Fitch raises Israel's rating outlook to positive

Moshe Kahlon

Stronger external accounts and a fallingdebt-GDP ratio are the mainfactors behnd the upgrade.

Rating agency Fitch today upgraded Israel's credit rating outlook to "positive" for its foreign currency debt, while retaining its A rating. Fitch thereby restored its previous rating outlook, after downgrading Israel's outlook from positive to stable in 2014.

The step by Fitch means that Israel's credit rating is likely to be upgraded in the coming months, and could also affect the rating by the two other major credit rating agencies, Moody's and S&P, whose rating outlook for Israel is currently "stable." Fitch assigns Israel an A rating, S&P A+, and Moody's A1.

In response to the announcement, Minister of Finance Moshe Kahlon said, "This is a vote of confidence in the Israeli economy. We'll continue acting responsibly and judiciously to bolster growth and maintain stability in the Israeli economy, while taking steps to lower the cost of living and narrow social gaps."

Ministry of Finance Accountant General Michal Abadi-Boiangiu said, "The report emphasizes the great importance of responsible debt management and reducing the ratio of debt to GDP in improvement of the credit rating. In addition, the rating company praises the debt structure and management, and the government's financing flexibility, reflected in a deep and liquid local market and access to the international capital markets."

Fitch emphasizes that strengthening of Israel's external accounts continued in 2015. The surplus in the current account rose to 4.6% of GDP, and the Bank of Israel's foreign currency balances climbed to $90.6 billion (equivalent to 10.9 months of current external payments).

Israel's status as a net lender improved, reaching 43% of GDP, compared with 35.4% in 2014 and 27.4% in 2008. This is double the external ratio of other countries with an A rating, and slightly higher than the median figure for countries rated AA. The rating company expects the surplus in the current account to be maintained in 2016-2017.

Better debt-GDP ratio

In its report, Fitch writes that Israel's ratio of government debt to GDP has improved in recent years in the direction of the comparative figure for reference countries for Israel, although public financing constitutes a weak point in comparison with other A-rated countries. The ratio of government debt to GDP fell from 95.2% in 2003 to 64.9% at the end of 2015. On the other hand, this figure is higher than the 44.6% external figure for the reference countries.

The report notes that the government debt-GDP ratio fell further in 2015, thanks to a drop in the government budget deficit to 2.1% of GDP, the lowest figure since 2008, as a result of a rise in revenues. The absence of an approved budget until mid-November 2015 also played a role in this improvement. Fitch expects a larger deficit in 2016, and that the government debt-GDP ratio will remain stable in 2016-2017.

Fitch's analysts also note that Israel is benefiting from a high degree of financing flexibility. The country has a deep and liquid domestic market, good access to the international capital markets, an active program for selling bonds to Jews in the Diaspora, and a program of guarantees from the US government in case of market shocks.

Fitch saysthat the low level of foreign currency debt helps explain why its outlook for the debt in local currency was not revised, and is also positive. Fitch's predicts that if Israel's credit rating for its foreign currency debt improves, the ratings for the debt in local and foreign currency will be the same.

The report states that natural gas production from the Tamar reservoir since 2013 has eliminated the need for gas imports, and improved the external accounts. At the same time, development of the larger Leviathan reservoir is uncertain, following the Supreme Court's April 2016 ruling against the proposed gas plan. In any case, if development of Leviathan progresses as planned, Israel can become a gas exporter starting in 2020. Gas production was not projected to begin during the period of Fitch's forecast, so the delays do not affect its external and fiscal forecasts.

The analysts state that growth in Israel has slowed in recent years. Annual growth averaged 2.8% in 2012-2015, compared with 4.5% in 2004-2011. The explanation lies in a number of factors, including slow growth in the working-age population, additional costs, lower labor productivity, the slowdown in world trade, and challenges involving the degree of competitiveness. The report states that in response, the government is seeking to implement a number of structural reforms for the purpose of improving efficiency in certain markets and the general business environment and encouraging participation in the labor force.

The report takes note of Israel's negative inflation in 2015, due to low commodity prices, shekel appreciation, and measure taken to encourage competition. Fitch expects strong domestic demand, with no one-time factors, to help raise inflation to the lower end of the 1-3% target in 2017.

The analysts cite with approval Israel's well-developed educational institutions and system, which have created a developed and diversified economy. Human development and per capita GDP are significantly higher than the median for the reference countries. The business environment promotes and encourages innovation, particularly in the high-tech sector. At the same time, indicators related to "doing business" measured by the World Bank have fallen below those of the reference countries for Israel. According to Fitch, the government is also faces a number of socioeconomic challenges involving income inequality and social integration.

Fitch believes that Israel's political risks are a burden on its credit rating. The local political system is liable to be turbulent; governments usually do not last for their full term. It does not appear that the parties in the current government coalition have a motive for dismantling the government and early elections, but the coalition remains vulnerable, resting on a majority of one MK.

The report says that the next test for the government will be passing the 2017-2018 budget. Uncoordinated but frequent terrorist attacks by young Palestinians and Israeli Arabs have continued to occur with varying intensity since September 2015. Although these attacks have not escalated into a third intifada at this stage, they reflect a lack of progress in the peace process between Israel and the Palestinians. The chances for a real peace process remain poor.

Fitch's analysts expect that Israel will continue to face geopolitical risks, but its rating profile has demonstrated its immunity to periodic conflicts and political shocks over a prolonged period. The country's borders are relatively quiet at the moment, but military conflicts against terrorists and military groups in neighboring countries occur on occasion, and are liable to cause economic damage. The ongoing war in Syria constitutes a risk for Israel and other neighboring countries liable to affect Israel, although the direct consequences of this conflict for Israel have been negligible so far. Implementation of the nuclear agreement between Iran and world powers will continue to be a source of concern for Israel.

In conclusion, Fitch believes that the continual strengthening of the external accounts; improvement in the business environment, which will increase the degree of confidence in the external accounts and the economy; further progress in lowering the government debt-GDP ratio; or a sustained easing of political risk will improve Israel's rating profile. At the same time, Israel's credit rating could be negatively affected by a continual deterioration in the government debt-GDP ratio, a substantial worsening of the political risk or a worsening of the state of the external accounts.

Published by Globes [online], Israel business news - - on April 21, 2016

© Copyright of Globes Publisher Itonut (1983) Ltd. 2016

Moshe Kahlon
Moshe Kahlon
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