FILE PHOTO: The sun sets over the Tel Aviv skyline, amid the ongoing conflict between Israel and the Palestinian Islamist group Hamas, in Tel Aviv, Israel, February 18, 2024. REUTERS/Dylan Martinez/File Photo

By Steven Scheer

JERUSALEM (Reuters) -Israel's cabinet approved on Sunday a three-year plan that would bring the state's budget deficit to less than 3% of gross domestic product through 2028, down from an expected 5% this year.

Under the Finance Ministry's plan, the deficit would come in at 2.8% of GDP in 2026 and 2027, and 2.9% in 2028.

The deficit target is about 5% of GDP this year after hitting 6.9% in 2024 following a spike in defence spending due to the Israel-Hamas war that erupted in October 2023.

Economic growth is projected at 4.4% in 2026 in the ministry's plan. Hurt by the war, growth was about 1% in 2024, but is forecast to accelerate to between 3% and 3.5% this year.

A Finance Ministry statement said the plan does not include the financial implications of an escalation in military conflict over the past month or government policy decisions that have yet to be finalised.

"The economic plan for 2026–2028 reflects a careful balance between cautious optimism and responsible fiscal steps," said Ilan Rom, the ministry's director general.

"It ensures that future budgetary commitments will be made within the framework of the state budget, adhering to principles of prudent and responsible public fund management."

At Sunday's cabinet meeting, Bank of Israel Governor Amir Yaron told ministers it was crucial for debt levels to decline to maintain market confidence.

He told them that despite the projection of a lower deficit in 2026 that could allow for a lower debt-to-GDP ratio, risks are higher than usual, according to a central bank statement.

For 2027 and 2028, the Bank of Israel forecasts budget deficits of 3.5% to 4.0%, bigger than those projected by the government.

"Additional adjustment measures are likely to be required, with their timing dependent on geopolitical and economic developments," Yaron said, adding that an escalation of fighting would lead to a breach in the deficit target for 2025.

Yaron advised against reopening the 2025 budget to raise the deficit target given uncertainty this year and into 2026.

Should additional adjustments be needed, he said preference should be given to reducing spending that harms incentives to work or pursue education, increasing some taxes and eliminating distortive tax exemptions, especially in indirect taxation.

(Reporting by Steven ScheerEditing by Bernadette Baum and Helen Popper)