Credit rating agency Standard & Poor’s sees Israel’s economy contracting 5 percent in the fourth quarter of this year, citing an escalation of geopolitical and security risks since the outbreak of the war with the Hamas terror group in a Monday report.
S&P, which affirmed Israel’s rating at AA-, the fourth-highest score, for now does not expect the current fighting with the Iran-backed terror group to spread beyond the Gaza Strip, but warned about a sharp slowdown in the economy in the coming few months.
The rating agency cited “lower business activity, depressed demand from consumers, and a very uncertain investment environment,” as well as the massive call-up of reservists, as reasons for the downturn.
“There have previously been several conflicts between Israel and Hamas in Gaza, but the current war is of significantly larger scale,” S&P analysts Maxim Rybnikov and Karen Vartapetov wrote in the report. “We currently assume the conflict will remain centered in Gaza and last no more than three to six months.”
On October 7, Hamas terrorists stormed across the border from Gaza into Israel by land, sea and air in a multipronged assault, killing at least 1,200 people, mostly civilians, and seized at least 240 hostages under the cover of massive rocket fire.
Along with the subsequent war inside Gaza, where Israel seeks to eradicate the ruling terror group, the Iran-backed Hezbollah has conducted and overseen daily assaults on Israel’s northern border from Lebanon, but has stopped short of launching a full-scale campaign.
Rybnikov and Vartapetov said in their statement that they project that Israel’s average budget deficit will rise to 5.3% of GDP in 2023 and 2024, due to a wartime increase in fiscal expenditure of billions of shekels to support households and businesses and an increase in defense spending. That is more than twice the rating agency’s previous forecast of 2.3% of GDP.
Israel’s fiscal deficit already widened to 2.6% of GDP in October, from 1.5% in the previous month. In 2022, Israel posted its first budget surplus in 35 years, of 0.6% of GDP.
“Although direct war spending and support will eventually reduce, we expect defense spending to stay elevated over the medium term,” the analysts wrote in the report.
Looking ahead, Rybnikov and Vartapetov see Israel’s economy rebounding in the first quarter of 2024 and gradually reaching prewar output by the end of next year.
S&P forecasts that the economy will expand 1.5% in 2023 and 0.5% in 2024, followed by faster growth of 5% in 2025 as consumer confidence returns and reconstruction and the investment cycle kick in more fully. The forecasts still mark a slowdown from the 6.5% growth rate in 2022.
The Bank of Israel’s research department assessed at the end of October that the costs of the war will lead to an increase in the government deficit to about 2.3% of GDP in 2023, from 1% forecasted previously, and to about 3.5% in 2024.
The central bank on October 23 trimmed its economic forecasts for this year and the following one. It now expects the economy to grow by 2.3% in 2023 and by 2.8% in 2024, as private consumption falls and the ability to work is constrained.
S&P’s update on the economy comes after the rating agency last month lowered Israel’s credit outlook from stable to negative, citing risks that the Israel-Hamas conflict could broaden, with a more pronounced impact on the economy.
S&P reiterated that the negative outlook reflects the risk that the “Israel-Hamas war could spread more widely or affect Israel’s credit metrics more negatively than we expect.”
“We could lower the ratings on Israel if the conflict widens materially, increasing the security and geopolitical risks that Israel faces,” the analysts wrote. “We could also lower the ratings in the next 12-24 months if the impact of the conflict on Israel’s economic growth, fiscal position, and balance of payments proves more significant than we currently project.”
A return to a stable outlook for Israel’s rating would require the end of fighting and a “reduction in regional and domestic security risks without a material longer-term toll on Israel’s economy and public finances,” S&P said.
Rybnikov and Vartapetov noted that support for Prime Minister Benjamin Netanyahu has slumped over the past month, citing opinion polls, following the Hamas onslaught that was not “prevented by Israeli military and intelligence forces.”
Meanwhile, the rating agency sees the government’s widely contested judicial overhaul proposed early this year, which led to weekly public protests and spurred political turmoil, not returning to the table.
“We consider the prewar judicial reform that was advocated for by the coalition since early 2023 will likely be suspended indefinitely,” Rybnikov and Vartapetov wrote.