By Steven Scheer

JERUSALEM (Reuters) -The Bank of Israel on Sunday warned of economic damage if more ultra-Orthodox Jewish men do not join the country’s military, weighing in on a contentious issue that has caused a rift in Prime Minister Benjamin Netanyahu’s wartime government.

In its 2023 annual report, the central bank said Israel’s war against Palestinian Islamist group Hamas in Gaza that began on Oct. 7 had highlighted the personnel needs of the military and has added a burden to the economy due to the sharply increased amount of service days that will be required for both conscripts and reserve soldiers.

This, it said, impairs the soldiers’ economic output as well as the spouse’s employment. “As the burden of military service is divided among a higher number of soldiers … the economic impact on each of them declines, as does the aggregate impact on the economy,” the Bank of Israel said.

“Expanding the circle of military personnel to include the ultra-Orthodox population….will therefore make it possible to answer the increasing defence needs while moderating the impact to personnel and to the economy.”

Netanyahu’s government said in February that it would seek a way to end exemptions to military service for ultra-Orthodox Jews, which date to the foundation of Israel in 1948, to spread the wartime burden across society more fairly.

But the decision met with a backlash from ultra-Orthodox Jewish parties and created a rift in the coalition.

Sunday had been the deadline for the government to come up with legislation to resolve the issue but Netanyahu filed a last-minute application to the Supreme Court for a 30-day deferment.

The Bank of Israel said that the fast growing ultra-Orthodox sector is now 7% of the economy but will be 25% in 40 years time. Only 55% of ultra-Orthodox men work and if this trend continues, Israel will lose six percentage points of gross domestic product by 2065, while the tax burden will jump.

Bank of Israel Governor Amir Yaron also said that to maintain fiscal discipline, the plan to boost annual defence spending must be met with cuts to civilian spending – although doing so also has an economist cost.

“It is important that if there is an additional increase in that budget, beyond what was already decided, it should be accompanied by fiscal adjustments that will at least prevent an enduring increase in the public debt to GDP ratio,” Yaron said in a letter to cabinet ministers and parliament members.

Lawmakers this month approved an amended 2024 state budget that added tens of billions of shekels to fund the war, while Israel intends to add some 20 billion shekels ($5.4 billion) of spending towards defence a year going forward.

($1 = 3.6831 shekels)