Fitch Affirms Israel at ‘A+’ Rating – Outlook Stable

Fitch, the world renowned ratings firm, has reaffirmed Israel as a good bet for investment by renewing the country’s A+ rating. The move came as Israel is going through domestic turmoil over a plan by its government to drastically overhaul the nation’s court system and in spite of warnings from many in the business sector that the judicial reforms would harm investments in the country. But Fitch did acknowledge such concerns in its report.

The government’s judicial reform plan would greatly curtail the power of Israel’s Supreme Court to nullify legislation passed by the Knesset and also limit the authority of Israel’s attorney general. Israel’s opposition charges this would harm Israel’s democracy thereby eroding foreign confidence in the country and hurting its economy.

Major financial firms like Goldman Sachs and JPMorgan have issued reports expressing such concerns and even some large Israeli business have begun taking their money out of the country.

Fitch said Israel’s ‘A+’ rating balances a “diversified, resilient and high value-added economy and strong external finances against a high government debt/GDP ratio, elevated security risks and a record of unstable governments that has hindered policymaking.”

Fitch expects Israel’s GDP growth to remain robust at 2.9% in 2023 after 6.4% in 2022, despite global challenges and monetary policy tightening that will hit private consumption and investment. Growth, it said, will be supported by continued exports from the high tech and the defense industries, strong population growth and growing government spending once a budget is in place. We project growth to return to its long-term potential above 3% in 2024 and 2025.

Fitch projects inflation to peak in 1Q23 and to gradually recede to around 3% by the end of the year. “The deceleration will be underpinned by the soft landing of the Israeli economy, with the cooling down of the frothy high-tech sector that has driven strong growth in private-sector wages,” it said.

Also, Israel will operate with a technical budget with capped monthly spending until the coalition government composed of Likud and mostly religious parties passes a budget, likely in 2Q23, predicted Fitch. They expect deterioration of the central government’s fiscal balance by about 1.8% of GDP in 2023, to -1.2% (target in government draft budget: 1% of GDP), with further deterioration to -2.5% in 2024.

Fitch projects government debt/GDP to continue to drop, to 57.9% by 2024 from 61.6% in 2022 and 68.9% in 2021 (Bank of Israel definition), with limited deficits and strong nominal growth.

But Fitch’s rosy predictions came with a major caveat regarding the judicial reform plan.

Fitch said Israel’s government made it a priority to pass a judicial reform that would curtail the powers of the Supreme Court and grant more power to the government majority in the Knesset on legislation and over the nomination of judges and acknowledged how the planned reform has been met with strong civil society and political opposition.

“While the exact content of the reform is still subject to negotiations in parliament,” they said, “Fitch believes the reform could have a negative impact on Israel’s credit profile by weakening governance indicator or if the weakening of institutional checks leads to worse policy outcomes or sustained negative investor sentiment.”

Fitch also said the ratings are constrained by geopolitical risks, but added that Israel’s credit profile has shown “resilience to periodic conflicts.” However, Fitch also stated that the absence of a deal on Iran’s nuclear program, continued Iranian progress towards nuclear weapons and greater apparent support by the US for militarily deterring Iran from acquiring nuclear weapons “could increase risks of an escalation of the long-standing conflict although we see a serious escalation with significant rating implications as only a tail risk.”

Israel’s Minister of Finance Bezalel Smotrich took the news as a sign that those who are saying his government’s judicial reforms would harm Israel’s economy are just doomsayers, political opponents looking for ways to attack the government.

“Israel’s economy is strong and with God’s help it will remain so,” said Smotrich. “Last week, the government approved an excellent, responsible and growth-oriented budget, and despite rising global inflation, we are succeeding in establishing Israel as an island of stability, a growing economy, and an excellent place to invest. “

“The credit ratings prove that we are taking all the right steps for the economy of the State of Israel,” he declared.

But Smotrich conveniently ignored Fitch’s mention of how the judicial reforms could cause problems down the road.