Israel Wary After S&P Downgrades U.S. Debt Rating

Central bank and Treasury fear that effects of the downgrade could batter exports, the main engine of Israel's economy.

S&P's unprecedented downgrade of the United States's sovereign debt rating from its spotless AAA to a lower AA + with a negative outlook on Friday caused great alarm at the Bank of Israel and the Finance Ministry.

The downgrade raised concerns that the global economy could be heading toward a slowdown, seriously damaging Israeli exports.

New York stock exchange  - AP

Officials in Jerusalem worried that Israeli exports to the United States could be cut dramatically as a result. Exports are the economy's main driver.

"The Finance Ministry held a series of discussions about the debt crisis in the United States and Europe, which took into account a potential U.S. credit downgrade," Finance Minister Yuval Steinitz said over the weekend. "Despite our full confidence in the strength of the U.S. economy and its recovery from the crisis, the downgrade is a warning light to all of us that the Israeli economy is still in stormy waters," he said.

A full 28% of Israeli exports, not including diamonds, are sent to the United States, worth a total of $11.6 billion. This makes it Israel's biggest export market by far. In addition, 12% of imports were sent from the United States in 2010, worth a total of $5.8 billion. This is down from $6.5 billion in 2009.

Another 30% of exports went to the 27 European Union states in 2010, and 35% of imports came from that bloc.

A full 40% of Israeli production is intended for export.

Bank of Israel Governor Stanley Fischer is reportedly concerned that the crisis could push down the value of the dollar. If the dollar is worth less, then Israeli exports will become more expensive in relative terms, and if exports are damaged, this in turn could jeopardize employment and growth. Fischer started reconsidering the central bank's currency policy on Friday shortly after the announcement, given that the Israeli currency is now likely to gain more strength against the dollar.

Israel has a string of trade agreements with the United States, including a free trade agreement, which made the economic superpower Israel's main export target.

The United States is the world's single largest economic player, and Israel consistently has had a current account surplus in its trade with the United States for the past several years. This is impressive, given that Israel had a $5 billion current account deficit in its trade with Europe in 2010 and a $3 billion deficit with Asian countries.

Despite the concerns, Israeli officials noted that exports were only moderately damaged during the financial crisis of 2008 and 2009, since U.S. demand for high-tech and medication was not impacted as much as other exports. However, diamond exports to the United States were hard hit.

The first effect of the U.S. credit downgrade on Israel will become apparent this morning, when the Tel Aviv Stock Exchange opens. Local shares are expected to nosedive on heavy volatility, following in the path of global markets over the weekend.

Since most markets are closed today, Israel's exchange will be of particular interest.

Another risk to Israel is the possibility that Israeli debt may be downgraded in the wake of the U.S. downgrade, since the United States secures Israeli government debt.

The United States gave Israel $9 billion in guarantees in 2003, at the peak of the second intifada, when Israel's economy was in dire straits and then-Finance Minister Benjamin Netanyahu turned to the superpower for help.

This enabled Israel to raise money with the United States's AAA rating, as opposed to Israel's A rating, which would have necessitated paying higher interest rates.

For the past three years, S&P and Fitch had given Israel a rating of A Stable, and Moody's had rated Israel A1 Stable.

Higher ratings give countries better standing in international financial markets, and enable countries and their companies to borrow money at lower interest rates.

Since 2004, the major rating agencies have noted that Washington's backing for the Israeli economy has influenced their ratings.