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The international credit rating company S&P published today (Monday) a report relating to Israel’s credit rating following the ‘Iron Swords’ war, this following the rating notice dated October 25, 2023 in which the company announced the reconfirmation of the credit rating of the State of Israel at the level of AA- Along with changing the rating forecast from “stable” to “negative”.
According to the company, Israel is facing significant geopolitical and security risks, where the scenario of the escalation of the war to other regions remains possible, although it is not a central scenario in its forecasts. The company notes that in the past there were several conflicts between Israel and Hamas in Gaza, but the current war is on a significantly wider scale. According to the company’s base scenario, the Israel-Hamas war will remain focused on Gaza, but the more the conflict expands to other countries in the region, the wider the impact will be on Israel’s economy and its security situation.
In the company’s estimation, the current war has effects on Israel’s economy. The company predicts that Israel’s growth will be 1.5% in 2023 and 0.5% in 2024. The company’s annual forecasts show a sharp contraction of 5% in GDP in the fourth quarter of 2023, compared to the third quarter, when all expenditure components are reduced, including local demand, Export and import. The contraction will be due to a decrease in business activity, a decrease in consumer demand and a very uncertain investment environment.
According to the company, the forecast decline in GDP in the fourth quarter of 2023 as described above will be slightly more than half of the decline experienced by the Israeli economy in the second quarter of 2020, with the outbreak of the Corona epidemic, when mobility was limited, businesses were closed and the tourism sector was shut down. Also, the company states that the economic impact of the current war is expected to be more significant than the effects of previous military conflicts, including ‘Tzuk Eitan’ in 2014, ‘Pillar Cloud’ in 2012, ‘Cast Lead’ in 2008-2009 and the ‘Lebanon War’ the second’ in 2006.
After that, the company expects a gradual economic recovery so that by the end of 2024 the economy will return to its pre-war level. Also, the company anticipates accelerated growth that will reach 5% in 2025, together with the return of consumer confidence, and fuller investment cycles.
The company expects an average budget deficit of 5.3% of GDP in 2023 and 2024, compared to 2.3% in its previous pre-war forecast. Although war expenditures are expected to decrease again, the company expects that defense expenditures will remain relatively high in the medium term.
The company states that the structure of the Israeli economy, centered on the export of high-tech services, as well as moderate levels of public debt and current account surpluses, partially reduce the economic risks inherent in the current war. In her estimation, the high-tech sector in Israel supports the country’s balance of payments and a high percentage of its employees can work remotely. Also, according to the company’s assessment, the moderate level of Israel’s government debt, mostly denominated in local currency, will reach a peak of about 67% of GDP in 2024, and then decrease to 64% in 2026. The Bank of Israel’s foreign exchange balances remain high As of the end of October 2023, while relatively low inflation compared to the reference countries provides margin for monetary policy easing, if necessary.
According to the company, the negative forecast in the credit rating reflects the risk that the Israel-Hamas war could spread more widely or affect Israel’s credit indices in a more negative way than the company currently expects. Currently, the company expects that the conflict will remain centered in Gaza and will not last more than three to six months.
The company states that it may lower Israel’s rating if the conflict expands substantially, increasing the security and geopolitical risks Israel faces. Also, a rating downgrade is possible in the next 12 to 24 months if the impact of the conflict on Israel’s economic growth, fiscal situation and balance of payments turns out to be more significant than the company currently expects.
The company also states that it may change the forecast from ‘negative’ to ‘stable’ if the conflict is resolved, while reducing regional and internal security risks without a significant long-term burden on Israel’s economy and public finances.
Despite the company’s assessment that the military conflict will not expand beyond Gaza, it foresees damage to Israel’s economic performance, as follows:
• Reducing the workforce and additional costs to the government after over 300,000 reservists (representing 3% of Israel’s population) were recruited.
• Continued shut down of gas production at the Tamar gas field due to its proximity to Gaza.
• Negative impact on the Israeli tourism industry following the security situation and the shutdown of air traffic lines.
• Effects on the real estate sector, where a significant portion of the workers used to be of Palestinian origin from Gaza and the West Bank. The border crossings are closed and this has implications for existing projects.
• Indirect effects resulting from the expectation of a reduction in local investment and the flow of foreign direct investments. The company anticipates the avoidance of investments by local and foreign companies during the period characterized by high uncertainty, especially in light of the high interest rates and weak economic performance in Europe – a major trading partner of Israel.
The company predicts that Israel’s budget deficit will increase in 2023-2024 due to government spending to support households and businesses, as well as an increase in defense spending and loss of tax revenue. The company states that it is difficult to estimate the extent of these effects on the state budget, but even before the war, central government revenues decreased by 5% year-on-year in the first nine months of 2023, with some of the government revenues related to strong performances in the stock market and the real estate market. during 2021-2022 was reduced.
The company expects an average deficit of 5.3% of GDP in 2023 and 2024, compared to 2.3% of GDP in the pre-war forecast. Also, the company predicts that the general government’s deficit will decrease towards 2% of GDP by 2026, when direct spending for the war and support measures will be stopped when the economy recovers. However, the company anticipates that there will be long-term effects on government spending, in which Israel’s defense spending, which has been on a prolonged downward trend and was reduced to 4% of GDP in 2022 compared to about 8% of GDP in 2000, is expected to increase.
The company states that in its opinion Israel has a number of cushions that should help it mitigate the immediate fiscal impact of the war. The company notes in particular the government debt-to-GDP ratio, which is moderate and estimated at a rate of about 60% of GDP as of the end of 2022, not much different from a rate of 59% at the end of 2019. Therefore, Israel has the fiscal flexibility to contain the budgetary changes in the near term. The company’s current forecast is that the ratio of government debt to GDP will reach its peak in 2024 and stand at about 64% of GDP, after which it will return to a gradual decline. Also, the company states that the government debt is mostly denominated in local currency and is mostly held by local investors, meaning it is less exposed to changes in the investment portfolios of foreign investors.
The company sees Israel’s balance of payments as a key strength for the credit rating. The country has had a current account surplus for the past 20 years, supported mainly by the rapid expansion of exports of high value-added information and communication services. The rate of surplus averaged 5% of GDP in recent years, and these led to foreign asset balances at a rate of about 30% of GDP – among the highest among countries that do not export goods, and reduced its external financing needs. According to the company, in 2023, the current account surplus is expected to expand further, reaching 4.7% of GDP, against a background of stronger performance in the export of goods and services during most of the year.
The company states that although the field of foreign tourism was significantly affected by the war, it only accounts for 5% of revenues while outbound tourism will also decrease significantly. Weak domestic demand is supposed to have a reducing effect on imports and therefore the company does not expect Israel’s current account surplus to decrease as a result of the war, at least for now.
The company notes that Israel enjoys strong access to the local and international capital market, which supports the government’s efforts to diversify its funding base and extend the average debt repayment date. The company notes that although the government traditionally turns to financing through its deep local capital markets, in the past international bond issues were carried out for different maturity dates over 30-100 years. Also, in cases of financing difficulties, the Israeli government has the option of realizing the remaining part of the long-standing US guarantee program.
The company notes the flexibility in Israel’s monetary policy as a strengthening element in the credit profile. According to the company, the Bank of Israel is a highly reliable institution, with a reputation for operational independence and a variety of financial instruments, which benefits from a deep local capital market and a deep local currency market. Throughout the general crisis of the Corona epidemic, the bank used a variety of tools to mitigate the effects on the Israeli economy, including interest rate reductions, quantitative easing and low-interest loans to banks. The foreign exchange balances of the Bank of Israel remain high and stable in the amount of 191 billion dollars (36% of the GDP of 2022) as of the end of October 2023, and they cover the external debt of the entire economy 1.4 times. The company also notes the Central Bank’s announcement of a $30 billion intervention strategy in order to moderate the excess volatility of the exchange rate, as well as additional steps to ease credit for certain customers affected by the war through the commercial banks.
In addition, the company notes that the inflation rate in Israel is lower than that of many reference countries, including the USA and the UK. The company predicts that inflation will continue its downward trend and reach a rate of 2% by 2025, compared to 4% in 2023. In the company’s estimation, this provides the Bank of Israel with a certain maneuverability if it becomes necessary to lower interest rates in the economy due to a more significant economic impact of the war.
In conclusion, the main points of the report:
According to the company, GDP in the fourth quarter of 2023 is expected to shrink by 5% due to the war with Hamas.
Also, the company predicts that Israel’s growth will be 1.5% in 2023 and 0.5% in 2024, due to the effects of the war on the economy.
According to the company, the war will remain focused on Gaza and will not expand to other areas. At the same time, there is a risk of the conflict expanding to other countries in the region, which could lead to a wider impact on Israel’s economy and its security situation.
The company expects an average deficit of 5.3% of GDP in 2023 and 2024, compared to 2.3% of GDP in the pre-war forecast. The company also states that in its opinion Israel has a number of cushions that should help it mitigate the immediate fiscal impact of the war.
The company notes in particular the ratio of government debt to GDP, which is moderate and estimated at about 60% of GDP as of the end of 2022, and will allow the State of Israel fiscal flexibility to accommodate the budgetary changes in the near term. The company emphasizes that the government debt is mostly denominated in local currency and is mostly held by local investors, meaning it is less exposed to changes in the investment portfolios of foreign investors.
The company emphasized that it considers Israel’s balance of payments as well as the flexibility of Israel’s monetary policy as a key strength for the credit rating.
