Citing the steady deteriorating fiscal situation and the absence of a plan to reduce the budget deficit, the global rating agency Fitch over the weekend downgraded one country’s sovereign debt outlook to Negative. The country was the United States, not Israel.
But the reasons Fitch gave for the downgrade could apply to Israel as much as they do to America. It was also an example of how even the world’s biggest and most powerful economies can be hurt by the coronavirus pandemic.
Should Israel, whose debt outlook has been tagged Positive or Stable for the past decade, be worried?
The warning signals have lately been growing stronger. Finance Ministry officials had resolutely opposed Prime Minister Benjamin Netanyahu’s universal grant program, among other things saying that it risked Israel’s credit rating. In addition, the delays in reaching a decision on whether to pass a one-year budget for the rest of 2020 or a two-year package that includes 2021 could be the final straw for the rating agencies.
If the government has not approved a 2021 budget by the end of this year, Israel may be added to the rating agencies’ watch list, increasing the risk that their Israel outlook will later be lowered to Negative,” says Gil Bufman, chief economist at Bank Leumi. “The political situation is not sending good signals vis a vis management of fiscal policy and it’s fair to assume that this will manifest itself in the credit agencies’ reports.”
The pandemic has hurt the credit rating of many of the world’s governments. However, in Israel’s case the problems preceded the onset of the coronavirus, starting with a high structural deficit and the government’s failure to address it. That was why another agency, Moody’s, lowered Israel’s outlook to Stable from Positive last April.
Almost every country has been expending huge sums to cope with the coronavirus, but they have adopted different spending strategies. In addition, even if every government is spending wisely, the speed of a country’s recovery from the pandemic will have a pronounced impact on national finances.
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The winners and losers will only become apparent after it is all over, but the credit rating agencies aren’t waiting: They will decide soon whether they judge Israel to be coping with the pandemic efficiently and effectively. In the view of most economists the universal grant is viewed as inefficient spending because most of it will go to the majority of the population that continue to hold a job and are still earning a living. It will cost the state an estimated 6.7 billion shekels (nearly $2 billion), or more than 0.5% of this year’s forecast gross domestic product.
Bank of Israel Governor Amir Yaron said on Sunday that Israel’s public debt had already ballooned during the pandemic and that every new expense should be considered very carefully.
The claim that a growing national debt right now is a problem isn’t supported by all economists. Some regard the crisis as a chance to invest more in infrastructure and human capital to lay the foundation for future economic growth, but the rating agencies themselves tend to be laser focused on controlling public debt no matter what the reason for its growth.
Bufman points to two warning signals vis a vis Israel’s rating that can be seen by comparing Israel to other countries. The first is the forecast ratio of debt to GDP by the end of this year. In Israel’s case, it is expected to reach 80%, the highest among the countries the agencies traditionally compare Israel to. The second is the size of the increase.
“The increase for Israel is sharper than any other countries in its peer group,” he says. “At the outset [of the crisis], our debt was not as low as in the countries we would like to compare ourselves to, so we need to be more budget-efficient. It is very easy to finance the deficit today, when interest rates are low, but it should be used effectively, and not run amok with debt raising.”
Added Bufman: “Sometimes we are tempted to compare ourselves to the United States, whose debt is expected to exceed 130% of GDP. But I do not think this is a proper comparison, because we are not in a situation where the whole world is running to buy Israeli government bonds.”
On the other hand, the interest rate on Israeli government bonds today is low and hasn’t risen in recent weeks.
But Bufman doesn’t think policy makers can remain sanguine. “The market doesn’t always react immediately to everything. It’s also a function of the Bank of Israel, which has bought up a lot of the excess supply of government bonds, and is also due to the fact that in recent months the need of the government to recycle debt has been relatively low. All over the world, yields are low, but debt needs to be repaid. Increasing the debt significantly today will mean raising taxes tomorrow, assuming that debt relief doesn’t enter our lexicon.”
The other factor that could work against the economy, and as a consequence Israel’s credit rating, is mismanagement of the coronavirus itself. If Israel suffers a prolonged rising rate of contagion, the economic toll will grow. Shira Greenberg, the treasury’s chief economist, warned on Sunday that the recovery from the pandemic will be akin to a recovery from a security crisis or the 2000 dot.com bubble, which could take years. It won’t be like the 2009 financial crisis, from which Israel rebounded quickly.
Greenberg’s most pessimistic forecast sees GDP contracting 7.2% this year and growing just 2.2% in 2021. Fears of a slower recovery and growing debt are common to most countries right now, but Israel is weighed down by an additional challenge: No budget. Hard decisions on fiscal matters were delayed by three back-to-back elections and to date have not been addressed by the unity government. On the contrary, it has been paralyzed by the political wrangling between Netanyahu and Benny Gantz over the one-year/two-year budget debate.
So far, the credit rating agencies have chosen to give Israel time, but if the new government fails to act, their patience is sure to run out.
Prof. Efraim Sadka was one of 15 senior economists signing a letter urging the government to opt for a two-year budget.
“When the government says that economists recommend a budget for 2020 only we are shocked,” he said. “It’s one thing for the government to make a decision for political reasons, there is no reason to hold the economy hostage to them. Although two-year budgets are not seen as ideal, the choice now is not between a one-year and a two-year budget, but between a budget for the two or three months remaining from 2020 after the budget is enacted, and a budget for about 15 months. A three-month budget broadcasts uncertainty and loss of direction.”