Rating downgrade was preventable

Minister of Finance Bezalel Smotrich credit: Noam Moskovitch Knesset Spokesperson
Minister of Finance Bezalel Smotrich credit: Noam Moskovitch Knesset Spokesperson

Minister of Finance Bezalel Smotrich treats Israel's declining credit rating as a decree of fate, ignoring his government's failure to take necessary steps.

Minister of Finance Bezalel Smotrich received the news of the downgrade of Israel’s credit rating by Fitch with equanimity. "The rating downgrade because of the war and the geopolitical risks that it creates is natural," Smotrich responded, in an attempt to portray the downgrade as an unavoidable decree of fate. It is hard to find even a single professional in the Ministry of Finance who agrees with the minister’s assessment. In Smotrich’s ministry, officials believe that the blow could have been averted despite the war, and that it is still possible to prevent future downgrades, if the government takes responsible economic steps.

It’s true that Israsel is in the midst of a long and expensive war, which it is estimated will cost about NIS 250 billion, on an optimistic scenario, by the end of 2024. But Fitch knew that in April, when it chose not to cut the country’s credit rating. The "hump" of the one-time costs of the war is a fact that the rating agencies are prepared to accept. This, as Fitch states in its announcement, is thanks to strong metrics such as the current account surplus and high foreign currency reserves. "Israel's external balance sheet remains stronger than peers' despite the shocks," the agency states. It’s harder for its analysts to come to terms with the prolonged uncertainty over the ways in which the government plans to finance the expected future rise in defense costs.

Budget delay

Instead of broadcasting economic certainty to investors, the government is delaying discussion on the 2025 budget, and even the Ministry of Finance does not know whether next year will open with a duly approved budget. Instead of conducting an in-depth discussion of the defense budget and examining in advance how the economy can bear it, the government has delayed for half a year the convening of the special public committee on the defense budget, and has not left it time to deal with the demands of the IDF for tens of billions of shekels in additional funding for next year. Instead of advancing austerity measures that will halt the rapid worsening of the debt to GDP ratio and restore it to a declining trend in future years, the government is actually talking about easing the tax burden, such as by cancelling the planned rise in the rate of VAT to 18%, after it has been approved by the Knesset and sold to the rating agencies as evidence of the government’s fiscal responsibility.

Fitch gave Israel several opportunities to save its rating, more than rival agencies S&P and Moody’s were prepared to give. At the beginning of the war, it put Israel on "negative watch". About six months later, it took the fairly soft step of cutting Israel’s rating outlook, and only this week did it cut the rating itself. The agency waited a long time to see how the military campaign would develop and how the government would deal with the structural increase in the fiscal deficit. Prime Minister Benjamin Netanyahu and Minster of Finance Bezalel Smotrich had time to try to clear the economic fog. But that would have required them to face the public and announce a series of austerity measures and tax hikes to deal with the costs of the fighting. In the current explosive political situation in Israel, the politicians’ default is procrastination.

"Fractious politics"

"Domestic Politics Remains Fractious" is the heading Fitch gives to its discussion of the political situation in Israel. "The emergency government was dissolved in June 2024 and the original coalition returned to power. It could remain until the next elections in October 2026, although coalitions rarely last a full term and this one will face pressure for early elections, given the events of October 2023 and controversy over the conscription of ultra-orthodox Jews," its announcement says. How will that affect the economy and the rating? "Political fractiousness, coalition politics and military imperatives could hinder consolidation plans and present a risk to our forecast," Fitch explains.

Unlike the politicians, the professionals in the Ministry of Finance believe that presenting certainty about Israel’s economic path is more important than prolonged wrangling over sub-clauses in the consolidation proposals. The Ministry of Finance wants to introduce taxation solutions that can be carried out through simple procedures, such as freezing the income tax brackets, something that can be done by an order only, without further legislation.

As "Globes" has reported, the Ministry of Finance is formulating a back-up plan for the eventuality that the government fails to pass the state budget, which mainly consists of freezing various benefits and raising income tax for people on low wages. That could be the lesser evil, but future rating downgrades probably cannot be prevented without an orderly budget and deep reforms. All three international rating agencies have negative outlooks for Israel, which means that they are on course for further downgrades. This is the time to signal to the markets that someone is at the helm of the Israeli economy.

The Prime Minister’s Bureau stated in response: "The Israeli economy is robust and is functioning well. The rating downgrade is a result of the fact that Israel is coping with a multi-front war that was forced upon us."

Published by Globes, Israel business news - en.globes.co.il - on August 13, 2024.

© Copyright of Globes Publisher Itonut (1983) Ltd., 2024.

Minister of Finance Bezalel Smotrich credit: Noam Moskovitch Knesset Spokesperson
Minister of Finance Bezalel Smotrich credit: Noam Moskovitch Knesset Spokesperson
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