Analysis

Israel’s Rating Upgrade Ignores Critical Aspects of Its Economy

Standard & Poor’s analysis is about whether the government can repay its debt, but it says almost nothing about the country’s economic, political and social performance, or lack thereof

A pedestrian passes in front of Standard & Poor's headquarters in New York, U.S., on Tuesday, Feb. 5, 2013
Bloomberg

Congratulations Israel! Standard & Poor’s raised the country’s debt rating over the weekend and, as expected, the nation’s leaders celebrated. “This is a day of celebration for the Israeli economy,” said Michal Abadi-Boiangiu,” former treasury accountant general and today chairwoman of its biggest investment house, Psagot. Finance Minister Moshe Kahlon extolled the virtues of the higher credit rating as saving the government interest costs and enabling it to spend more on health, education and welfare.

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The raising of Israel’s sovereign credit rating from A+ to AA- is indeed an important and joyous event, but we should be clear about what kind of event it is.

S&P and the other two global rating agencies, Moody’s Investors Service and Fitch Ratings, employ economists and finance experts in order to offer their customers — mainly institutional investors on one hand and on the other hand companies and governments that want to be rated — an opinion on one thing and only one thing: the likelihood that the company or government can repay its future debt on time.

Their criteria for making that judgment is based on several factors, including present debt, the ability to generate cash flow to repay it, the government or company’s history on meeting its obligations and other risks. To the small team of economists that assessed Israel, all the numbers looked good and we were moved up a notch in the ratings.

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Which numbers? The first was Israel’s debt to gross domestic product ratio, which is relatively low and declining. The second is the outlook for GDP growth over the next four years, which is forecast to average 3.3% annually, S&P believes. It was also impressed by the government’s ability keep its financial house in order.

The risks, as the S&P economists see them, is the security problem, the risk of a housing bubble and political and grassroots pressure on the budget. But S&P’s economists said they didn’t believe those will have a long-term impact and so they discounted their importance in the final decision. On the other hand, a major war, a sharp decline in economic growth or a major deterioration of Israel’s fiscal situation could lead to a lower rating.

What S&P economists don’t do is to look at the wider economic, social or political picture. It’s not their job. As long as Israel is repaying its debt on time, they have nothing to say about income inequality, the cost of living, public health care, democracy or 1,001 other things that concern ordinary Israelis.

Here’s a simple example: With the latest upgrade, Israel joins an elite list of AA-countries that include, among others, Qatar. Qatar is a very, very wealthy country, thanks to vast natural gas reserves, which guarantee it plenty of cash to cover its debts. But it is also a dictatorship, sharia is the law of the land and most of its residents are foreigners with no legal rights.

A notch above Israel and Qatar are Abu Dhabi and Kuwait, with AA ratings, no democratic institutions and little concern for equality and basic freedoms.

In other words, the rating agencies don’t care about how the money being used to repay debt is distributed — most citizens can be poor or lacking in basic rights, and the country’s credit rating can still be high. Even the United States — whose credit rating since 2011 has been one level below a perfect AAA — suffers from deep inequality and declining social mobility.

On the other hand, Costa Rica has a relatively low, BB rating, even though its citizens for years have reported high levels of personal satisfaction and happiness.

The same kinds of values occur in the stock market, where companies are rated purely on their business performance and not on their ethical or social strengths or weaknesses. Altria Group, one of the world’s largest producers of tobacco and cigarettes, enjoys “buy” ratings from a host of analysts and not a single “sell.”

So, while Israel’s rating upgrade is a vote of confidence in the economy and is likely to slightly reduce the government’s borrowing costs, it also points up the failure to deliver the country’s economic and social benefits to more than a lucky few.

Anyone, including S&P’s economists, can find the evidence easily. These include high poverty for a Western country; among the greatest income and asset inequality in the West; poor school performance in international tests; high living and housing costs.

Nevertheless, there’s no reason not to expect Moody’s and Fitch to join S&P in raising Israel’s credit rating.