Standard & Poor's associate director for sovereign ratings Dr. Elliot Hentov has no plans to upgrade Israel's credit rating anytime soon. In an interview with "Globes" ahead of the 2013 Israel Business Conference, where he will participate in the session on the Middle East, he is optimistic and explains why he does not foresee financial collapse because of developments in Israel's real estate market.
Nonetheless, Hentov warns that the market conditions have affected the Bank of Israel's flexibility, and that the agreement with Iran is liable to increase the region's geopolitical risk. He adds that the effect of natural gas on Israel's credit rating largely depends on the amount of exports from Leviathan.
"Globes": The government has collected tax windfalls of NIS 4.3 billion from the release of trapped profits and NIS 3.3 billion from the sale of companies. Will this affect Israel's credit rating?
Hentov: "This is excellent news, which joins good news in the first half of the year, when several transactions were made that increased tax revenues. But it is important to remember that these are windfalls, and not something permanent. The structural deficit is unchanged. What is certain is that these events improve fiscal flexibility. You can use this money or cut taxes, or increase expenditures, or pay debt - but we do not make policy recommendations. That's not our job.
"As for the credit rating, this has no far-reaching consequences, since it is rare for a windfall, which is not repeated, to affect the credit rating. We look three years ahead. We're talking about a nice, but not huge, amount of money, and it will not change the A+ rating and "Stable" outlook. By the way, alongside the revenues news, there is less good news on the spending side, because of the postponement in the defense budget cut. So things more or less balance out. In general, the size of the deficit and debt for the next two years are more or less as we forecast."
Are there changes in Israel's geopolitical risk?
"We're very closely monitoring the Iranian story and the negotiations with it for several reasons, especially because of the price of oil, which affects the markets so strongly."
It can be said that Hentov's perspective on the issue (which was made before Sunday's agreement limiting Iran's nuclear program) is very close to Prime Minister Benjamin Netanyahu's perspective. "A real and comprehensive agreement will bring Iran back into the oil and gas market, open the Iranian market to foreign investment, and reduce the risk of a military collision," says Hentov. "However, a limited and temporary agreement like the one that the parties tried to reach earlier this month, will increase the risk because it will ease sanctions, which will harm Israel's position in such a way that will narrow the maneuvering room of Israel's leaders. This will increase the risk of war, but it will not change the rating."
Let's talk about economic risks, such as the real estate bubble.
"We invest a lot of time and resources in monitoring the real estate market. We know from our experience that real estate problems can weigh on government bonds, because we've seen governments forced to bear the burden of such a crisis."
Hentov, who lives and works in London, declines to call the situation in the Israeli market a "bubble", preferring to use the phrase "problematic situation". He says, "The Israeli market has features related to supply and demand which reduce the risk that we'll see a sudden plunge in prices and an inability of households to repay, causing the collapse of the financial system, which is the classic story of a housing bubble. We saw a similar situation in Ireland, for example. Such a situation is almost utterly unlikely. This is not the case in Israel because the leverage is reasonable; not low, but reasonable.
"Housing prices have risen, in part, as a correction to a very long period of stagnation. This is also not the classic case of investors seeking huge loans, buying homes, and trying to immediately throw them on to the market. I do not see a situation in which homeowners will reach a situation in which prices collapse and it will not be worthwhile for them to service the debt. That is quite unlikely."
So everything is OK?
"No. We're already seeing the first casualty from the situation in the real estate market: the Bank of Israel's monetary policy. During 2013, we saw the weakening of the monetary policy's credibility. The weakening has not been strong enough to downgrade the rating, but we always used to think that the Bank of Israel had very strong flexibility in monetary policy - and this has changed. Under the current circumstances, the Bank of Israel has two conflicting or competing goals: price stability, in the context of rising home prices; and a competing goal - to protect the export sector, which is suffering from the appreciation of the shekel. In theory, one objective requires raising the interest rate, and the other requires lowering it. So it's clear that, in practice, the Bank of Israel is using other tools, but we still believe that its flexibility has weakened."
Why is the shekel appreciating? Are speculators responsible?
"The Israeli economy is very competitive, so there is a lot of foreign money seeking to buy Israeli companies or make foreign direct investment on quite a large scale. This is not speculators' money, and we're not talking about investors buying Israeli bonds to sell them later at a slightly higher yield compared with the yield on the dollar. This is simply the strengthening of the shekel."
Will the natural gas result in another upgrade?
"There are too many open questions about the gas market, and the answer to your question largely depends on the amount of gas exports. It's known that the government has already decided on the amount of gas exports, but we don’t know for certain how this will look, what the future price of the gas will be, or how the sovereign wealth fund will work and function. This is a fund that is supposed to rein in the shekel's appreciation. What is clear is that the gas discoveries are positive for the rating, because they give the economy another safety cushion."
So we won't see a rating upgrade soon?
"In the present global environment, other economies have to struggle with far more serious problems that the ones facing the Israeli economy. Moreover, Israel's credit rating in the past six years has been upgrade twice, compared with almost every other country, which has seen one or more downgrades, including Mediterranean countries," says Hentov, laughing.
"As for the credit rating, before the crisis, Israel was ranked in eight place among Mediterranean Basin countries; today it's in second place. You're right at the top of the rankings, which is a new global context. Israel is quite good. It would be great if Europe had your growth rate."
Published by Globes [online], Israel business news - www.globes-online.com - on November 27, 2013
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