On Friday, International credit rating agency Moody’s announced a double downgrade of Israel’s sovereign rating to Baa1, and appended a negative outlook, meaning that the rating is liable to be downgraded further within the next eighteen months to two years.
Apart from the change itself, which puts Israel on a par with much less successful economies, the downgrade has significant implications.
The Israeli capital market may have appeared to ignore previous rating downgrades, and equities indices even reached new peaks on Thursday, but it doesn’t really shake them off so easily. The downgrade announcement will find expression in a host of elements that in the end affect the lives of all of us. Israel’s national debt becomes more expensive, taxes will have to rise to finance that, inflation will probably fall more slowly, and the bond market is also likely to respond, harming everyone’s pension savings.
The immediate significance of the downgrade is that the ability of the Israeli government to repay its debts is considered lower. That means that new debt will be more expensive to raise, i.e., lenders will demand higher interest rates to compensate for the higher risk. In that respect, however, the effect of the downgrade announcement will be limited, since Israel’s risk premium, as expressed in the spread between interest rates on Israel government bond and US ten-year Treasury bonds already represents a rating more like BBB.
Chen Herzog, chief economist at BDO Consulting Israel, explains that the rating downgrade creates a domino effect. "Interest rates on government debt rise because of the low rating, further swelling the fiscal deficit. Higher government spending on servicing its debt makes it necessary to raise taxes and cut other spending, worsening the economic slowdown."
The burden on the public will grow
In addition, because of the harm to the economy, the Israeli public’s savings are also likely to be harmed. The lower rating is liable to affect adversely the performance of pension funds and advanced training funds. Herzog stresses that the consequences of the rating downgrade will reach the public’s pocket because of "higher taxes, higher prices, erosion of wages, and also harm to savings and pensions because of the effect of an economic slowdown and higher interest rates on the markets."
Herzog explains that interest rates on corporate debt will also rise, because of the perceived higher risk, which will lead to price rises and a higher rate of inflation. Inflation, currently running at an annual rate of 3.6%, is not expected to moderate significantly until the second quarter of next year.
Will the banks be harmed?
In the downgrades of Israel’s sovereign ratings this year, some of the rating agencies also downgraded the ratings of Israel’s banks. The reason for that is that the banks are considered entities that the state will support in a crisis, and when the state’s rating falls, then, theoretically, so does its ability to support the banks. Following its previous downgrade of Israel’s rating, Moody’s also downgraded the five major banks in Israel: Leumi, Hapoalim, Mizrahi Tefahot, Discount, and First International.
Harel Gilon, joint CEO of Oppenheimer & Co. Inc. Israel, told "Globes" that he thought that the downgrade would have an immediate effect on the financial markets.
"The banks are in effect a derivative of the state, and we will now see their costs of raising debt rising accordingly," he said, although he hedged that by saying, "Examination of the banks shows that the vast majority of their profits come from the Israeli economy, and so if there is no change in the local economy I see no dramatic change in their profits as a result of the downgrade."
The main indices on the Tel Aviv Stock Exchange have actually risen strongly this morning. The Tel Aviv 35 Index is currently up 1.55%, at 2,128.16 points.
Published by Globes, Israel business news - en.globes.co.il - on September 29, 2024.
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