A political stalemate in Israel that could hinder its ability to bring spending under control in 2021 could trigger a “real risk” of a downgrade of its sovereign rating, a senior director of S&P Global Ratings said this week.
“If the political situation led to a lack of consensus or lack of decision making regarding further fiscal consolidation, that could be a real downside risk to the rating,” Christian Esters, senior director, analytical manager, Sovereign and International Public Finance Ratings, S&P Global Ratings, said in an interview with The Times of Israel.
In November, the ratings agency affirmed its AA- rating for Israel with a stable outlook, even as the country has been economically wracked by the coronavirus pandemic, has been without a budget since 2019, is facing a near-certain fourth general election within two years, and has its Prime Minister Benjamin Netanyahu on trial for bribery, fraud and breach of trust.
S&P forecasts Israel’s economy to contract by 5% this year and grow by 4.5% in 2021. Only in 2022 is Israel’s economy forecast to reach its pre-pandemic level, he said, with GDP per capita catching up to its 2019 level only in 2023, due to population growth.
The second wave of the coronavirus could affect worldwide economic recovery, so the first quarter of 2021 will have a “more difficult start” than previously forecast, said Esters. The rollout of the vaccines, however, which is expected to be widely available globally by mid-2021, will help the economy “rebound” next year, more likely in the second quarter than the first quarter, he said.
The likelihood of Israel holding another election early next year and of it not passing a 2021 budget in the near future were both already factored in when S&P reaffirmed its rating in November, Esters said.
“The fact that there might be a fourth round of elections within a couple of months, basically, in a very short timeframe, in and of itself will not have any immediate implications on the ratings,” Esters said.
Even without a budget the government was able to pass the necessary fiscal stimulus measures needed to cope with the coronavirus pandemic, he noted.
However, there could be “real risk” for a lowering of the rating if a fragmented Knesset hinders the financial belt-tightening that will be needed after the pandemic.
Because of the coronavirus, Israel’s debt-to-GDP ratio has surged as the government has sought to bankroll rescue plans for the economy. S&P forecast the ratio to be at 74.5% at the end of 2020, up from 60% in 2019, and to climb further to 78.4% and 78.6% in 2021 and 2022.
Israel’s “fiscal situation has deteriorated quite substantially in 2020,” Esters said. This has occurred in all the advanced economies in the world, due to the fiscal stimulus packages set out to stem the economic fallout from the pandemic, and with governments collecting less tax money due to a shutdown of business activity.
“Our baseline expectation that we reflect in our rating is that this is a temporary effect in 2020, due to those exceptional circumstances in Israel and worldwide,” he said. “We are rating through this cycle, through this event, and taking a more medium-term perspective.”
S&P, however, is expecting “some fiscal consolidation in 2021, and further in 2022 and in the following years,” both in Israel and in other nations.
“Our current expectation for Israel is for fiscal debt to stabilize at below 80% of GDP,” Esters said. “So, if for instance the political situation led to debt remaining on a further increasing trend, that could be a downside risk to the rating. A pattern of unstable governments, a focus on more immediate electoral prospects — if policy makers focus on near term election outcomes rather than on fiscal consolidation over the medium term — could increase the likelihood of a negative rating action.”
An economic downturn that is deeper or longer than expected could also be a “downside trigger” to the rating, Esters said.
Upside scenario ‘unlikely’ in current environment
Esters emphasized that S&P’s outlook for Israel is stable, which basically means that for the next 12 months it does not see a change in the rating, short of “unforeseen or unexpected events.”
“An upside scenario, in which the rating is raised, is probably unlikely in the current economic environment,” Esters said. “I think, overall, downside risks are higher than a potential upside.”
Meanwhile, the geopolitical risk, which has traditionally weighed on Israel’s rating, continues to be high, he said, even as Israel forges new ties with Arab nations including the UAE, Morocco and Bhutan.
Israel and the UAE and Bahrain signed normalization agreements in September, called the Abraham Accords, paving the way for a buzz of business and tourist activity. Earlier this month, Israel and Morocco agreed to reestablish diplomatic relations and full diplomatic ties with Bhutan were also announced.
“The normalization between GCC countries such as the UAE, Bahrain, and Israel, contribute to broader geopolitical stability in the region,” he said, and this could eventually be a “supportive factor also for the sovereign ratings” of Israel, though not in the near term.
“We expect there will be a significant increase in cooperation in certain areas, for example, tourism, security, telecommunications, technology, health and possibly education,” he said. “This can be positive for economies of all the parties to this collaboration.”
But with regard to the size of the economic impact, Esters said, “it is too early to tell. The jury is still out.”
Geopolitical risk still high
These new ties are unlikely “in the near term” to trigger an upside in the rating, he said.
“It’s not only about agreements between the Gulf countries and Israel,” Esters said. “There are other players in the region who also have their own interests, and who are probably very unlikely to be on board with any peace agreement in the foreseeable future. So, I think some of those risks will remain. And that suggests that this underlying concern about security risks will persist.”
Esters was a speaker earlier this week at the Eli Hurvitz Conference on Economics and Society for 2020, organized by the Israel Democracy Institute.