ISRAEL AT WAR - DAY 145

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After Moody’s downgrade, government urged to rethink wartime budget priorities

Business leaders say coalition must go back to drawing board on revised 2024 spending plan, cutting away discretionary funds and ministry chaff to lower deficit, restore confidence

Sharon Wrobel is a tech reporter for The Times of Israel.

Prime Minister Benjamin Netanyahu, right, and Finance Minister Bezalel Smotrich attend a Knesset vote on the state budget, February 7, 2024. (Yonatan Sindel/Flash90)
Prime Minister Benjamin Netanyahu, right, and Finance Minister Bezalel Smotrich attend a Knesset vote on the state budget, February 7, 2024. (Yonatan Sindel/Flash90)

Business leaders are calling on the government to rethink its revised 2024 budget in the wake of a decision by the Moody’s rating agency to lower Israel’s sovereign credit rating due to the impact of the ongoing war with the Hamas terror group.

Moody’s late on Friday cut Israel’s credit rating by one notch from A1 to A2 and said it expects the country’s “debt burden will be materially higher than projected,” noting that public finances are deteriorating and citing ongoing risks stemming from the war and its aftermath.

The decision had been widely expected, but the rating agency’s move to also lower its outlook to “negative” came as something of a surprise, raising red flags about confidence in the government to keep the economy afloat as it takes on more and more debt to pay for the war.

Behind the reasoning for the negative outlook Moody’s cited “the risk of an escalation involving Hezbollah in the North of Israel, which would have a potentially much more negative impact on the economy than currently assumed.”

“Government finances would also be under more intense pressure in such a scenario,” Moody’s stated.

Moody’s said it would “stabilize the outlook if there was evidence that Israel’s institutions are able to formulate policies that support the economic and public finance recovery and restore security while dealing with a wide range of policy priorities.”

Business leaders pointed a finger at the revised 2024 budget, intended to finance the conflict, which awaits final approvals in the Knesset.

The smoke of rockets fired from the Gaza Strip toward Israel lingers above a building on January 7, 2024. (AFP)

The downgrade and the negative credit outlook are “dangerous developments the like of which we have not seen in 36 years, even during previous wars and challenges that we have coped with,” warned the Israel Business Forum, representing a group of the 200 largest companies in Israel, including the largest employers in the private sector.

The business forum said that Moody’s action was “further proof that the budget proposal for 2024 is not balanced and is not focused enough on measures that support growth and the rehabilitation and recovery of the economy the day after.”

“We believe that it is not too late to submit a responsible budget with a lower deficit than the one set and with an order of priorities that is biased towards supporting growth, while encouraging innovation, creativity and productivity,” the business forum said in a statement. “It is likely that such a proposal could have led to a different result, and even prevented the negative outlook set for the economy.”

Destruction caused by Hamas on Kibbutz Be’eri, near the Israeli-Gaza border, in southern Israel, seen on October 19, 2023. (Erik Marmor/Flash90)

The spending changes put Israel’s deficit target at 6.6 percent of national output for 2024, the second largest deficit in the Western world after the US.

Israel’s right-wing coalition has been criticized for failing to shift funding priorities to help pay for the war effort. The government has opted for across-the-board cuts, rather than jettisoning ministries deemed superfluous, and has left in place discretionary funds made available to political allies under deals reached in coalition talks over a year ago. Ultra-orthodox parties in particular have been criticized for continuing to insist on money to fund Haredi education that does not meet core curriculum requirements.

IBI Investment House chief economist Rafi Gozlan recommended that the government act to amend the 2024 budget so that it includes the “closure of unnecessary government offices, the cancellation of coalition [discretionary] funds, and the diversion of resources to areas that encourage and support growth.”

Illustrative: Ultra orthodox Jewish men at an ATM in Jerusalem on February 5, 2024. (Chaim Goldberg/Flash90)

He suggested that the government can “minimize future damage and prevent further rating downgrades, if it accepts the criticism and acts to create a political horizon at the same time as improving the fiscal situation.”

So far, there’s little indication that the government will change course in reaction to the downgrade. Both Prime Minister Benjamin Netanyahu and Finance Minister Bezalel Smotrich have played down the Moody’s decision, asserting that the Israeli economy is “strong.”

Smotrich dismissed Moody’s assessment as “a political manifesto based on a pessimistic and unfounded geopolitical worldview.”

The Bank of Israel estimates that the cost of the war for the years 2023 to 2025 will stand at about NIS 255 billion or around 13% of GDP, due to higher defense and civilian spending and expectations of lower tax revenues.

Moody’s projects Israel’s defense spending to be nearly double the level of 2022 by the end of this year and to continue to rise by at least 0.5% of GDP in the coming years.

Credit ratings are meant to grade a government’s ability to repay bonds and other debt tools, but are read by the larger business community as an indicator of country’s economic health. As Israel looks to raise money to pay for the war and finance its ballooning deficit, the lower ratings will impact the attractiveness of its debt instruments, and likely raise the interest rate it will need to pay on bonds and other loans.

In addition, the rating downgrade will impact financial instruments that public savings are invested in, such as funds tied to bond pricing, stocks and the foreign exchange rate. It could also have a negative effect on Israeli businesses when they seek to raise money on the global market.

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