Moody’s, a world leading rating agency, downgraded Israel’s economic outlook from “positive” to “stable”, citing concerns over the “deterioration of Israel’s governance.”
The move came after Israel has seen months of political upheaval marked by massive nationwide protests that were sparked by the Benjamin Netanyahu government’s controversial judicial overhaul plan. The opposition charges the plan will harm Israel’s democracy by stripping its Supreme Court of the power of judicial review over the government’s actions and laws passed by the Knesset. Netanyahu counters that the plan is needed to “restore” Israel’s democracy after its courts, in his opinion, have taken on too many powers for themselves.
Moody’s had previously warned that Israel’s credit outlook could be negatively impacted if the hardline government, led by Prime Minister Benjamin Netanyahu, pushes forward with plans to increase political control over judicial appointments and weaken the powers of the High Court of Justice. If these proposals are fully implemented, Moody’s states that it would “materially weaken the strength of the judiciary and as such be credit negative,” as mentioned in a report released by Moody’s in early March, spanning six pages.
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Despite mass protests and the government’s pause on the legislative efforts to weaken the judicial system, Moody’s has downgraded Israel’s economic outlook from positive to stable.
In a strongly worded, eight-page report, Moody’s cited the “deterioration of Israel’s governance” and the lack of broad consensus in implementing the proposed judiciary overhaul as indicators of weakened institutional strength and policy predictability.
However, Moody’s maintained Israel’s credit rating at A1, acknowledging the country’s strong economic growth and improving fiscal strength. Israel’s economy has been resilient to economic and geopolitical shocks, with its high-tech industries significantly driving growth.
The tech sector, which accounts for many exports and GDP, has been vocal in opposing the government’s judicial plans. Some companies are considering relocating or moving funds abroad.
Moody’s also warned that Israel’s credit ratings could face downward pressure if the current tensions escalate into a prolonged political and social crisis, negatively impacting the economy, particularly in the high-tech sector.
Before the report’s publication, Israeli officials, including Prime Minister Netanyahu and President Herzog, discussed with senior Moody’s officials to reassure them of efforts to reach broad agreements and prevent a downgrade in the credit rating. President Herzog expressed optimism but acknowledged the challenges of finding a compromise, while Prime Minister Netanyahu indicated that aspects of the proposed legislation would be less extreme in future drafts.
Moody’s credit rating agency has warned that the ongoing protests against the Israeli government’s efforts to weaken the judicial system, and the potential for further political and social tensions, could have negative implications for Israel’s economy. While Israel’s credit rating has been maintained at A1, reflecting strong economic growth and improving fiscal strength, Moody’s has downgraded Israel’s credit outlook from positive to stable due to concerns about the country’s governance.
Moody’s has highlighted that the manner in which the government has attempted to implement judicial reforms without seeking broad consensus has weakened institutional strength and policy predictability. The agency has also noted that the risk of further political and social tensions remains, as the government has reiterated its intention to change how judges are selected despite holding deliberations and seeking compromise.
In addition to domestic concerns, Moody’s has also pointed out that geopolitical tensions, particularly with the Palestinians, could endanger Israel’s improved relations with neighboring countries and potentially lead to increased international isolation.
This could have negative implications for Israel’s export-oriented economy and overall economic strength, as the country has been building diplomatic and economic ties with countries such as the United Arab Emirates and Morocco through the Abraham Accords.
Other economic organizations, such as the OECD and the Bank of Israel, have also raised concerns about the potential economic ramifications of the ongoing situation in Israel. The OECD has projected a moderation in Israel’s economic growth rate for 2023 and 2024, with risks skewed to the downside due to global and domestic uncertainty.
The Bank of Israel has estimated that the potential impact of the proposed legislative and institutional changes on Israel’s risk premium could result in a significant hit to GDP, ranging from 0.8% to 2.8% annually, depending on the intensity and duration of the shocks.
The recent release of the March consumer price index (CPI) in Israel showed an increase of 0.4% from February. This continues the trend of inflation remaining above the government’s target range of 1% to 3% for the past six months, with CPI hovering above 5% in annual terms. Despite efforts by the Bank of Israel to rein in inflation by steadily increasing its benchmark interest rate from a record low of 0.1% in April last year to 4.5% earlier this month, inflation has been slower to ease.
One factor contributing to the persistent inflation is the weakening of the shekel, Israel’s local currency, which has made imported goods more expensive. Since the beginning of this year, the shekel has depreciated by approximately 4% against the US dollar. In comparison, the US dollar index, which measures the strength of the US dollar against six major world currencies, has declined by about 2% since the start of 2023.
The depreciation of the shekel has likely put upward pressure on the prices of imported goods, contributing to the inflationary pressures in Israel. This may challenge the central bank’s efforts to bring down price growth and achieve its inflation target. The Bank of Israel will need to closely monitor the impact of the weakening shekel on inflation dynamics and assess appropriate policy measures to address the inflationary pressures in the economy.
Inflation is a critical macroeconomic indicator that affects consumers, businesses, and overall economic performance. High or persistent inflation can erode purchasing power, impact investment decisions, and affect the overall stability of the economy. Central banks, including the Bank of Israel, closely monitor inflation trends and use monetary policy tools, such as interest rates, to manage inflation and achieve their inflation targets.
