London hedge funds wary of overhaul impact on Israel’s risk premium, credit ratings

In meetings in London with Bank Hapoalim, one of Israel’s largest lenders, some asset managers say they expect a downgrade of Israel’s outlook by credit rating agencies

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

An anti-overhaul protest in Tel Aviv on July 29, 2023. (Amir Goldstein)
An anti-overhaul protest in Tel Aviv on July 29, 2023. (Amir Goldstein)

Top hedge funds in London are raising concerns over the impact the political turmoil around the widely contested judicial overhaul is having on Israel’s risk premium and the country’s credit ratings.

Coming back from meetings held last week in London, Bank Hapoalim chief strategist Modi Shafrir said Sunday hedge funds and asset managers were highly preoccupied with the uncertainty around the domestic political issue.

“In stark contrast to the past, significant part of the meetings we held over the past week revolved around the political situation, Israel’s risk premium, and the probabilities of political developments and their potential impact on the markets,” said Shafrir in the bank’s weekly note to investors. “Questions about the appointment of the next [Bank of Israel] governor also came up at almost every meeting, and some traders noted that the uncertainty around the issue raises Israel’s risk premium.”

Bank of Israel’s Amir Yaron, who has been critical of the unilateral advancement of the judicial overhaul and is due to end his term as governor at the end of 2023, said last month that he will announce his decision whether to ask to stay on for another five-year term around the Jewish holidays in September-October.

The round of meetings with hedge funds and asset managers in London comes as leading financial institutions and global rating agencies sounded bearish notes following late July’s passage of the first bill in a series of legal changes advanced by the coalition government without broad consensus.

Business executives, startup founders and employees have been at the forefront of mass protests against the changes to Israel’s judicial system advanced by the coalition government, led by Prime Minister Benjamin Netanyahu, since the start of the year. The concern is that the judicial overhaul plan undermines Israel’s system of checks and balances and its democratic character, which in turn, it is feared, threatens the ecosystem’s position as a stable hub for investments.

Modi Shafrir, the chief strategist at Bank Hapoalim. (Courtesy)

On Thursday, Citibank lowered its forecast for Israel’s economy in 2023 and 2024, citing the plunge in investments over concerns of the impact of the government’s judicial overhaul and other policy decisions. The US bank reduced its 2023 growth projection for Israel from 3.3% to 3.1%, while the 2024 forecast fell from 3.3% to 2.8%.

US investment bank Morgan Stanley cut Israel’s sovereign credit to a “dislike stance,” citing “increased uncertainty about the economic outlook in the coming months.” Global credit rating agencies Moody’s Investors Service and Standard & Poor’s issued warnings that the continued political turmoil around the judicial overhaul is posing risks to economic growth and social stability in Israel. However, for now, the agencies have not acted with changes to Israel’s ratings since the latest legal passage.

Moody’s raised concerns about the slump in venture capital investments into local tech firms during the first half of the year since the judicial plan was presented and cited data showing that 80% of new Israeli startups chose to register overseas during the same period. Back in April, the credit rating agency 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.

“Some of these traders assessed that it is quite possible that one of the credit ratings agencies will lower Israel’s rating outlook to negative later this year,” Shafrir said.

With regard to Israel’s risk premium, Shafrir noted that over the past decade foreign institutions viewed Israel as a developed market that trades with a very high correlation to interest rates in advanced markets.

“Currently, about half of the entities we met with stated that Israel’s strong economic data in the long-term — strong balance of payments, leading high-tech sector in a global perspective, and more — will continue to be the main factor that will affect the markets,” Shafrir said. “However about half of the traders/entities indicated that in light of the impact of politics on the economy and markets, Israel, at the present time, is more of an emerging market, and therefore Israel’s risk premium should be higher than in the past.”

Traders and strategists, who were more negative in their assessment of the political situation in Israel, noted that in a scenario of a constitutional crisis or continued advancement of legislation without negotiations, there is growing concern of a sharp increase in Israeli bond yields in the medium and long terms, while the shekel already prices in a considerable risk premium, Shafrir added.

In contrast to the trend in recent years, Shafrir noted that geopolitical risk was also raised in some of the meetings with hedge funds and asset managers.

“Some traders noted that Israel’s risk premium should also rise due to the fear that Israel’s enemies will try, at the present time, to attack Israel — which is weakening internally,” Shafrir said.

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