May 29, 2024
Economy

Israel’s economy affected by S&P credit rating drop


In an unscheduled revision, ratings company S&P Global dropped Israel’s credit rating on Thursday, cutting the long-term score from AA- to A+, after Israel’s confrontation with Iran escalated last week. 

A rating was expected from S&P next month, and this deviation from schedule was only allowed due to the significant increase in geopolitical and security risk in Israel and the impact of these on Israel’s risk profile, said the company. 

This ratings cut follows Fitch Ratings’ April decision to leave Israel’s A+ rating and remove a negative watch while adding a negative outlook, as well as Moody’s February downgrade of Israel’s score.

The updated credit score, along with the other recent ratings, has the potential to impact Israel’s economy in a number of ways. 

How can the update impact Israel’s economy?

A country’s credit rating, or sovereign credit rating, is a score given to a country based on how the rating company perceives the country’s ability to pay back its debt.

Credit rating (Illustrative) (credit: PR)

This rating can give investors an idea of how risky it is to invest in the debt of a particular country (such as buying a country’s bonds). In determining the rating, companies will assess a number of factors impacting a country’s economy as well as anticipated future events.

The rating drop signals to investors that it is more risky to invest in Israeli bonds, meaning Israel may need to offer higher interest on them to compensate investors for this risk. This could make Israel’s debt more expensive for the country, as it needs to pay more for the money it borrows.

The effects of the war on Israel’s economy

The Israel-Hamas war has led to a doubling of the country’s borrowing, the Finance Ministry said last week. Israel raised 160 billion shekels ($43 billion) in debt in 2023 – half of it, 81 billion shekels, since the outbreak of the war in October, according to the ministry.

Total debt amounted to 62.1% of the gross domestic product in 2023, up from 60.5% in 2022 due to the spike in war spending, and is expected to reach 67% in 2024.

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Debt raised going forward may be more expensive given the rating drop, and in the context of the other recent ratings.

An additional, possibly significant impact of the rating drop is the signal it sends that things could get worse before they get better. 

Not only did Israel’s current rating go down, but in its assessment, the company made clear that Israel’s rating could drop further if the conflicts Israel is currently involved in escalate, expand to regional instability, or have a significant impact on Israel’s economic parameters. 

The rating was based on an assumption that there would not be a wider regional conflict, and if such a conflict were to occur, Israel’s rating could be downgraded again.

This serves as a message to those interested in investing in Israel – things may get worse. This may leave investors reluctant to put their money in Israel either because the risk seems too great, or because they want to wait and see how risk parameters develop before buying Israeli bonds.

This negative statement about the present and future could possibly also serve as a signal for those investing in Israel’s private sector. The rating could send a message that Israel is not a stable place to do business, not only with its government but more generally.

The influence the decision has on the Bank of Israel

The rating could also potentially influence the Bank of Israel’s decision on whether to change its interest rate. One of the roles of Israel’s central bank is to maintain stability in Israel’s financial markets. 

This goal could take on more weight in the bank’s monetary decision-making, as the ratings drop signals instability, leading the BOI to signal stability by leaving the interest rate unchanged, IBI Investment head economist Rafael Gozlan explained to TheMarker.

The Bank of Israel interest rate is the center of the range between the rate at which the bank lends and the rate at which the bank borrows money from Israel’s commercial banks, and this rate impacts those that banks then offer to customers.

When the BOI interest rate increases, the prime rate also increases. Many other interest rates are determined by the rate or directly tied to it.

Israel’s access to capital markets – her ability to raise capital, while always important, may be much more so as the costs of the Israel-Hamas war force the country to increase its defense budget as well as care for those impacted and rebuild critical infrastructure.

This rating, alongside the negative signals of the other rating companies, may begin to impact this access beyond simply driving up the cost of Israel’s debt if investors decide that the risk of investing in the country is too great.

While Israel’s ratings are still far above the lower bar for what is considered “investment grade,” meaning investments in Israel are still considered to have a relatively low risk of default, this rating is a step in the wrong direction.

S&P said that Israel’s outlook will be upgraded back to “stable” if the company sees a decrease in the risk of military escalation and moderation in the broad security risk it currently identifies.

Reuters contributed to this report.







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