Moody’s warns judicial shakeup could scorch Israel’s credit outlook

Company says overhaul will weaken country’s institutional strength, leading to ‘longer-term risks for economic prospects’

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)

The Moody’s rating agency said Tuesday that the Israeli government’s plans to curb the judiciary could weaken the country’s institutional strength and negatively affect its economic outlook.

The warning was the latest signal from the business community that the government’s plans may hamper continued investment in the country, with reports saying some investors have already begun curtailing or completely freezing the flow of money into Israel.

The “proposed judicial overhaul could lead to weaker checks and balances with negative implications for the country’s institutions and governance strength,” the ratings agency said in a six-page report.

“If implemented in full, the proposed changes could materially weaken the strength of the judiciary and as such be credit negative,” Moody’s warned. “The planned changes could also pose longer-term risks for Israel’s economic prospects, particularly capital inflows into the important high-tech sector.”

Moody’s noted that the judicial plans would “materially alter judicial independence and effective checks and balances” in the government, and said Israel’s institutions were a significant factor in its credit profile.

“We typically expect a highly-rated government would implement major institutional reforms on the basis of broad consensus and through extensive dialogue,” the report said. The government has steamrolled the initial parts of the judicial package through the legislative process without negotiating with the opposition.

Moody’s said it did not expect the government plans to have a short-term economic impact, but would likely continue to stoke currency volatility and economic uncertainty, hurting investments.

The report highlighted Israel’s crucial tech sector, which accounts for about half of all exports and a quarter of income tax, and relies on foreign investment.

Moody’s also said government hardliners promoting West Bank settlements could harm relations with neighboring Arab countries which could have a negative economic impact.

Moody’s is one of the main international credit rating agencies used by banks and other financial institutions to gauge investment risk.

Prime Minister Benjamin Netanyahu’s hard-right coalition has prioritized a package of controversial proposals to transform the justice system, which are being spearheaded by Justice Minister Yariv Levin. The proposed legal overhaul would grant the government control over the appointment of judges, including High Court justices, and severely limit the High Court’s ability to strike down legislation — concentrating almost all governing authority in the hands of the political majority.

Noting that the Israeli government has presented “a package of reforms that would represent substantive changes to the country’s judiciary system,” Moody’s added: “The scale of the changes and the speed with which the government attempts to push them through parliament have led to widespread criticism from civil society groups, opposition politicians and the international community. Israel has seen continued large-scale protests since January 2023. It remains to be seen whether the proposed changes will be implemented in their current form or whether some sort of compromise will be reached.”

A Channel 12 report said government officials had been holding talks with Moody’s in recent days trying to convince them that the reforms will not have a negative impact.

Last week, Fitch Ratings affirmed Israel’s A+ credit rating with a stable outlook, citing the country’s “diversified, resilient” economy, but also warned that the government’s planned judicial changes could have a “negative impact” on the country’s credit profile.

Prime Minister Benjamin Netanyahu with Justice Minister Yariv Levin ahead of a vote on the government’s judicial overhaul plans, in the Knesset on February 20, 2023. (Yonatan Sindel/Flash90)

Fitch cautioned that the judicial shakeup could weaken institutional checks, leading to “worse policy outcomes or sustained negative investor sentiment.”

Moody’s downgraded Israel’s credit outlook from “positive” to “stable” in April 2020, citing political instability and financial uncertainty surrounding the COVID-19 pandemic. It went back to a “positive” outlook two years later, citing moves by Naftali Bennett’s government to reduce public debt and restore economic growth.

Amid a torrent of criticism by top public figures, jurists and economists, as well as mass demonstrations throughout the country and increasing threats of reservists that they will refuse to serve if the overhaul passes, pressure has been growing on the coalition in recent days to reach a compromise that will receive broad public backing.

Currently, however, the coalition is moving full steam ahead on its legislative plan.

A group of hundreds of Israeli economists issued a fresh warning on Thursday that a financial meltdown could occur more “powerfully and faster” than they had originally forecast when they penned an “emergency letter” cautioning that the far-reaching judicial shakeup being advanced by the government could have grave implications.

Illustrative: View of the Tel Aviv Stock Exchange, November 29, 2020. (Miriam Alster/Flash90)

“Since we published our first petition, there are many growing indications that the damage to the economy could manifest itself more powerfully and faster than we expected,” the second letter warned. “In recent weeks we are seeing the first signs of capital flight that compels the Bank of Israel to continue raising interest rates at a fast pace.

“Even if the markets eventually stabilize in the short term, experience from other countries where judicial and financial institutions were harmed, and research from recent decades, shows that we can expect long-term damage to economic growth and Israelis’ standard of living,” the experts warned.

“It is still not too late to stop the train before it leaves the station,” they said.

Sharon Wrobel contributed to this report.

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