous Israeli election cycles where the Shekel weakened and local equity markets treaded water during extended periods of government formation.
But as ballot counting progressed, the Netanyahu bloc appeared to be comfortably ahead of Eisenkot’s, albeit short of a majority and with no clear path to making up the shortfall. While a slight lead for any single bloc might offer some fleeting relief, the overarching challenge of forming a stable government persists, casting a shadow over Israel’s economic outlook. Fiscal policy, a critical driver for investor decisions, could be left in limbo, potentially impacting the nation’s ability to tackle inflation, manage its growing budget deficit, or embark on large-scale infrastructure projects.
With about 72 per cent of votes counted, Netanyahu’s coalition group — which unites his Likud party with two ultranationalist and two ultra-Orthodox parties — was projected to win 54 seats in Israel’s 120-seat Knesset, or parliament. Yashar and three other Jewish opposition groups were forecast to win 48 seats. Israel’s Arab parties, who also oppose the current government, were predicted to win the remaining 18 seats, which — if confirmed — would represent a sharp increase on the 10 they held in the outgoing parliament.
The official results will depend in part on whether various smaller parties clear the 3.25 per cent electoral threshold for representation in the Knesset. This razor-thin margin for smaller parties adds another layer of complexity, as their eventual inclusion or exclusion could decisively swing the balance, prolonging the uncertainty that often deters foreign direct investment (FDI) and encourages local capital to seek safer havens.
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How does parliament choose a prime minister?
It can take Israel’s Central Elections Committee several days to tally and formalise the vote count. By law they have seven days from the election to provide the official results to President Isaac Herzog. In past election cycles officials have completed the bulk of the count sooner, though legal challenges may delay certification of the results. For markets, every day of delay in formalizing results translates into prolonged uncertainty, potentially affecting the Shekel’s stability against major currencies like the USD and EUR, and keeping local equity benchmarks under pressure.
Once this is done and each party is allocated its share of the 120 seats, Herzog will hold consultations with party officials as to whom they “recommend” be tasked with forming a government. Critically, this is not necessarily the leader of the largest faction, but whoever is deemed to have the best chance of cobbling together a governing coalition. This flexibility, while democratic, often introduces an element of unpredictability that can unnerve investors seeking clear policy signals.
Once a politician is given a “mandate” to form a government by the president, they have 28 days — with the option of a 14-day extension — to negotiate the terms of any such coalition. If that person fails, the president invites a second person to attempt the task within 28 days, with no option of an extension. These deadlines are critical checkpoints for market observers; progress towards a stable government can spark rallies, while failures can trigger sell-offs. The potential for multiple rounds of coalition attempts implies a multi-week, or even multi-month, period of market sensitivity.
In the event that this also fails, the president can give the Knesset 21 days to find an absolute majority of parliamentarians willing to back a third candidate, who then has 14 days to form a government. Otherwise, the Knesset is dissolved and new elections are called. The prospect of a fifth election in recent years would be a significant blow to investor confidence, signaling deep structural political instability and potentially leading to a downgrade in sovereign outlook by rating agencies, increasing Israel’s cost of borrowing on international markets.
Who can form a government?
In theory, Herzog could give the first “mandate” to form a government to a party with fewer seats if it had stronger prospects of cobbling together a coalition. Former military chief Eisenkot’s Yashar is set to garner about 21 seats, according to the partial vote tally. Yet Eisenkot’s path to forming a coalition is not straightforward. With the four main Jewish opposition parties predicted to fall well short of an absolute majority of 61 seats, they would require the support — both explicit and tacit — of the two Arab Israeli political factions. This complex political arithmetic has profound economic implications; different coalition compositions could pursue wildly different fiscal and social policies, impacting everything from tech sector regulation to social welfare spending.
Eisenkot during the campaign had indicated a willingness to lead a minority coalition if necessary. This could be achieved with a simple majority in parliament if Arab parties aid the formation of a government. While legally possible, this has never before been tried in Israeli history. A minority government, while potentially avoiding new elections, would be inherently unstable, struggling to pass legislation and budget bills, thus creating an environment of policy uncertainty that often deters long-term investment.
But some opposition leaders have previously rejected the idea, with Avigdor Lieberman — a former defence minister and head of the rightwing Yisrael Beiteinu party — previously ruling out such a scenario. The political divisions underscore the difficulty of forming a broad-based, stable government that can enact sustained economic policy, which is critical for maintaining Israel’s “start-up nation” reputation and attracting crucial foreign capital.
The mandate could also be given to Netanyahu and Likud — which is predicted to be the largest party in parliament with about 27 seats — although his path to forming a majority coalition is complicated by the fact that all opposition factions have ruled out serving under him. The live vote count — if it holds — would strengthen his claim to receiving the mandate as the leader of a bloc that would only need a handful more members to reach the 61 seats needed for a majority. Netanyahu’s economic policies have historically favored a free-market approach, but his reliance on ultra-nationalist and ultra-Orthodox parties could introduce pressures for increased social spending and reduced government oversight in certain areas, which could be viewed cautiously by fiscally conservative investors.
If deadlock and another election loom, Herzog may also urge Netanyahu and Eisenkot to come together in a unity government with a rotating premiership, as happened in April 2020. A unity government, while politically challenging to forge, could offer markets a semblance of stability and a more centrist policy agenda, potentially boosting confidence and providing a firmer footing for the Shekel and local equities. It remains unclear — and highly contentious — which politician would serve first as premier in such an arrangement.
Netanyahu claimed victory within the “Jewish camp” and urged his Zionist rivals to shun Arab parties and join his “national, rightwing” government. Such a narrow-based government, even if majority, might struggle with international relations and domestic consensus, potentially adding to Israel’s geopolitical risk profile.
What else can Netanyahu do?
In the event that Netanyahu is unable to form a government, opposition officials and civil society activists are increasingly concerned that he and his supporters could refuse to recognise the results, which risks fomenting a constitutional crisis. Such a crisis, unprecedented in Israel’s modern history, would send shockwaves through financial markets, potentially leading to significant capital flight, a sharp depreciation of the Shekel, and a substantial increase in Israel’s sovereign risk premium. The rule of law and institutional stability are cornerstones for investor confidence, and any threat to them would be profoundly negative.
The new Knesset’s first session is set to take place by law on November 14, during which the opposition is expected to move to replace the current parliamentary speaker, Likud official Amir Ohana. In 2020, another Likud Knesset speaker initially refused to vacate the post and threatened to ignore a Supreme Court ruling on the matter. Ohana has in the past made statements indicating that he may not abide by the top court’s rulings. This institutional friction could further exacerbate political instability, creating an environment inhospitable to long-term economic planning and foreign investment.
Also looming is the threat of a renewed US-Israeli offensive against Iran, something both Netanyahu and President Donald Trump have pledged to carry out — though a fresh campaign is seen as unlikely until after next week’s US midterm elections. Netanyahu has repeatedly warned that Israel faces an existential threat from Iran and has vowed to restart the war. Any such military action, especially if initiated by a transitional prime minister, would dramatically escalate regional tensions, directly impacting global oil prices, shipping routes, and the broader Middle East risk premium. For Israel, it would mean increased defense spending, potential disruption to energy exports (e.g., natural gas from Leviathan and Karish fields), and a significant blow to investor confidence.
But many Israelis are concerned that doing so before a new government is formed — when Netanyahu would still be a transitional prime minister — could upend the government formation process and spark a regional conflagration. The market implications of such a scenario are dire, pointing towards sharp downturns in the Shekel, a flight from Israeli equities, and a surge in demand for safe-haven assets, as the region’s geopolitical risk factor reaches critical levels.
Market Impact
As Israel navigates complex and potentially protracted coalition talks, global investors will be keenly monitoring for signs of political stability or further fragmentation. A prolonged deadlock, the specter of a constitutional crisis, or any escalation of regional tensions, particularly regarding Iran, could trigger significant depreciation of the Shekel, elevate sovereign bond yields, and prompt a retreat from Israeli equities. Conversely, the successful and relatively swift formation of a stable, market-friendly government – even a unity government – could provide a much-needed boost to investor confidence, potentially attracting capital back into the nation’s robust tech and energy sectors. The outcome will dictate not only Israel’s domestic policy agenda but also its perceived risk profile on the international stage, directly influencing foreign direct investment, credit ratings, and the overall cost of capital for Israeli businesses and the government alike. Investors should brace for heightened volatility and remain sensitive to both political developments and geopolitical shifts in the coming weeks and months.