JERUSALEM (Reuters) -Israel's government said on Sunday it would sell the financially strapped postal service to an investment group led by municipal service provider Milgam and Phoenix Insurance for 461 million shekels ($124 million).

The group of buyers, which also include sweets manufacturer and distributor Leiman Schlussel, will take on 900 million shekels in debt and have an option to lay off another 500 workers, the government said.

"We fully believe in the state of Israel, in the strength of the economy and the country's future to emerge stronger from any crisis. The Israel Post Company is a cornerstone in Israel's economic history," the Milgam-Phoenix-Leiman Schlussel group said in a statement.

Israel Post CEO David Laron said the sale agreement "is a demonstration of strength for the Israeli economy during a war (with Palestinian Islamist group Hamas)."

To complete the privatisation, various regulatory approvals are still needed, the Government Companies Authority (GCA) and Communications Ministry said.

"We will work so that the privatisation is completed as soon as possible, in order to open the market to real competition," said Communications Minister Shlomo Karhi.

"I believe in a free and competitive market. I am sure that the winner will bring with him a new management, a new approach and above all a faster and better quality service for the benefit of Israeli citizens."

Last July, the government put the postal service up for sale after scrapping in 2022 a plan to sell 40% of the postal service in a Tel Aviv share offering, with the remaining 60% slated to be sold to a strategic investor.

Karhi said on Sunday that the ministry would monitor compliance with the postal company's license so that consumers are not adversely affected.

Israeli media reported that in 2021, Israel Post was valued at 1 billion shekels.

Israel Post has been in a financial crisis a number of times since 2006, severely affecting the service to the public. The state began the privatisation process in 2018 in the hopes of saving hundreds of millions of shekels a year.

Over the past two years, Israel Post underwent a recovery plan of reducing payroll expenses, moving to digital services, closing branches while opening hundreds of delivery centres and transferring a significant portion of its assets to the state.

"This is a step of great importance for the postal services in Israel ... which under a private investor will be able to renew itself and prosper," Yuval Yaakobi, deputy director of the GCA, said on Sunday.

($1 = 3.7047 shekels)

(Reporting by Steven Scheer; Editing by Susan Fenton)

By Steven Scheer