Moody’s drastic downgrade will have ripple effect on war-torn consumers and taxpayers
A lower rating raises credit costs for the government, businesses and households; translates into higher taxes and prices, reduced disposable income; also impacts public savings
Sharon Wrobel is a tech reporter for The Times of Israel.
In a dramatic move on Friday, Moody’s cut Israel’s credit rating by two levels. It warned about the long-term economic fallout of the ongoing war, as fighting with the Hezbollah terror group intensified and prospects of a ceasefire strategy diminished, and described an environment of uncertainty that is detrimental to investments and economic growth.
Moody’s lowered Israel’s rating for the second time this year — this time from A2 to Baa1 — underlining that the cost of war has gone beyond the battleground and is negatively affecting the country’s creditworthiness. The highly unusual two-notch cut was also a result of the “diminished quality of Israel’s institutions and governance” to manage state finances, and increased spending needs during the war period, the rating agency noted.
Despite all of this, Finance Minister Bezalel Smotrich on Saturday chose to downplay the impact of the downgrade and maintained that it would be reversed once the conflict ends, since the Israeli economy is strong and attracts investments.
While Moody’s announcement was released just as a massive Israeli airstrike killed long-time Hezbollah leader Hassan Nasrallah, the rating agency had plainly prepared it beforehand.
The Beirut strike pushed Tel Aviv shares up on Sunday, the first trading day after the downgrade, amid cautious investor optimism that the elimination of the Hezbollah leader would avert further escalation with the terror group for the time being.
Notwithstanding the initial market response, however, Moody’s downgrade will have a snowball effect that ultimately affects everyone’s pocket.
A lower credit rating makes it more expensive for the Israeli government to raise debt, as the risk of repayment rises at a time when it needs billions of shekels to fund the costs of the ongoing war. Investors see more risk to park their funds in the country.
To finance higher interest payments on the country’s growing national debt, and a widening budget deficit as defense and other war-related civilian costs are rising, taxes will need to be hiked.
“Interest payments on national debt are paid out of the state budget, hence if Israel needs to pay more interest to service its debt, the government will have less funds to spend on important civilian services, such as education and welfare, and will probably have to raise taxes,” IBI investment house chief economist Rafi Gozlan told The Times of Israel. “As a result, we will have to pay more in taxes, our disposable income for spending will shrink, and we will receive reduced services.”
Due to the increased credit risk, businesses will be charged higher interest on their loans, pushing up their costs, which eventually will trickle down to higher prices paid by consumers. As a result, the annual inflation rate, which has already climbed to 3.6 percent in August — above the government’s target range of 1% to 3% — is not expected to moderate in the coming months. If inflation persists for longer, borrowing costs for mortgage holders and households will likely remain higher for longer.
“The financing costs for the government and businesses will increase, which will directly lead to a decline in private sector investments, especially by global companies, who will reduce investments in Israel and as a result may decide to halt or slash projects in the country,” said ManpowerGroup Israel CEO Dror Litvak. “There is also growing concern about layoffs due to the reduction of projects.”
Additionally, apart from the direct damage to the economy, the rating downgrade is poised to have a negative effect on the performance of pension funds and other savings vehicles of the working population. The public’s funds that are widely invested in local government bonds are considered among the safest investments.
However, a lower credit rating increases the riskiness of government bonds, which is reflected in a decline in the price of the debt and an increase in yields, that overall lowers the value of savings portfolios.
Even more worrying is that in addition to the immediate impact of Moody’s harsh action, the credit rating agency chose to maintain a negative outlook, leaving the door open for further downgrades in coming months as it’s losing confidence in the government’s willingness and ability to manage its finances and lower debt.
Whereas in the past, Israel’s economy was praised for its ability to recover fast from previous conflicts, Moody’s now expects a delayed and slower economic recovery because of “Israel’s institutions and governance which have not fully mitigated actions detrimental to the sovereign’s credit metrics.”
Specifically, alongside heightened geopolitical risks, Moody’s raised concern about growing domestic risks, including tensions between the government and the security services as portrayed in the delay of the bill to draft ultra-Orthodox men into military service to lower the reserve duty burden, as well as the delay of important judicial appointments, including to the position of President of the Supreme Court.
Overall, the agency scrutinized the government for failing to lay out an “exit strategy from the military conflict that would help restore a level of certainty and security, on which the economy and business investment ultimately rely.”
“The loss of confidence comes as the government has not been taking the minimum steps of governance that it can during the war period such as formulating a responsible budget and changing spending priorities, to show fiscal responsibility,” said Gozlan.
In an effort at reassurance, Finance Minister Smotrich was quick to reiterate that the government will pass a “responsible budget [for 2025] with required austerity measures.” But action, not words, will be necessary as Moody’s has already raised serious doubts about the ability of the government to implement its proposed measures.
