Fitch Lowers Israel's Credit Rating Outlook From Positive to Stable

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Finance Minister Yair Lapid at the inauguration of the new Tel Aviv Stock Exchange building, September 8, 2014.Credit: Ofer Vaknin

On Friday, the Fitch Ratings agency issued a revised outlook on Israel’s long-term foreign currency Issuer Default Rating (IDR), downgrading it to Stable from Positive. The ratings agency did not, however, change Israel’s actual credit rating, leaving the long-term foreign IDR rating at A and the local currency IDR at A+.

The lowering of the outlook stems from concern that the Israeli economy is slowing, as well as from the government’s growing investment in defense and the 2015 budget’s higher deficit ceiling. Fitch’s decision has prompted concern in Israel over the consequences that the lowered outlook may have on Israel’s standing in international markets, as well as on upcoming credit announcements by Moody’s and Standard & Poor’s, the two other major credit rating agencies.

For their part, however, Finance Ministry sources noted over the weekend that Fitch leaves its credit outlook in place for two years at most. When the rating agency sees stability in the rating, it gives the country a Stable rating, meaning that the agency does not expect to raise the rating in the next two years, the ministry officials said. Therefore, the downgrading of the outlook could mean that Fitch simply doesn’t expect to raise Israel’s credit rating during the upcoming year.

If other rating agencies follow Fitch’s lead, however, it could spell higher lending costs for the country. In talks that Fitch representatives held recently with high-level government officials in Israel, the Israelis were told that if there was no dramatic improvement in how the country’s economy was managed, its current A rating could not be assured.

For her part, Bank of Israel Governor Karnit Flug recently issued warnings of her own about steps that could hurt Israel’s credit rating, including raising the budget deficit ceiling. It appears that Fitch economists understand that political considerations are currently taking precedence over economic ones on Prime Minister Benjamin Netanyahu’s and Finance Minister Yair Lapid’s agenda. On the other hand, speaking at a manufacturers’ convention in Eilat on Friday, Flug said that data on economic growth for the fourth quarter of this year should be expected to show a return to a pace of the kind that the Israeli economy has experienced in recent years – just under 3%. Noting the global economic slowdown in recent years, she said the 0.4% decline in economic output for the third quarter was also a result of this past summer’s military hostilities.

In explaining their decision to change Israel’s credit outlook from Positive to Stable, Fitch’s analysts specifically cited the high military expenses that the Israeli government incurred due to this past summer’s fighting with Hamas and its allies in the Gaza Strip, and the effect of these outlays on Israel’s finances this year and next. In addition, they cited the proposed increase in the country’s budget deficit ceiling from 2.5%, as originally proposed, to 3.4% of Israel’s gross domestic product.

The report also noted the stalled peace talks with the Palestinian Authority in addition to the confrontation with Hamas as geopolitical risks, in addition to those posed by Iran and Syria, as weighing on Israel’s credit rating. Fitch projects real growth of Israel’s GDP this year at 2.3%, just 0.1 percentage point lower than the Finance Ministry’s projection.

Change in outlook may have been avoided

There is hardly any doubt that if matters relating to the approval of next year’s budget had been handled differently, Fitch would have been more reticent to touch its outlook for Israel’s credit rating. In fact, concern is being expressed by Knesset sources over the prospect that the 2015 budget, along with the Economic Arrangements Bill that supplements it, will not be passed into law by January 1, when they are due to take effect. If that happens, the Finance Ministry will simply fund government operations based on the same allocations that were provided for in the 2014 budget, doling out 1/12 of the annual allocation every month until a budget is passed.

Netanyahu is furious with Lapid (Yesh Atid) over his refusal to remove reform plans contained in the Economic Arrangements Bill so they can be converted into separate legislation. Last week the prime minister even tried to change the political constellation of forces in the coalition by broadening his government by wooing new coalition partners. The effort failed, however.

Lapid’s flagship piece of legislation, which would provide an exemption from 18% value added tax to qualifying buyers of new residential construction, is separate from the Economic Arrangements Bill. There is concern in Netanyahu’s Likud party that once the 0% VAT law passes, Lapid would not hesitate to bring down the government despite opinion polls that show Yesh Atid winning barely more than half the 19 seats that it won in last year’s election. There are efforts afoot to get Lapid and Netanyahu together to break the deadlock, but in the interim, the legislative process on the 2015 budget, the Economic Arrangements Bill and the 0% VAT legislation are all stalled.

The nub of the differences between the finance minister and prime minister on the budget legislation relate to three reform plans contained in the Economic Arrangements Bill. One has to do with a proposed change in the status of the Jewish National Fund, the non-profit organization that was founded in 1901 to acquire and develop land in trust for the Jewish people. JNF owns a large chunk of the country’s land and the proposed reform plan would transfer about a billion shekels ($261 billion) in land sale proceeds from the organization to the state’s coffers.

The other two reforms in dispute relate to curbs on private medical care in a plan spearheaded by Lapid’s party colleague Health Minister Yael German, and a proposed sale of additional stakes in government-owned companies to the public.

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