Fitch could raise Israel's rating if reforms halted

Benjamin Netanyahu and Bezalel Smotrrich credit: Alex Kolomysky Yediot Ahronot

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Fitch writes, "The advancement of certain policies favored by the governing coalition could aggravate strains and influence the sovereign rating."

International credit ratings agency Fitch has published its latest survey of Israel for investors. Under the headline, "Strong Economic Growth Key to Israel's Debt Trajectory," the agency's analysts believe that Israel's debt/GDP ratios will continue to fall in the coming years despite the return to fiscal deficits and due to relatively strong growth. Fitch says that this trend "could lead to positive rating action in combination with other factors such as stable governance indicators." It is a while since the ratings agencies have used the word 'positive' when talking about Israel.

But after the complements on Israel's economic strength, Fitch expresses reservations about raising the rating and makes it clear it is dependent on halting the government's judicial overhaul. Fitch writes, "Israel continues to face high levels of internal social and political tension, and the advancement of certain policies favored by the governing coalition could aggravate these strains and influence the sovereign rating."

Fitch adds, "Prime Minister Benjamin Netanyahu said after the budget’s passage that judicial reform will return, but the coalition’s exact proposals remain unclear."

Fitch meanwhile is giving a change to the compromise talks held by President Isaac Herzog but repeats its warning from last March that the repercussions of a failure to reach broad consensus will result in chaos if the legislation moves forward unilaterally. Fitch writes, "Judicial reform has the potential to have a negative impact on Israel's credit profile if it weakens governance indicators, or if the weakening of institutional checks leads to worse policy outcomes or sustained negative investor sentiment."

London-based Fitch also mentioned the state budget passed last week, which included large additions for the haredi parties. Fitch writes, "The 2023-2024 budget, which was approved on 24 May, projects a relatively large rise in spending, averaging 5.7% a year. This partly reflects the impact of high inflation in 2022 and 1Q23, which contributed to the government agreeing in March 2023 to an 11% wage rise for public-sector workers over the next four years. It also encompasses several new expenditure commitments designed to address the policy priorities of member parties within the governing coalition."

Alongside increased government expenditure, Fitch also expects government revenues to decline by 2.3% in 2023, citing the housing market and weak performance on the capital market as factors contributing to this.

Fitch has raised its forecast for Israel's fiscal deficit from its current 1.2% to 1.5%, which is higher than the Ministry of Finance's forecast of 1.1%. But Fitch adds optimistically, "We expect deficits over the next three years to remain narrower than in 2019 before the Covid-19 pandemic."