Has the era of reducing Israel's debt reached an end? Are Israel's politicians showing overconfidence when they increase spending and cut taxes? A detailed analysis of the state of the economy by the Moody's credit rating agency following the state budget arouses questions likely to trouble Israel's economic leadership.
The lowering of Mexico's credit rating forecast by the S&P agency last week aroused a financial storm in a country accustomed to a different kind of storm : the prices of insurance against Mexico's insolvency shot up, and the value of the country's currency and its stock exchange plunged. S&P said that the grounds for its downgrading of Mexico were a combination of disappointing growth and an increase in Mexico's ratio of government debt to GDP to 46.8%. Mexico's S&P rating is now BBB+, three rungs lower than Israel, whose rating is A+.
Israel's current debt ratio is 63.9% of GDP, after it fell substantially in 2015. The ratio is also projected to fall in 2016 for the 14th consecutive year (other than a one-time rise in 2009). With this background, the detailed report published by Moody's last week, following approval of the state budget, should be regarded as a warning. Moody's wrote in its report that renewed budgetary expansion would jeopardize the credibility of the Israeli government's responsible budget management, after the pace of improvement in the debt ratio has already slowed in recent years.
Atmosphere worsens
On August 11, exactly while the cabinet was discussing approval of the state budget, Moody's published an announcement affirming Israel's current credit rating. The announcement was written in a positive and general friendly spirit. In an expanded and detailed analysis published last week following the approval of the budget, however, a change for the worse in the atmosphere was discernable. Moody's wrote that the new 2017-2018 budget proposal increases government spending twice as much as initially planned, adding that the inclusion of tax cuts undermined the possibility of continuing fiscal consolidation (i.e. a continued reduction in the debt ratio) in the next two year. Moody's complained that the Israeli politicians were obviously taking for granted the increase in tax revenues in recent years resulting from higher private consumption, even though it was temporary.
In general, Moody's continues to give Israel high marks for the Israeli economy's performance, as well as the government, although it notes that the Israeli economy has lost its growth engine in recent years, mainly as the result of poor exports and the strengthening of the shekel. The credit agency predicts economy growth of 2.8% in 2016 and 3% in 2017, to a considerable extend as a result of the development of the Leviathan natural gas reservoir and the possibilities for exporting Israeli gas to Turkey and Europe.
Moody's severely criticizes Israeli political culture and the bargaining accompanying approval of the budget. Moody's commented that the built-in noise typical of Israeli politics, especially the budget approval processes, were deleterious to the administration's force, but added that although politicians frequently ignore the rules, or change them, good results were achieved in the end when the politicians' attention shifted to other matters.
According to Moody's, the most prominent example of this pattern is the success in lowering the debt ratio. Although the Ministry of Finance changed the fiscal rules established in 2005 for the purpose of lowering the debt ratio almost every year, Israel has nevertheless succeeded in lowering its debt ratio since the outbreak of the global credit crisis, putting in it a very small class of developed countries, together with Norway, Switzerland, and Singapore, that have lowered their debt ratios since 2009. This picture, however, is expected to change if the current budget proposal, which include an increase of over 5% in government spending, increasing the deficit target to 2.9%, a corporate tax cut, and an income tax reform, passes. Moody's asserted that government spending in Israel was still relatively high, and that the proposed deficits were high enough to halt the downtrend in the debt ratio that had continued for 13 consecutive years. Furthermore, because the results of the undertaking to increase spending on the one hand and cut taxes on the other are permanent, not a one-time event, further deviations are expected in the budgets in 2019 and afterwards.
The Ministry of Finance today said that Moody's analysis had nothing new to say about reversing the downtrend in the ratio of debt to GDP, and emphasized Israel's high marks in a number of parameters, including economic and institutional power.
Published by Globes [online], Israel business news - www.globes-online.com - on August 28, 2016
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