Since its birth in 1948, the State of Israel has only seen its credit rating rise. An economic, arms and technological power far in excess of its population, the country has overcome — with the help of the West — recurrent outbreaks of violence and global financial crises after leaving behind the socialist heritage of the Zionist pioneers and turning to exports (civilian and military) and attracting foreign investment.
Last Friday, after more than four months of war in Gaza that has driven away investors and tourists — and in which Israel has mobilized some 300,000 reservists and is paying the bill for some 200,000 displaced persons from its borders with the Gaza Strip and Lebanon — Moody’s has become the first international credit rating agency to downgrade its rating: from A1 (medium-high) to A2. It also changed the country’s economic outlook to “negative.” “There is nothing to worry about,” said Israeli Prime Minister Benjamin Netanyahu. Analysts are not so sure. For the time being, the two main indexes of the Tel Aviv Stock Exchange fell moderately Sunday, the first day of the working week in Israel, by 0.61% and 0.74%.
Like all other agencies, Moody’s has been rating Israel for about three decades, and it has risen despite the Second Intifada (2000-2005), a war with Hezbollah in Lebanon (2006), the Covid pandemic and the impact of the conflict in Ukraine. If Moody’s has taken this decision now, it is not only because the country is immersed in its biggest conflict in half a century, but also because the future looks bleak.
What does the downgrade mean for Israel? For starters, it will be more expensive to finance itself on the international markets, at a time when it is planning to issue bonds to feed the war machine. It will also be more expensive for companies to obtain funds from abroad.
In its report, Moody’s stated that “the main factor” behind its decision is the “assessment that the ongoing military conflict with Hamas, its aftermath and wider consequences materially raise political risk for Israel as well as weaken its executive and legislative institutions and its fiscal strength, for the foreseeable future.” It added an important addendum: “While fighting in Gaza may diminish in intensity or pause, there is currently no agreement to end the hostilities durably and no agreement on a longer-term plan that would fully restore and eventually strengthen security for Israel.”
13% of GDP
The Bank of Israel estimates that the conflict will cost the country some 255 billion shekels (about €64 billion or $69 billion) between 2023 and 2025 — 13% of estimated GDP for 2024 — both through increased civilian and defense spending and lower tax revenues. Moody’s estimates that by the end of 2024 Israel’s defense budget will have doubled compared to 2022, and that it will raise it by 0.5% of GDP over the next few years.
It is not that, however, that concerns the agency most. Moody’s acknowledges the soundness of the national economy in its report, and has also done so de facto by waiting four months to lower the bond rating. In other conflicts, the decision has been immediate. It is rather the sensation that no one knows what exactly the “total victory” Netanyahu aspires to implies, or when it will come. The prime minister said Sunday that it is “within reach,” having previously said it would be achieved in “months,” not years. For the time being, Israeli forces are preparing the forcible evacuation of more than a million Gazans to launch an assault on Rafah, near the border with Egypt.
Moody’s, whose experts spent months in meetings with Israeli officials, highlighted these uncertainties in its report: that it is “unclear” whether a second cease-fire, with a prisoner-for-hostage swap that mediators have been negotiating for weeks, will come to fruition; that Israel rejects the U.S. post-war plan for Gaza; and that the political crisis and social polarization brought to light by Netanyahu’s judicial reform is likely to resurface as soon as the emergency government created specifically for the war fractures. More and more people are calling for early elections. Fitch, another of the main ratings agencies, plans to publish its conclusions at the beginning of March and Standard & Poor’s in three months, although the latter could bring them forward.
These are minor problems compared to the prospect of a war with Hezbollah. Israel and the Lebanese militia engage in daily measured skirmishes, but a misstep could lead to escalation. Israel has been relocating some 80,000 inhabitants of the border area to hotels or apartments since October. It will only allow them to return if “the security equation” changes. And, as Defense Minister Yoav Gallant points out every week, that will only happen in two ways: through diplomacy (several countries are negotiating behind the scenes to reach an agreement to keep Hezbollah away from the border), or by force of arms. Moody’s, in fact, sees “significant” risk of a full-scale conflict with Hezbollah, a much larger and more heavily armed militia than Hamas, although the agency notes that both sides are fully aware of the negative consequences of escalation. Open conflict with Hezbollah would pose “a much higher risk to Israeli territory,” because of the foreseeable damage to infrastructure, the remobilization of reservists and the limbo in which evacuees would be left. All of this represents a lot of money. So much so that the Ministry of Finance estimates that, instead of growing by 1.6%, it would contract by 1.5% in 2024 if war with Hezbollah is unleashed.
Netanyahu, however, downplayed the report. A former finance minister aware of the importance of Israel’s international image, he took the unusual decision to issue a statement on the Sabbath to underline the strength of the national economy. “The rating downgrade is not connected to the economy, it is entirely due to the fact that we are in a war,” he said. “The rating will rise back at the moment we win the war — and we will win the war.”
The Minister of Finance, the far-right Bezalel Smotrich, took another tone. He called Moody’s report a “political manifesto” that “did not include serious economic claims” and is based on a “pessimistic and unfounded geopolitical worldview, which reflects a lack of confidence in Israel’s security and national resilience.” He also complained that the report does not use the term terrorist organization when referring to Hamas and Hezbollah.
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