More rating cuts feared after Moody’s downgrades Israel by two notches

By Steven Scheer

JERUSALEM (Reuters) – A two-notch downgrade of Israel’s credit rating by Moody’s (NYSE: as fast as in the past. conflicts.

Moody’s surprise move on Friday to downgrade Israel’s credit rating to “Baa1” from “A2” was criticized by government officials but reflected uncertainty about Israel’s economic outlook amid the conflicts.

“The ratings would likely be downgraded further, possibly by several notches, if the current heightened tensions with Hezbollah develop into a full-scale conflict,” Moody’s said.

Bank Hapoalim economist Victor Bahar noted that “a Baa1 debt rating typically characterizes countries that are much less rich and less developed than Israel.”

The downgrade kept Israel’s investment-grade rating at three notches, down from six earlier this year.

“There are a lot of issues that we have to do to keep this current rating,” said Yair Avidan, a former Israeli banking regulator.

Israel’s year-long war against the Palestinian Islamist group Hamas in Gaza has cost an estimated 250 billion shekels ($67 billion). At the same time, it responded to rocket fire from Hezbollah in Lebanon.

MOODY QUESTIONS CHANCES OF QUICK RECOVERY

Moody’s said the unusual length of the conflict and the lack of a clear prospect of a resolution raised doubts about how quickly the economy would recover.

“It’s certainly a pretty strong indication that they think the risks are rising more than they thought before, and the deterioration is fast,” said Karnit Flug, a former central bank chief now at the Israel Democracy Institute.

Israeli politicians, including Finance Minister Bezalel Smotrich, said Moody’s downgrade, which followed downgrades by Fitch and S&P Global, underestimated the strength of the Israeli economy.

Fitch expects Israel to increase long-term defense spending from pre-war levels by nearly 1.5 percent of GDP, and S&P Global also bemoaned ever-increasing geopolitical risks and a growing budget deficit.

Israel’s Accountant General Yali Rothenberg said it was clear the multi-front war would exact an economic price, but said there was “no justification” for Moody’s latest downgrade.

But growth has clearly taken a hit over the past year, slowing to an annualized 0.7 percent in the second quarter — or a contraction of 0.9 percent per capita as Israel’s population expands — increasing pressure on government finances.

WAR WITH HEZBOLLAH COULD SLOW ECONOMY, EXPAND DEFICIT

According to the Aharon Institute for Economic Policy at Reichman University, an all-out war with Hezbollah, including a land campaign, would lead to an economic contraction of 3.1 percent this year and a budget deficit of 9.2 percent of GDP.

With the defense budget rising and Prime Minister Benjamin Netanyahu’s coalition partners insisting on maintaining favored spending programs in the delayed 2025 budget, Moody’s criticized fiscal policy.

Finance Minister Bezalel Smotrich’s plan targets a deficit of 4 percent of GDP and 35 billion shekels in spending cuts.

A senior government official said Moody’s should have waited until the 2025 budget was approved, but that process has already been delayed by two months amid coalition disputes.

“What is clear is that they do not trust the government in terms of the fiscal outlook,” said Flug of the Israel Democracy Institute.

For many in Israel’s business sector, the underlying strength of the economy and its dynamic high-tech sector outweigh questions about government spending targets.

Yossi Abu, chief executive of NewMed Energy, called Moody’s decision “a colossal mistake” that “reflects a lack of understanding of Israeli resilience and the Israeli spirit.”

For its part, the Bank of Israel has called for spending cuts and tax hikes to control a deficit that the government projected at 6.6 percent of gross domestic product by 2024, but currently stands at 8.3 percent. Moody’s sees a deficit of 7.5% this year.

($1 = 3.7074 shekels)