Credit rating agency S&P warns lack of overhaul consensus imperils Israeli economy

Credit rating agency Standard & Poor’s warned on Thursday that it sees the continued political turmoil around the government’s widely contested judicial overhaul threatening economic growth in Israel.

“The controversial reform has led to sizable public protests, and, in our view, if government and opposition do not achieve an agreement on the topic, this could further exacerbate domestic political confrontation and weigh on medium-term economic growth,” S&P credit analyst Maxim Rybnikov wrote in a report. “In the short term, we expect that persisting political uncertainty will combine with weaker economic performance in Israel’s key trading partners in Europe and the US as well as tighter monetary policy.”

The rating agency sees Israeli economic growth slowing to 1.5 percent in 2023 from 6.5% in 2022. Against this, S&P cited Israel’s “wealthy and diversified economy, its net external asset position, and the benefits that accrue from flexible monetary settings and a relatively deep pool of domestic savings,” as credit strengths.

Back in May, S&P affirmed Israel’s favorable rating at AA- with a “stable” outlook, but cited “persistent domestic and regional political and security risks” to the economy. Back then, the agency said it expected “some form of consensus” over the judicial overhaul bid, which will allow “political tensions to moderate.”

S&P put out the report in response to the passage of the so-called “reasonableness” law, which was ratified by the Knesset on Monday despite mass public protests and after efforts to reach a compromise between coalition and opposition parties collapsed. The bill prevents judicial oversight of government and ministerial decisions on the grounds of reasonableness. The government’s critics say removing the standard opens the door to corruption and improper appointments of unqualified cronies to important positions.

Going forward, S&P projected that “domestic political polarization and volatility in Israel will remain high in the coming months,” as the adoption of other parts of the judicial overhaul remain “unclear.”

In a similar format, Moody’s Investors Service on Tuesday warned about “negative consequences” and “significant risk” for Israel’s economy, cautioning that “executive and legislative institutions have become less predictable and more willing to create significant risks to economic and social stability.”

For now, Moody’s still expects the country’s economy to grow at a rate of 3% both this year and in 2024, but cautioned that the projection does not “incorporate a negative effect from a prolonged period of social and political tensions.” In April, Moody’s lowered Israel’s credit outlook from “positive” to “stable,” citing a “deterioration of Israel’s governance” and upheaval over the government’s bid to dramatically overhaul the judiciary.

Finance Minister Bezalel Smotrich dismissed the latest warning from S&P and blamed the ongoing mass protests against the government’s bid to overhaul the judiciary, starting with the contentious “reasonableness” law the coalition passed this week. The law, passed on Monday, prevents judicial oversight of government and ministerial decisions on the grounds of reasonableness. The government’s critics say removing the standard opens the door to corruption and improper appointments of unqualified cronies to important positions.

“When you look past the headlines in the media, you see that S&P, like Moody’s, doesn’t recommend a credit ratings downgrade because of a warning about economic damage caused by the judicial reform, but because the protests are creating instability,” Smotrich wrote on X, the platform formerly known as Twitter, on Thursday.

“Meanwhile, Moshe Radman, one of the protest leaders, said openly he intends to harm the Israeli economy,” Smotrich said in reference to one of the most prominent and active protest leaders, a high-tech entrepreneur.

“The opposition must condemn leaders like him who are damaging the state of Israel, and come to real talks that will lead to shared agreements and together we can fix the essential things in the legal system and strengthen the Israeli economy,” said the finance minister, who heads the far-right Religious Zionism party.

Israeli finance officials and business leaders have consistently warned of the damage to the economy, and high tech workers make up a prominent part of the protest movement.

The law was the first part in a larger package of bills that critics say will fundamentally alter Israel’s democratic system by stripping the judiciary’s ability to act as a check on the governing coalition.

After passing the “reasonableness” law, Prime Minister Benjamin Netanyahu said he would work with the opposition to build consensus and come to a compromise on the rest of the legislative package.