After repeated warnings and due to the effects of the ongoing war in Gaza, international credit rating agency Moody's lowered Israel's credit rating from A1 to A2 on Friday. The agency has also downgraded Israel's outlook from stable to negative and sees a possible further downgrade in the future.
Considering this is the first time that Moody's has ever cut Israel's credit rating, what are the implications of this move on the Jewish state's economy?
The rating downgrade—the first ever since Israel has been assessed by credit ratings since 1998—is expected to increase the interest rates on loans that the country must take due to the ongoing war on the southern front and hostilities on the northern front. Additionally, interest rates for Israeli companies and households are also expected to go up.
Markets have effectively been responding to Israel as though the downgrade had already occurred due to awareness of war risks and pre-existing political and social instability from judicial reform upheaval. Consequently, many central organizations have preemptively increased loan interest rates to Israel.
So why should the current decision worry us?
Although the rating now aligns with market treatment, Israeli officials worry this will cement Israel's position at the lower rating for much longer. Moody's bleak assessment suggests raising the rating again will be challenging, with the new rating likely to stick long after the ongoing war is over.
The primary concern with downgrading Israel's credit rating is the potential for further reductions. The agency warned that the rating could drop further if it perceives the situation in the north as escalating and deems the government's response inadequate.
Another worry stemming from the downgrade is the possibility that the other two major rating agencies, S&P and FitchRatings, might also lower Israel's credit rating soon, especially since they placed Israel under "Rating Watch Negative" at the war's onset.
Will the downgrade affect prices in Israel?
The downgrade could cause a temporary drop in share prices on the Tel Aviv Stock Exchange and devalue the shekel against foreign currencies in the near future. This may result in higher import costs, including for raw materials, warranting price hikes. For instance, a few percent drop in the shekel's value might lead to a third fuel price hike in three weeks.
What were the reasons behind Moody's decision?
The agency's economists believe the ongoing conflict with Hamas will greatly increase political instability in Israel, undermine the Knesset and government, and severely impact the state's budgetary stability.
Moody's highlighted the absence of a post-war plan for Gaza as a troubling sign, pointing out that while hostilities in Gaza might diminish or cease, there's no current deal or long-term strategy to enhance Israel's security. Although countries like the U.S. have proposed outlines to bolster Israel's security on the day after the war, the realization of these plans remains uncertain.
Moody's cautioned that an escalation with Hezbollah in Lebanon could worsen Israel's security situation and have a more adverse impact on the economy than initially warned. The downgrade was attributed to the weaknesses in legislative (the Knesset) and executive (the government) authorities. However, Moody's economists view the legal system and civil society positively, crediting them with preventing more severe damage to Israel at this time.
Moody's reference to the internal situation in Israel
The downgrade also considers social risks in Israel that could weaken state institutions, particularly the government and the Knesset. The assessment acknowledges the robust track record and recent signs of strength in civil society and the judicial system, highlighting their role in providing effective checks and balances.
Moody's specifically commends the Supreme Court for thwarting government efforts to curtail judicial oversight, thereby underscoring the judicial system's strength and independence. The agency also offers special praise to civil organizations for their activity since the war began.
What else did Moody's point out favorably?
Despite concerns in Israel about the government's handling of the state budget, Moody's commended the government's tax increase, noting it as an improvement over previous administrations. The report suggests that if fiscal measures are fully implemented, they could balance out rising security costs and higher interest rates.
However, Moody's cautions against risks from long-term demographic shifts and their effect on the labor market, particularly highlighting populations that do not contribute to economic growth.
How likely is another downgrade?
Moody's went beyond just lowering Israel's rating, adding a "negative" outlook, indicating the possibility of a further downgrade. The forecast suggests that Israel's security, geopolitical and economic situation could worsen in the coming weeks, either from the ongoing Gaza war or the opening of a new front in the north, which could justify an additional downgrade.
Currently, Moody's does not foresee changing its rating or outlook for Israel unless the government formulates and implements policies for economic and fiscal recovery amid the war's security repercussions. There are predictions of a further rating drop if the situation in the north worsens, complicating Israel's economic recovery efforts.
PM: decision due to war, not Israel's economy
This claim is entirely unfounded. While Israel's economic downturn is largely attributed to the war, the government's inadequate measures to curb the massive deficit and its undermining of the judicial system are also to blame. Moody's report highlights that the Supreme Court was instrumental in averting significant damage by the government at the eleventh hour.
Prime Minister Benjamin Netanyahu's assertion that the rating will rebound post-victory is contradicted by Moody's forecast, suggesting the war's repercussions on institutions may persist long after the war ends.
What does the credit rating mean?
A credit rating assesses the ability of countries, companies and individuals worldwide to repay loans. It reflects the financial strength and stability of the entity, considering its financial history, timely debt repayments and asset ownership and condition.
These factors collectively determine the risk associated with a state, company or individual's ability to repay future loans. A lower credit rating results in higher loan interest rates and financial burden for the borrower, which, in this context, directly affects the citizens of the State of Israel.
What was Israel's situation over the years?
Since receiving its first credit rating just before the turn of the century, Israel's rating had consistently improved and never declined until now. Throughout its 75-year history, the State of Israel has always met its loan repayment obligations on time and adhered to the terms established when the loans were granted.
Israel's robust economic performance over the past two decades led to a significant improvement in its credit rating, positioning it among the world's highest. Consequently, the country's Finance Ministry accountants-general managed to secure loans with favorable terms and low interest rates during the early 2000s crises and the COVID-19 pandemic.
Who are the agencies that determine Israel's ranking?
Three esteemed international firms—S&P, Moody's, and FitchRatings—recognized for their credibility in finance, previously commended the Israeli government and the Bank of Israel's management during and after the COVID crisis for the rapid economic recovery.
Before the judicial overhaul controversy and ensuing protests, these agencies were considering upgrading Israel's rating. In April 2022, Moody's adjusted Israel's outlook to "positive" due to its successful emergence from COVID. However, by April 2023, Moody's revised the outlook to "stable," reflecting concerns over potential political and social instability from the judicial changes and related protests. The outlook has since been downgraded to "negative."