How Israel's Government Debt Stacks Up in Global Eyes

Was the latest bond issue a success? Depends how you look at it.

Yaacov Gabai, Yigal Dar
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After a three-year hiatus, Israel has returned to the international capital markets with a 10-year dollar-linked bond issue. The offering closed at a 4.115% yield, representing a 2.05% spread over the benchmark 10-year U.S. Treasury note. Oversubscribed by a factor of four, the amount raised was increased by 50% to $1.5 billion.

Was it a success? That depends how you look at it. The previous offering in February 2009 closed at a 2.625% spread over U.S. T-notes. This time, the yield and spread are lower, which means the state's borrowing costs are lower and investors ascribe less of a risk to Israel now than they did then.

Milan. Italy’s austerity measures aren’t necessarily evident in the country’s bond yields or credit ratings. Credit: AP

But such a comparison is a bit distorted, not just because prevailing interest rates have changed, but also because Israel's credit rating has since risen (A + according to Standard & Poor's ) while the U.S.'s rating has declined (to AA +, as rated by S&P ).

The bonds coming due in 2019, by the way, are currently trading at a 3.4% yield.

The Israeli government could consider the recent offering a success. One of its big worries lately has been that the 2012 budget deficit will be much larger than forecast due to rising expenses and diminishing revenues. The government now estimates the actual deficit will be 3% to 4% of GDP, as opposed to its previous forecast of 2%. The expectations of a larger deficit fueled concern that with the government needing to issue loads of new debt, thus dramatically increasing the supply of bonds, longer-term bonds would necessitate higher yields.

The government appears to have somewhat calmed fears that yields would climb by proving there is global demand for Israel's debt, and it seems like it could go through with another international offering if necessary. Based on this, it could be assumed that the government won't take steps to reduce the deficit as long as it remains within the current forecast. Yields may remain steady as long as U.S. yields don't climb sharply and the euro zone crisis doesn't plunge the world once again into recession or another economic catastrophe.

Barring any such adverse developments, the government can go back and raise more funds abroad. The current bond issue hasn't substantially increased Israel's foreign currency debt: As of September 2011, about $110 billion - 18% of the government's total debt - is in foreign currency terms, with 84% of this in dollars.

Could the bond offer also be deemed a success from the perspective of world markets? To answer this, we could examine trading prices or yields for dollar-denominated bonds of countries with credit ratings close to that of Israel. While S&P boosted Israel's credit rating to A+, Moody's raised it to its own equivalent rating A1, while the Fitch Group left its rating unchanged at A.

Italy, for instance, is still rated A + by Fitch and A2 (equivalent to A- ) by Moody's, even though S&P recently downgraded that European nation to BBB. Its dollar bonds maturing in 2023, one year after the most recently issued Israeli bonds, are trading at a 6.79% yield, significantly higher than the Israeli bonds' yield.

The markets therefore seem to agree with Israel's ranking, and somewhat less so with Italy's. However, other examples show that the picture isn't quite so clear. Dollar-denominated bonds maturing in 2025 issued by South Korea, rated A by S&P and A + by Fitch, are trading at a yield of just 3.66%. Dollar bonds maturing in 2021 from Chile, ranked A + by all three rating agencies, trade at a 3.009% yield.

Few countries with similar ratings to Israel's have issued dollar bonds, so a clear conclusion can't be easily reached. Therefore, a good alternative is to examine credit default swaps (CDS ), an insurance-like mechanism for investments, on 10-year bonds for these countries. The more basis points, the more the country is considered to be likely to default.

The CDS for the Israeli government on 10-year bonds is 212.6 basis points, similar to the yield spread of its new bond issue over U.S. T-notes.

Like in the previous comparison on yields, South Korea's CDS (174 ) and Chile's (139 ) are lower. So is, for example, the CDS for Estonia, rated AA- by S&P and A + by Fitch, at 151 basis points.

For the Czech Republic, rated A +, it is 171 basis points, but for Slovakia and Slovenia it is higher - 309 and 418, respectively. Here, though, it seems the deepening crisis in Eastern Europe has exhibited increasing impact and, going by their CDS, these countries can be expected to have their ratings downgraded.

The writers are managers of Harel Pia mutual funds. This article should not be construed as marketing any investments or substituting for independent tax advice.