Moody’s Investors Service said Monday that the key trigger for lowering Israel’s credit outlook to “stable” was concern that the planned changes to the country’s legal system would threaten the independence of the judiciary, which is crucial in particular in Israel.
Speaking at a webinar after Friday’s outlook downgrade, Moody’s Senior Vice President Kathrin Muehlbronner explained that the credit agency assesses a country’s strength of executive and legislative institutions, the strength of its civil society and the judiciary and how effective they are.
“The only driver for our rating action last Friday were the events around the government’s plans for judicial changes [which] have shown us that, in Israel, you can have a government that is willing to take pretty significant risks with economic and social stability,” said Muehlbronner. “With Israel, our main concern is the executive pushing through important changes to the institutional setup of the country at such a speed, and without any dialogue really, for us is not a sign of strong institutions.”
Muehlbronner cautioned that the controversial overhaul plans “risk undermining the independence of the judiciary because the government would have control of the appointment of judges — in particular the appointment of Supreme Court judges — and it would also limit the ability of the Supreme Court to review legislation and decide on the legality of laws.”
“Having a strong and independent judiciary is important everywhere, but even more so in a system like Israel, where there are really only two branches of government, the executive and the judiciary,” she emphasized. “Other checks and balances that exist in other countries are relatively weak in Israel.”
The comments came after Moody’s reduced the country’s economic outlook from positive to stable, citing a “deterioration of Israel’s governance,” and criticizing the “manner in which the government has attempted to implement a wide-ranging [judicial] reform without seeking broad consensus.” This, the agency warned, “points to a weakening of policy predictability.”
Asked about why Moody’s decided to lower Israel’s credit outlook even though Prime Minister Benjamin Netanyahu paused the legislative process to hold negotiations and reach a compromise, Muehlbronner cited the determination of the government to push through the change on the selection of judges and the risk of increased social unrest and protests.
“Despite halting the legislative process and agreeing to negotiations, it [the government] has reiterated its intention to change how judges are selected,” said Muehlbronner. “That’s the key proposal and the key point of conflict here: Who can decide how judges are nominated, and how big the influence is of politicians over the nomination of judges, and here the government has made it very clear that this is the part that it will want to push through.”
Muehlbronner said she was impressed with Israel’s civil society and other institutions such as labor unions and the security establishment, which, she said, have “clearly shown in this whole turmoil, that they are highly effective checks on the exercise of government power.”
“Their protests have brought the government to change its position and stop the bill for some time,” she added.
The Moody’s analyst also raised serious concerns that the protests have exposed “deep divisions” in Israeli society and cautioned that the rating agency expects social and political risks to remain elevated for quite some time.
“We think those [divisions] run deeper than the judicial changes,” she warned. “They have a lot to do with the demographic composition in Israel and the highly unequal income distribution.”
For now, Moody’s sees Israel’s outlook as stable, which means upside potential, downside risks are broadly balanced and investors are waiting to see what will come out of the negotiation efforts to reach a broad consensus on the judicial overhaul.
However, Muehlbronner cautioned that Israel’s outlook could be further downgraded if the situation is not resolved, and if social and economic tensions continue; in particular, if there is a significant negative impact on Israel’s high-tech sector, the country’s key engine of economic growth.
“The high-tech sector is of crucial importance to the economy as it generates 50% of exports and 16% of GDP, and is a major contributor to tax revenue,” said Muehlbronner. “What could bring the rating down is if this is not resolved, the tensions continue with voices from the high tech sector and a lot of employees in the high tech sector participating in the protests and some high profile entrepreneurs, CEOs of Israeli high tech companies, threatening to leave the country and take their money out.”
Muehlbronner noted that as the high tech sector is very mobile and dependent on most of its funding from abroad, “the biggest risk that we see and for a lot of the people we have been speaking to see is, money that could have gone to Israel might not go to Israel, or some Israeli firms might decide to launch their next startup not in Israel, but elsewhere.”
Finance Minister Bezalel Smotrich on Sunday sought to downplay the Moody’s downgrade as “no big drama,” reiterating his claim that the planned judicial changes will be good for the economy and any damage would be a result of the “campaigns of lies” against the overhaul.
“I don’t think economists are great experts in constitutional, judicial law; they don’t hold a doctorate on governmental structure in Israel,” Smotrich said. “The responsibility of Israel’s economy lies on my shoulders, not on Moody’s shoulders.”
Moody’s reaffirmed Israel’s A1 credit rating backed by “strong economic growth and improving fiscal strength.” Muehlbronner praised Israel’s good growth prospects and improving fiscal and debt metrics as positive trends, which she said are still in place.
“They could reassert themselves if the institutional question marks are solved in a positive manner,” she remarked.
In 2022, Israel posted the first budget surplus in 35 years of 0.6% of GDP as state revenues rose 4.8% to NIS 468.5 billion and exceeded total expenditure of NIS 458.8 billion. For this year, the Finance Ministry targets budget deficits of 0.9% in 2023 and 0.8% of GDP in 2024.
“Most of the very strong fiscal results were the result of extraordinarily strong tax revenues and I think everybody agrees that some of those aren’t permanent,” Muehlbronner said. “Tax revenues have benefited a lot from high valuation and equity markets and in real estate.”
“That’s the main reason why we we think that the [current] budget proposal is prudent,” she added.
In late March, the Knesset approved in its first reading the state’s 2023-2024 budget. It is currently under discussion at the Knesset Finance Committee. Netanyahu’s government has until May 29 to successfully complete the two remaining budget votes on the Knesset floor or risk automatically triggering the government’s collapse.
Asked about Moody’s credit view if the budget is not passed, Muehlbronner said: “Going back to a situation where you enter a new election cycle, where it’s completely unclear how things would evolve at first sight, I think would be negative.”
Asked about what would cause Moody’s to reconsider Israel’s credit outlook and restore it to positive, Muehlbronner said that would require a “solution to the current tensions that doesn’t deepen the underlying social tensions between these various demographic groups, and a continuation of the positive fiscal debt trends and the positive economic trends that we have seen.”