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Israel Keeps Its Rating, but Shouldn’t Rest on Its Laurels

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Finance Minister Israel Katz and Prime Minister Benjamin Netanyahu in Jerusalem, October 27, 2019.
Finance Minister Israel Katz and Prime Minister Benjamin Netanyahu in Jerusalem, October 27, 2019. Credit: Gali Tibbon / Reuters
Sami Peretz
Sami Peretz

When Shaul Meridor, the head of the treasury’s budget division, announced August 30 he was quitting, in a sharply worded letter critical of Finance Minister Yisrael Katz, there was a lot of talk about Israel’s credit rating now being at risk of being downgraded.

It wasn’t due to Meridor’s going home in a huff, but rather because of the letter he left behind, in which he claimed that Katz was fiddling with the treasury’s budget forecast in order to create fictional revenue sources that in the future he could use to justify additional spending. Meridor said Katz was ignoring macroeconomic data and the advice of the ministry’s professional staff. If anyone needed reminding, Meridor pointed out that Israel has been without a budget since 2018.

However, it’s doubtful that any of the credit rating agencies ever read the letter or examined its claims in depth. Two and a half months after Meridor’s letter, as well as the resignations of Treasury Director General Keren Terner-Eyal and Accountant General Rony Hizkiyahu, both Standard & Poor’s and Moody’s have decided to leave Israel’s rating unchanged.

Their analysts met with senior treasury officials and concluded that there was no reason for a downgrade or even a change in the outlook. A lot of Israelis are concerned about the absence of a budget and the unmanned jobs at the treasury, but the rating agencies are far less so. On Friday, S&P kept Israel at a relatively higher AA-minus rating, with a stable outlook; a month earlier, Moody’s affirmed its A1 rating, also keeping the outlook stable.

Finance Ministry budget department director Shaul Meridor, December 31, 2019Credit: Tomer Appelbaum

Somebody has to be misreading the situation. Either the rating agencies don’t fully appreciate Israel’s increasingly problematic politics and where it’s leading the economy, or Israeli commentators and economists are giving too much weight to the chaos.

A credit rating is basically about one thing – the ability of the borrower to repay its debt. As a rule, a sharp deterioration in macroeconomic data – for instance, a big rise in public debt, lack of fiscal discipline or an extended recession – lead to a rating downgrade.

However, the coronavirus crisis is a global event, not something unique to Israel. The rating agencies have adopted the same attitude as the world’s central banks: The situation is bad enough that they think it over multiple times before risking making things worse by strangling economies that are gasping for air. Issuing dire warnings could do just that. As long as Israel isn’t doing worse than other developed economies, we remain in good company.

In any case, Israel has one major asset because its economy is more heavily weighted to high-tech than others. On the other side of the coin, tourism is a relatively small contributor to the economy, compared with Western European countries.

It was no surprise that Katz celebrated the S&P report, calling it “a great expression of trust in Israel’s economy and a mark of praise for the State of Israel.” He even praised Hizkiyahu for managing the absence of a national budget for 2020 and his success in borrowing abroad.

Rony Hizkiyahu in Tel Aviv, November 2020.Credit: Eyal Toueg

More realistically, it would be fair to say that Israel resembles a bunch of people being chased by a hungry lion and is staying alive by not being the last in the line of the pursued. Compared with other developed economies, our performance has been about in the middle. Britain, for example, suffered a ratings cut by Moody’s in October, due to low economic growth before the coronavirus and to Brexit.

A rating, however, doesn’t just take into account new data but past developments and policies. Here, Israel has benefited from a 17-year history of current account surpluses and massive foreign currency reserves, a record of relative budget discipline and an independent central bank that has exhibited creativity and flexibility during the pandemic crisis.

Okay, but what about three back-to-back general elections and the distinct possibility of a fourth one coming soon? That doesn’t elicit much excitement from the rating agency economists. The fragile coalition? That doesn’t both them either. The lack of any progress toward a 2021 budget? We’re good. S&P economists limited themselves to warning that political uncertainty and a fragile government that failed to set budget priorities could eventually lead to a lower rating.

The view from the outside of Israel’s fiscal chaos is fundamentally different from the view from the inside. The fact that has been using its 2019 budget (allocated on a month-by-month basis) during 2020 is seen as the kind of fiscal restraint ratings agencies like. As long as Israel struggles with passing a budget, it remains inside the government’s fiscal targets (not counting the considerable extra spending to cope with the coronavirus). There’s no reason to lower our rating.

The government’s failure to pass a budget serves as an insurance policy against fiscal indiscipline. The problem is that the policy only works for the short term.

Leo Lederman, the chief economist at Bank Hapoalim, has another explanation for the rating agencies’ serenity: “The experience of recent years has taught that the agencies lag a little behind the markets. In Israel, yields on government bonds have not changed significantly despite the political uncertainty, even though we have been through three elections and may go into a fourth one even as the government struggles to do its job.”

Leo Lederman, the chief economist at Bank HapoalimCredit: David Bachar

But Lederman also has a warning: “The rating agencies give credit to a country’s ability to repay its debt. We shouldn’t be wasting that credit and should be acting quickly on the budget and creating [economic] growth engines.”

It would be a big mistake if the government concludes from Israel’s rating being left intact that it is functioning well and that it can continue without a state budget and without economic reforms. Israel now enjoys being able to borrow overseas at low rates of interest, but it will have to prove that it is using the money effectively to ensure that hundreds of thousands of unemployed and tens of thousands of troubled businesses have a route to jobs and recovery.

A country’s political conduct can also have an impact on its rating, in particular when a government engages in short-term, populist policies. The current government has done just that on several occasions, like the 9 billion shekels ($2.7 billion) in grants given out without any reference to the recipient’s need. At least those same politicians have created the potential for the economic benefits from the normalization agreements with the United Arab Emirates and with Bahrain.

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