Fitch has downgraded Israel’s credit rating to A from A+, with a negative outlook. In other words, the international credit ratings agency thinks there is a high likelihood of an additional rating cut soon. Fitch’s rating cut for Israel follows a similar move by the two other major international credit ratings agencies - Moody’s and S&P - in the first half of 2024. The main reasons for the cut were the continuing war, geopolitical risks and the consequent fiscal results.
The numbers behind the decision
Fitch cited the expected fiscal deficit and debt-to-GDP ratio as behind the decision. The agency believes that the fiscal deficit will amount to 7.8% at the end of 2024, above the Ministry of Finance and Bank of Israel’s estimate of 6.6%.
Fitch’s analysts wrote, We project Israel's central government budget deficit to reach 7.8% of GDP in 2024 after 4.1% in 2023. This reflects large outlays related to military operations, the mitigation of economic damage and relocation expenses for those in the north of the country." This is a slightly more optimistic forecast than S&P, which sees a fiscal deficit of 8.5%.
Fitch added, "We project a budget deficit of 4.6% of GDP in 2025 on lower military spending and revenue growth, although it could be wider if the war continues in 2025. Moreover, we expect the government will permanently increase military spending by close to 1.5% of GDP versus pre-war levels. Israel is likely to maintain a stronger presence along its borders than in the past, plans to widen mandatory draft and to increase domestic military production, which would also add to spending."
Regarding debt-to-GDP ratio Fitch provides a negative forecast. Previously Israel has enjoyed a particularly low debt-to-GDP ratio, which was 60.5% in 2022. According to Fitch’s report, Israel’s debt-to-GDP ratio will rise to 70% in 2024 and 72% in 2025 - higher than the 71% during the Covid pandemic in 2020. The agency points out that such a level is higher than the forecast 'A' peer median of 55% for 2025.
The conditions beyond the numbers
Of the three big international ratings agencies, Fitch is considered the least critical of Israel. A market source says that Fitch’s analyst covering Israel "is very focused on the state's ability to repay debt and gives less weight to events such as the struggle over the judicial reform, in contrast to Moody's. At Fitch, they did not like it, but they only considered debt parameters and the state's ability to service it."
In addition, estimates in the local market had increased in recent days that this step was approaching due to several indications received from Fitch, certainly with the threats of an attack by Iran and Hezbollah in the background and the fear of a regional war.
If there is one fact that has the most impact of all, it is Fitch's assessment that the war is not likely to end soon, but to grind on into 2025 - this is contrary to its previous assessments. As a result, the debt-to-GDP ratio will remain at levels of more than 70% in the medium term. This ratio compares the country's national debt to its GDP and expresses its ability to pay its debts. As far as the rating agencies are concerned, this is a key parameter that provides a clear picture of economic stability over time and the risk involved in investing in it. Put simply, if in the past Israel was praised for its low debt-to-GDP ratio, it has now been warned.
The market has had its say
Despite Israel's rating cuts by all three major rating agencies, it is still on par with A-rated countries - a level that indicates a relatively low credit risk and a strong ability to meet its obligations. However, in terms of the markets, the situation is much less good. The spread between Israel's 10-year dollar bonds and the US bonds is 1.8%. That is, interest on Israel’s debt is much higher and is priced like countries rated at the BBB minus level. For comparison, Israel's debt raising costs in dollars are higher than countries like Peru, Mexico and Hungary, and is approaching those of Romania (1.9%).
This situation has existed for months, and it is possible that this puts pressure on the rating agencies to take action. The gap between the market’s estimates and the rating agencies’ estimates is 5-6 levels and causes them to examine the rating they give. The market is often ahead of the agencies and dictates the pace.
The influence of the markets and the big concern
Fitch’s rating decision won’t shake up the markets and there was negligible volatility in shekel-dollar trading this morning. The markets have been pricing in a rating downgrade for a long while and Fitch has simply fallen into line with the other ratings agencies. However, a senior market source told "Globes" that Israel has now reached a red line and that any further downgrading would have a much more significant impact.
What will the other ratings agencies do?
Following Fitch’s decision, Israel must wait and see how the other ratings agencies react. All eyes are on S&P where Israel has a relatively higher rating out of the three agencies. Only two weeks ago S&P issued an exceptional announcement about the situation in Israel and indicated that a security escalation on the northern border would probably lead to a rating downgrade.
In addition, "Globes" has learned that representatives of Moody’s will be holding talks in the coming weeks with a range of institutions in Israel ahead of a re-examination of the rating.
Concerns that the politicians will interfere
Fitch praised the planned VAT hike from 17% to 18% from January 1, 2025, an mentioned the fact that additional measures are being discussed that could lead to an increase in revenues and cut in spending. However, the agency warns, "Political fractiousness, coalition politics and military imperatives could hinder consolidation plans and present a risk to our forecast."
In addition to the six points mentioned above, there are two other points worth mentioning in Fitch's report. The first - the agency stated rather vaguely, "World Bank Governance Indicators are likely to deteriorate, weighing on Israel's credit profile," but did not elaborate. At Fitch, unlike other rating agencies, they prefer to keep a distance from internal events in Israel and prefer to look at the macro data. This sentence may express to a certain extent concern about governance processes in Israel.
Fitch also describes Israel as a strong borrower despite the geopolitical upheavals. Among reasons for this, the agency cites the current account surplus and the high foreign exchange reserves of the Bank of Israel (over $200 billion). But Israel's ability to finance the deficit, which is also still relatively good, has greatly been eroded. The interest payments that the state is currently required to pay are high, and at this point it is possible that the rating agency believes Israel will take the difficult and necessary steps to continue to have a strong financial capacity to repay its debts. For this to happen, the 2025 state budget must be passed and include some painful measures.
Published by Globes, Israel business news - en.globes.co.il - on August 13, 2024.
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