S&P gives vote of confidence in the Israeli economy

Amiram Barkat

Israel's lower debt ratio and budget deficit, and high growth have been impressive achievements over the past decade.

The upgrading of Israel's credit rating by the S&P credit rating agency follows the changing of its rating outlook to positive a year ago, which meant that a credit rating upgrade in the ensuing 18 months was highly likely. This is the sixth time that S&P has upgraded Israel's credit rating since it began covering Israel in 1988.

Credit ratings by S&P (and its competitors Moody's and Fitch) are considered the most prominent indicator of a country's economic situation. While the rating is designed for the purpose of assessing a government's ability to repay its debts, S&P takes macroeconomic, political, and strategic factors into account in its rating and compares the country's performance with those of other countries. The ratings have retained their prestige and status despite severe criticism of the credit rating agencies a decade ago, when they lowered their ratings only after the global crisis occurred.

The upgrading of Israel's rating puts it in the prestigious group of 15 countries with AA ratings, including the US and Austria (AA plus) and the UK, New Zealand, and France (AA). Countries with AA minus ratings include Qatar, Taiwan, the Czech Republic, Estonia, and UK channel islands Guernsey and Jersey. There are 11 countries with the top AAA rating.

The upgrading of Israel's rating by S&P is likely to have a positive impact on the other two rating agencies. Moody's already announced the upgrading of Israel's rating outlook from neutral to positive on July 20. Fitch, which kept step with its two competitors by upgrading Israel's rating to A plus in November 2016, still lists Israel's outlook as neutral.

The basis for the upgrade

Ever since S&P upgraded Israel's credit outlook rating to positive on August 5, 2017, an upgrading of the rating itself was anticipated as part of one of its regular updates published in February and August. S&P left Israel's credit rating unchanged in February, but stated that it did not usually make credit rating upgrades in its first revision, making the current revision the most suitable one for upgrading Israel's credit rating.

In the framework of its previous regular revision published in February, S&P's analysts stated that Israel's credit rating would probably be upgraded if its budget performance improved, resulting in further lowering its debt ratio. Although no such improvement has taken place since the previous revision, economists familiar with S&P's work say that the rating agencies are "looking at the long term."

The economic achievement that impresses the credit rating agencies more than anything else is the lowering of the ratio of debt to GDP, a figure almost unknown to the general public, but regarded as a key indicator of the government's ability to repay its debts.

Israel has lowered its debt ratio from 70% to 60%, an almost unique achievement among the world's countries, which have increased their debt ratios in an effort to emerge from the global credit crisis. As noted by Moody's in its explanations for upgrading Israel's credit rating outlook, Norway, Singapore, and Switzerland, all AAA-rated countries, are the only countries other than Israel that have succeeded in lowering their debt ratios since 2008. Another Israeli achievement that impressed the agencies was the fact that Israel finished each of the past four years with a budget deficit of only 2%. Economists in Israel are less impressed by this achievement, primarily because they attribute the low budget deficits to one-time tax revenues stemming from car imports, real estate taxes, and tax collection campaigns by the Israel Tax Authority.

Besides cutting debt and responsible budget management by recent governments, the other main reason for the credit rating upgrade was the notable performance of the Israeli economy in recent years. Israel's 3.5% growth rate over the past decade is 20% higher than that of the other countries in Israel's old credit rating group. The credit rating agencies were especially influenced by the composition of growth, based on the flourishing high-tech sector and other sources, as well as Israel's natural gas discoveries, which are expected to ensure energy independence and increase state tax revenues in the coming years.

The security situation

"Israel is more dramatically threatened than in the past," Minister of Finance Moshe Kahlon said a week ago in an interview with Galei Tzahal (Army Radio). Kahlon and Prime Minister Benjamin Netanyahu argue that there is a critical need to increase the defense budget in view of the threats to Israel. How can the warning of the Israeli government of a increase jeopardy to state security be reconciled with the current credit rating upgrade? The credit rating agencies list the security situation as the main risk to the stability of the Israeli economy in the short and medium term. The recent security escalation on the Syrian front and in the Gaza Strip, however, have not really been taken into account in S&P's decision.

S&P's analysts base their confidence on Israel's military power, its close relations with the Trump administration, and its understandings with the Russian administration. When asked about the situation in Syria in the past, the analysts said that the situation in Syria was too chaotic for an assessment of its significance. It is also possible that the precarious economic situation of Israel's main enemies, Iran and also to some extent Turkey, were taken into account. Above all, the analysts are convinced that conclusions about the future can be derived from the fact that Israel's military conflicts in recent years, headed by the Second Lebanon War, had a minimal effect on the Israel economy's performance. It is true that the missile threat has grown, but it is being handled through the plan to invest NIS 30 billion in building stronger protection of homes against missile bombardment and anti-missile systems. The idea that Netanyahu is considering a permanent link between the defense budget and GDP, should it be carried out, should alarm S&P.

Final point - will the blessing become a curse

Beyond the dramatic influence on Israel's image, the credit rating upgrade is not expected to have any effects. In theory, a credit rating upgrade enables a country to raise money at lower cost, but Israel is already paying the interest rate for AA-rated countries on the debt it raises. The move from A to AA-rated countries is significant for investments, but does not constitute a major improvement like entering the group of investment-rated countries.

The truly big question, however, is how the credit upgrade will affect decision-makers - whether it will make them feel a heavier responsibility or push them in the direction of irresponsibility. Kahlon has abandoned the traditional "not enough money for that" warning of the ministers who preceded him and acted against the advice of Government of the Bank of Israel Karnit Flug by cutting taxes and increasing government spending. Kahlon is now likely to argue that the credit rating upgrade is confirmation that his policy is economically correct.

Kahlon is the one who is supposed to make a stand against extra budget demands that are growing stronger as the election date approaches. A partial list of the demands includes billions for the Ministry of Defense (with support from Netanyahu and Kahlon), a NIS 7 billion supplement for members of the security forces (with the support of Minister of Information and Public Security Gilad Erdan), and demands that the Ministry of Finance pay for the National Insurance Institute's debts (by Minister of Labor, Social Affairs, and Social Services Haim Katz). In contrast to previous years, no revenue in excess of the budget forecast is expected; the budget deficit is projected to reach the target of almost 3%.

Published by Globes [online], Israel business news - www.globes-online.com - on August 5, 2018

© Copyright of Globes Publisher Itonut (1983) Ltd. 2018

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