Israel’s credit rating is under no immediate threat for a downgrade, even as the country struggles to contain the coronavirus, has been working without a budget and faces the prospect of a fourth round of elections in two years.
That is the message that emerges from an exclusive interview The Times of Israel held with the credit analyst at Standard & Poor’s in charge of setting Israel’s sovereign rating.
Israel’s macroeconomic economic fundamentals are “strong” and its institutions, including the Bank of Israel, are “credible,” said Karen Vartapetov, the Frankfurt-based director for S&P’s Global Ratings and a sovereign credit analyst for the ratings firm. Vartapetov, a doctor in philosophy graduate of the University of Oxford, is a former employee of the Russian Finance Ministry.
“We really need to see some persistent and protracted weakness in economic and fiscal performance before we start moving the rating,” Vartapetov said in the interview.
Israel’s budgetary performance this year is “likely to be very, very weak,” he said, with double digit deficits of over 14 percent of GDP, up from 3.7% in 2019.
But this is “not unique,” to Israel, he emphasized, and other nations will be suffering from a similar malaise.
“In the US we expect budget deficits to widen to 17% of GDP, in Japan and Italy to 14%-15% of GDP and so on, so this is not unusual,” he said.
The “exceptional sudden stop” of economic activity globally will have an impact on the sovereign credit ratings of mainly emerging market economies, those less advanced countries that have less credible fiscal and monetary policies, Vartapetov said.
“They have already taken the hit,” he said. “Look at Latin America, Africa, Asian countries – we have actually taken quite a lot of negative rating actions just because the current crisis has exposed weaknesses” that existed before COVID- 19.
But for advanced countries, Vartapetov added, including Israel, which have “relatively effective institutions, relatively high income and credible economic policies,” there have been no downgrades.
“Look at the US, Japan, Eurozone, none of the ratings have moved. We have changed some outlooks but not the ratings themselves,” he said. “And this is because we believe that these countries have exceptionally high flexibility, primarily in terms of monetary policies, to support their economies with extraordinary policy stimulus. This flexibility buys governments time, which they can use to focus on growth-enhancing reforms and fiscal consolidation post-COVID-19.”
“What we think is that basically, given the relatively strong market fundamentals of many advanced countries, and especially those which issue global reserve currencies, like the euro or the dollar, yen and so on, they have a chance to use monetary policies to back stop their respective government’s fiscal efforts,” Vartapetov said.
“This means central banks can actually buy government debt to keep borrowing costs in check, and this is what has been happening globally, and in Israel. And that prevents a significant deterioration in the government’s debt profile – meaning that interest rates, or cost of new debt remains very low. And even though public debt will increase substantially in 2020, if economic growth recovers later on this year and other credit fundamentals remains strong, negative repercussions for sovereign credit-worthiness could be avoided.
“The combination of economic recovery partly enabled by the current policy stimulus, and fiscal consolidation, should put public debt back on the declining path again,” he said.
And that is why for most advanced countries, S&P can “look through this temporary weakness in fiscal performance,” and focus on medium-term trends, Vartapetov said. This is the same approach S&P takes for Israel, he added.
The coronavirus pandemic has caused unemployment in Israel to surge to record levels this year, and is expected to trigger the economy’s largest contraction ever.
Israel’s economy is expected to contract in 2020 by some 6.2%-8.3% compared to last year, an OECD report said in June. Unemployment, which was below 4% before the onset of the crisis, could, in a worse-case scenario be as high as 15% at the end of this year, according to a Finance Ministry forecast for 2020-2023, based on data that includes furloughed workers.
Israel had 88,554 confirmed cases of COVID-19 and 639 deaths from the illness as of Thursday morning. With a second wave of the pandemic hampering economic recovery, jobless figures that spiked to over 1 million in April, were around 22% on August 12, according to the National Employment Service.
Israel’s debt-to-GDP ratio, which was at 60% at the end of 2019, is expected to surge to 76% this year and 78% in 2021, according to the central bank. A low debt-to-GDP ratio indicates an economy that produces and sells goods and services sufficient to pay back debts.
To counter the crisis, the Israeli government has set out a total coronavirus rescue package that has ballooned to NIS 135 billion ($39.6 billion), according to January-July budget data published by the Finance Ministry in August, from an original NIS 80 billion ($23.5 billion) package announced in March.
But businesses and economists have been decrying what they say is a lack of economic leadership, as Israel copes with the fallout of the coronavirus pandemic.
The economic package that the country provided as the crisis struck was too little, too late, they said.
Now, as the second wave of the virus strikes the nation, bringing with it the threat of further lockdowns, and as the streets roil with anger and discontent at the government’s handling of the crisis, Netanyahu, in what seems to be a panicky reaction, is simply doling out cash in an as yet unsuccessful bid to appease the masses: The government in July approved a controversial grants program of a total of NIS 6.7 billion ($1.96 billion) that is being handed out to citizens, allocated according to the number of children in a family.
Not just an economic mess, a political one too
Meanwhile, the nation’s political leaders and coalition partners, Likud party’s Netanyahu and Blue and White leader Benny Gantz are embroiled in coalition in-fighting that is raising the specter of a fourth set of elections. Netanyahu and Gantz agreed to create an emergency unity government amid the pandemic, after three consecutive rounds of elections — in April 2019, September 2019, and March 2020 — failed to yield a clear winner.
The Knesset passed, in a preliminary reading Wednesday, a bill to grant the government more time to pass the national budget. The proposed bill gives the government an additional 100 days to approve the budget beyond the current August 25 deadline. If a budget isn’t approved by the deadline, the government will automatically fall and elections will be called.
The bill still requires three future votes to pass.
Why ratings are important
A sovereign credit rating is the grade given to nations by rating firms — like S&P, Moody’s Investors Service and Fitch Ratings — and indicates the risk level for investors who buy bonds issued by these governments, and the feasibility of them defaulting on future payments. The higher the risk, the greater the interest nations need to pay, when they seek to raise money from investors through the issuance of government bonds.
A low rating makes it harder and more expensive for a nation to raise money on international markets to finance its expenses. S&P is considered the largest of these big three credit-rating agencies.
S&P’s credit rating for Israel stands at AA- with a stable outlook. Moody’s Investors Service credit rating for Israel is a at A1 with a positive outlook, while Fitch Ratings’ credit rating for Israel is at A+ with stable outlook. These are all investment grade ratings — meaning that the likelihood of Israel defaulting on its payments to investors is very low.
S&P upgraded Israel to a rating of AA-, with a stable outlook in August 2018, the highest ever rating for Israel, and S&P’s fourth highest rating. On May 15 this year, S&P reaffirmed its rating and outlook, as the nation was already in the midst of the coronavirus pandemic.
Cedric Berry, associate director of sovereign ratings at Fitch Ratings, told Reuters earlier this month that a budget delay “would heighten concerns about Israel’s ability to implement prudent fiscal policy and erode (its) track record of debt reduction.” This could put pressure on Israel’s ratings, he said.
Israel scores ‘very, very high’
The message from S&P’s Vartapetov is far more soothing.
“Even if the budgetary performance this year and next year is going to be weaker than we forecast, it is not going to automatically and immediately lead to a negative rating action,” Vartapetov said in the interview. A lower rating “would imply that this weakness is more persistent.”
Sovereign rating criteria does not focus on fiscal and public debt indicators only, he said.
“There are a lot of other credit factors which we reflect in our ratings and fiscal indicators only count for less than 20% of the final rating,” Vartapetov said.
These other “even more important factors” are GDP per capita; the external profile, meaning the strength of the balance of payment of the country and its external balance sheet; and also the credibility of Israel’s monetary policies.
“These three factors taken together, count for about half of the rating,” he said. “And on all of those factors Israel scores very, very high.”
Israel has an “exceptionally strong external profile, meaning that external assets substantially exceed the external liabilities of the Israeli economy. Also, the income level – GDP per capita, is very high – and the credibility and the effectiveness of the Bank of Israel policies is also very high,” Vartapetov said.
Israel’s GDP per capita was $43,700 in 2019; the country has been running a current account surplus for the past 17 years, which has given it a net external asset position of about 40% of GDP, one of the highest levels among non-commodity exporting nations, S&P said in its May 2020 report when it reiterated Israel’s AA- rating and its stable outlook.
Some pressure maybe, but ‘fundamentals remain strong’
“S&P’s existing outlook on the ratings is stable, meaning that we do not expect immediate negative or positive rating actions in the next two years, that speaks for itself, that stable outlook,” Vartapetov said.
That could change “if events actually deviate from our baseline scenario substantially, and now the baseline scenario is that the economy is going to recover next year, budget deficits will narrow and there will be a sitting government — so our baseline expectation is that this government will survive in the next 12 months.
“But if there is another round of political turbulence and there is no visibility on what happens with the fiscal path — and if the pandemic lasts longer, meaning that economic performance is going to be much weaker than we forecast, then of course there might be pressure building up on the ratings,” he added. “But again, at the moment the credit fundamentals of Israel remain strong.”
Israel has also “a historical track record” of operating without governments in the past, especially in the last year and a half, and “macroeconomic fundamentals still remained strong”, Vartapetov said.
What S&P is looking forward to will be Israel’s budget for 2021, “to get some visibility regarding the government’s medium-term fiscal plans,” he said. “We would like to see how the government sees the medium-term fiscal path, meaning what kind of revenue and expenditure measures the government will be taking to put the public debt to GDP ratio back on the declining path.”
Regarding the debate in Israel about whether a one-year budget is better than two — a key point of contention between Netanyahu and Gantz — Vartapetov said that it is not the role of a ratings agency to advise on policies, but to assess credit risk.
If there is another round of elections, he said, that could hinder visibility into the government’s medium-term policies.
But even if there is another election, political parties competing within the election could provide some insight into how they see public finances going forward, post the COVID-19 crisis.
S&P’s next credit assessment on Israel will be in mid-November, he said. “And by that time, we hope to get some visibility on next year’s budget.”
Vartapetov said that S&P assumes a vaccine for the virus will be available in the second half of next year.
“If that doesn’t happen then lockdowns will continue and, of course, growth might under-perform and the government might have to spend more to support the economy. In that scenario we might see a much more negative impact on the public finances.” S&P forecast a 6.5% GDP growth for 2021 in its May report.
“But the bottom line is that Israel does have the capacity to support the economy, and has some time to decide on how to return to growth enhancing-reforms and fiscal consolidation post-pandemic,” he said.
If economic recovery next year happens as forecast, he said, then that will boost tax revenues for the government and might narrow next year’s budget deficit.
Regarding the sharp criticism of local players against the government’s handling of the crisis and the protests, Vartapetov said that it is too early to judge, and that this kind of concern exists in most countries.
“As a global ratings agency, we have the privilege of offering the global perspective,” he said. “We work with 135 governments around the world and…these concerns exist in most of them.”
“Local stakeholders are not always happy with the way the crisis is handled by governments, but looking in the comparative perspective, what Israel has done in terms of policies is not unusual: the authorities were quite quick to roll out sizable fiscal and monetary support to the economy, and there is good reason to suggest that this kind of policy package should help the economy to recover. Not supporting the economy now might require more spending in the future.
“One can always criticize the government for being too slow or short-sighted. If anything, another couple of months will show whether these extraordinary measures have been effective and allowed the economy to recover. I think it is probably too early to judge,” he said.
In the conversation, Vartapetov stressed that negative geopolitical developments continue to be a “very important” factor to Israel’s credit risk profile.
“Israel’s rating is constrained by these risks which is very untypical for an advanced economy,” he said. “If there is some escalation of tensions domestically, or war internationally, that could also put pressure on the ratings.”