Return of judicial overhaul could hurt Israel’s credit rating, Fitch warns

Bank of Israel head says economy has suffered significant shock in recent months due to proposed sweeping changes to judicial system

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

An illustrative photo of the Tel Aviv financial business district skyline. (Elijah Lovkoff via iStock by Getty Images)
An illustrative photo of the Tel Aviv financial business district skyline. (Elijah Lovkoff via iStock by Getty Images)

Fitch Ratings warned that growing domestic social and political upheaval and renewed uncertainty around the proposed judicial overhaul could hurt Israel’s A+ sovereign credit rating.

“Israel continues to face high levels of internal social and political tension, and the advancement of certain policies favored by the governing coalition could aggravate these strains and influence the sovereign’s rating,” Fitch said in a report released late on Monday titled “Strong Economic Growth Key to Israel’s Debt Trajectory.”

In March, the ratings agency affirmed Israel’s A+ credit rating with a stable outlook, citing the country’s “diversified, resilient” economy, while warning that the government’s planned judicial changes could have a “negative impact” on the country’s credit profile if it “weakens governance indicators, or if the weakening of institutional checks leads to worse policy outcomes or sustained negative investor sentiment.”

While Fitch welcomed the government’s passage of the bi-annual 2023-24 state budget before the May 29 deadline, the ratings agency issued a caution over the resumption of the contentious judicial overhaul.

“Prime Minister Benjamin Netanyahu said after the budget’s passage that judicial reform will return, but the coalition’s exact proposals remain unclear,” Fitch said.

Speaking at the Israel Democracy Institute conference in Jerusalem on Tuesday, Bank of Israel governor Amir Yaron said the Israeli economy has experienced a significant domestic shock in recent months as the proposed judicial overhaul created uncertainty for investors and Israeli markets.

Bank of Israel governor Amir Yaron speaks at the Israel Democracy Institute (IDI) conference in Jerusalem, May 30, 2023. (Oded Karni)

“As soon as certainty in the economy is undermined, then the certainty of doing business is also undermined,” Yaron said. “Since the beginning of the year, the domestic capital market has underperformed global markets, and the credit risk premium on local government bonds has increased.”

Yaron, noting the global decline in high-tech fundraising volumes, emphasized that Israeli startups have suffered a sharper drop in recent months than the rest of the world.

“The volume of capital raised in Israel relative to the US also declined markedly, returning to pre-2019 levels,” Yaron said. “This does not mean that from one day to another the world will stop trading with Israel; it also does not mean that we will not see significant investments in the Israeli economy.”

“But it does mean that the continued uncertainty has considerable economic costs. Therefore, decision makers must restore stability and certainty to the Israeli economy by reaching broad agreement on the legal changes with all stakeholders while maintaining the strength and independence of institutions,” he said.

In an encouraging note, Fitch raised the possibility of “positive action” on Israel’s credit rating subject to “stable governance indicators,” which include political stability, rule of law, and government effectiveness, and as the agency expects Israel’s government debt-to-GDP ratio to continue to decline in the coming years despite the return to fiscal deficits. Fitch projects Israel’s economy will expand by an average 6.9% over the next three years.

Commenting further on Israel’s current state budget, Fitch raised questions about the funds directed to education and transportation infrastructure under the just-passed two-year budget.

“The quality of such spending will also be important, and we believe there is still a risk that shortfalls in infrastructure and human capital could become more of an obstacle for Israel’s growth potential in the long term if it is not utilized effectively,” Fitch noted.

As part of the state budget, the government approved the allocation of discretionary funds of more than NIS 14 billion that had been promised to meet coalition commitments and will mostly go toward bolstering ultra-Orthodox institutions and programs and the distribution of food vouchers.

The majority of non-official ultra-Orthodox educational institutions are not subject to supervision by the Education Ministry and do not teach core studies such as math, science or English, which are considered basic skills for the integration of Haredim into the labor market.

Central bank governor Yaron said the budget lacks “essential growth generators for both physical and human capital and in some parts it constitutes a negative contribution to growth in the economy.”

“Overall, in the current budget, the Finance Ministry has exhausted the funds for investment in infrastructure,” Yaron said. “There is a gap between fast demographic growth in Israel and investment in national infrastructure such as public transportation, roads, and the metro project.”

Additionally, Yaron reiterated the central bank’s view that one of Israel’s strategic and economic challenges lies in boosting labor productivity.

“Improving the quality of human capital requires improving the quality of the education system, in order to acquire the skills required for the labor market, especially among Haredi men and Arab women,” Yaron said. “As a society we must ensure that there are equal opportunities for all segments of the population regarding the level of basic skills required in the labor market – mainly math and English – so that in the future every boy or girl from every sector in Israel will be able to choose to go out to work and earn a decent salary.”

Most Popular
read more: