Moody’s downgrades Israel’s credit outlook, citing ‘deterioration of governance’

Leading credit agency demotes outlook from positive to stable despite reported talks with PM, Herzog on overhaul compromise; keeps credit rating at A1 amid ‘strong economic growth’

A sign for Moody's Corp. in New York, August 13, 2010. (AP Photo/ Mark Lennihan/ File)
A sign for Moody's Corp. in New York, August 13, 2010. (AP Photo/ Mark Lennihan/ File)

Leading rating agency Moody’s downgraded Israel’s economic outlook from positive to stable on Friday, citing the “deterioration of Israel’s governance” amid months of upheaval over the government’s highly contentious bid to dramatically overhaul the judiciary.

The report Friday confirmed fears that Israel’s credit outlook could be knocked down, as Moody’s had warned last month, if the hardline government of Prime Minister Benjamin Netanyahu pursues plans to bring most judicial appointments under political control and dramatically curb the powers of the High Court of Justice. If implemented in full, the proposals for judicial revamp would “materially weaken the strength of the judiciary and as such be credit negative,” Moody’s said in a six-page report in early March.

Weekly mass protests around the country against the government’s persistent efforts to weaken the judicial system have continued even after Netanyahu paused the legislation late last month to allow dialogue on reaching a compromise between the sides. Coalition members have nevertheless vowed to press forward with the legislative push after the Knesset’s Passover recess.

On Friday, the agency said the change — which came just a year after Moody’s upgraded Israel’s credit outlook — “reflects a deterioration of Israel’s governance, as illustrated by the recent events around the government’s proposal for overhauling the country’s judiciary.

“While mass protests have led the government to pause the legislation and seek dialogue with the opposition, the manner in which the government has attempted to implement a wide-ranging reform without seeking broad consensus points to a weakening of institutional strength and policy predictability,” Moody’s strongly worded, eight-page report read.

Before April 2022, Israel last earned a positive outlook from Moody’s in July 2018, which was lowered to stable in April 2020 when the COVID-19 pandemic started gaining pace.

While Israel’s credit outlook took a hit on Friday, the agency kept the country’s actual credit rating at A1, citing “strong economic growth and improving fiscal strength,” it said.

Tel Aviv’s financial business district skyline, June 2022 (Elijah Lovkoff via iStock by Getty Images)

Moody’s credit rating scale runs from Aaa (the highest) to C (the lowest); an A1 grade falls in the upper portion of the medium grades.

Israel’s economy, Moody’s said, “has proven resilient to many economic and geopolitical shocks over the past decades and has grown at a rapid clip, helped by Israel’s globally competitive high-tech industries. Moody’s baseline projections assume continued robust growth in the medium term.”

“The Israeli economy has grown at a rapid rate over the past several years, averaging 4.1% over the decade to 2022, helped to an important extent by the globally competitive and increasingly diversified high-tech industries,” it said.

Israel’s vaunted tech sector has long been touted as the main engine of Israel’s economic growth, accounting for 49% of total exports and generating around 15% of GDP in 2022.

It has been a key part of the opposition to the government’s judicial plans, with some firms moving significant funds abroad and threatening to relocate.

Moody’s warned Friday that Israel’s credit ratings could also come “under downward pressure if the current tensions were to turn into a prolonged political and social crisis with material negative impact on the economy, possibly linked to substantially lower capital inflows into the important high-tech sector and relocation of Israeli firms abroad.”

Tech workers protest against the government’s judicial overhaul ‘time is running out for Israeli high-tech,’ in Tel Aviv, on March 23, 2023 (Avshalom Sassoni/Flash90)

In recent days before the publication of the report, Netanyahu and President Isaac Herzog, who is hosting compromise talks on the overhaul, have held urgent discussions with senior Moody’s officials, trying to reassure the agency that legislation has been put on hold in an effort to reach broad agreements, Channel 12 reported.

Aiming to at least prevent a downgrade in Israel’s credit rating, Herzog spoke with senior Moody’s officials for over an hour, and told them he was optimistic but not naive about the prospects of a compromise, while Netanyahu said the legislation would not advance with great rapidity and aspects of it relating to constraining the court and thwarting its rulings would be less extreme than in current drafts, the TV channel said.

Moody’s said that while the Israeli government was indeed holding deliberations, it has also “reiterated its intention to change how judges are selected. This means that the risk of further political and social tensions within the country remains.” But should a compromise be reached “without deepening these tensions, the positive economic and fiscal trends that Moody’s had previously identified remain,” it went on.

On the geopolitical front, while tensions “have traditionally not had a major or lasting impact on Israel’s economy, a serious escalation of tensions with the Palestinians could endanger Israel’s improved relations with some of its neighbors and potentially lead to increased international isolation with negative implications for the export-orientated economy and Israel’s economic strength,” Moody’s said in reference to Israel’s growing diplomatic and economic ties to Abraham Accords signatories including the United Arab Emirates and Morocco.

Earlier this month, the OECD cautioned that the country’s pace of economic growth is expected to moderate, warning that “risks are skewed to the downside, related to high global and domestic uncertainty.” The organization sees GDP slowing from the 6.4% growth rate last year to 3% in 2023 and 3.4% in 2024.

In early April, Bank of Israel economists presented an analysis of the potential economic ramifications depending on the intensity of the shocks over the next three years if the proposed legislative and institutional changes lead to an increase in Israel’s risk premium.

In a case where the shock of the legislative changes subsides relatively quickly, the potential impact could be a 0.8% annual hit to GDP and cost the economy NIS 14 billion. In case shocks from the changes persist, the adverse impact is estimated at about 2.8% to GDP, or NIS 50 billion per year.

Protesters rally against the government’s judicial overhaul plans, at the Azrieli junction in Tel Aviv, on April 8, 2023. (Avshalom Sassoni/Flash90)

On Friday, the release of the March consumer price index (CPI), a measure of inflation that tracks the average cost of household goods, showed an increase of 0.4% from February. CPI has been hovering above 5% in annual terms for the past six months, falling short of the government’s target range of 1% to 3%.

The rise in inflation came despite steps taken by the Bank of Israel to rein it in. The central bank has over the past year steadily hiked its benchmark interest rate from a record low of 0.1% last April to 4.5% earlier this month in a bid to bring down price growth.

Inflation has been slower to ease in part due to a weaker shekel, which is making imported goods more expensive. Since the beginning of this year, the local currency has depreciated about 4% against the US dollar. The US dollar index, which measures the greenback against six major world currencies, has declined about 2% since the start of 2023.

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