Prime Minister Benjamin Netanyahu faces a test this month when his coalition of nationalist and religious parties seeks approval for a spending package which the government's own budget unit says will stifle growth.
Lawmakers must approve the bi-annual 2023-24 budget package by the end of May to avoid triggering an election. With 64 of parliament's 120 seats, Netanyahu's coalition appears on course to vote it through.
But economists say the spending plans could derail the government's own fiscal targets, while even the Finance Ministry says it could slow growth.
Israelis are already grappling with rising living costs, while the economy has been knocked by the government's now-suspended judicial overhaul which triggered a political crisis, drove away investment and cut growth prospects.
Three economists said the government's deficit targets of 1% of gross domestic product in 2023 and 0.8% in 2024 could double or triple in size, which could send bond yields up.
"Projections were too optimistic," Victor Bahar, Bank Hapoalim's chief economist, told Reuters.
An official in Netanyahu's office played down concerns, saying: "The prime minister along with the finance minister intend to pass a responsible budget in the coming weeks that will serve all Israelis. The budget will enhance stability and growth."
Strained by months of unprecedented street protests, Western disapproval and plummeting polls, the government has set 13.7 billion shekels ($3.8 billion) for "coalition funds", money to finance political deals with the ultra-Orthodox Jewish and pro-settler parties on which Netanyahu's coalition depends.
The funds include adding hundreds of millions of shekels to stipends and schooling for the ultra-Orthodox community, which limits study of non-religious subjects like math and English, while its men focus on scripture and live off benefits.
The ultra-Orthodox, or Haredim, are only 13% of Israel's population but they are a fast-growing sector many of whose men - around half - are jobless. Many opt not to work, while those that do seek a job are often ill-equipped for employment.
The Finance Ministry's budget division, in an unusual analysis on Thursday, said the government would reverse economic incentives to encourage Haredim into the workforce by increasing spending on religious schools, food stamps and stipends.
Those steps would impact growth in the immediate and medium term, the analysis said, and would eventually hurt the "productivity, growth and quality of life of all Israelis."
'NO CRISIS'
For Haredi leaders, scripture comes first.
"The finance clerks don't understand Haredim," ultra-Orthodox lawmaker Yizhak Pindrus told Kan radio. "There will be no Israeli society, no Jewish society if there will be no people devoting their lives to Torah study."
Finance Minister Bezalel Smotrich said the funds would fix years of injustice toward the Haredim, whose children often are packed into derelict classrooms. He said other steps would be taken to help Haredim find jobs.
"There is no crisis here," he said, pointing to a fiscal surplus so far in 2023 and a responsible budget.
But Michael Eisenberg, of Israeli venture capital firm Aleph, said the extra spending would fuel inflation, hamper growth and "cost Israel dearly, the ultra-Orthodox public too."
Government figures already forecast Israel's economic growth will ease in 2023 from 6.5% in 2022 to about 2.7% and down from the 3% forecast in January.
Credit ratings agency S&P forecasts growth of just 1.5% for 2023 and says it could slow further because of political uncertainty over the government's suspended drive to limit the role of the Supreme Court in its judicial changes.
Since returning to office in December, Netanyahu has fired his defence minister over his opposition to the judicial drive and then backtracked. He suspended the overhaul to allow for talks with the opposition and has faced a vote boycott by far-right minister Itamar Ben-Gvir.
The judicial drive has led to a drop in foreign investment and prompted some capital flight. The shekel has weakened and Moody's has lowered Israel's outlook to stable.
Judicial negotiations seeking broad agreements that would likely stave off further damage have so far been fruitless and some are concerned the budget does not properly factor in sharply slowing growth, potentially causing more damage.
"Netanyahu has sold Israel's economy and our children's future in order to stay in power," said opposition leader Yair Lapid.
($1 = 3.6280 shekels)
(Writing by Maayan Lubell; Editing by James Mackenzie and Edmund Blair)
