S&P warns Israel: "Weakening state institutions is a ratings risk"

"We are not only looking at the composition of any one government but more broadly at the effectiveness of the functioning of the overall institutional system and to what extent the government's policies and actions are carefully scrutinized by it. If it seems that the current institutional arrangements will be particularly weakened, this is something that we will indeed take into account to determine a rating, and it may pose a downside risk. In this regard, we are closely monitoring the consequences of the expected changes in everything related to the Supreme Court. We are also monitoring the coalition's statements regarding the budget and the planned budgetary policy in general." These remarks were made by Maxim Rybnikov, a Director at S&P Global Ratings - the most important rating company in the world, and the chief analyst of Israel's sovereign rating, in a first and exclusive interview since the inauguration of the government and the publication of its basic guidelines.

Maxim Rybnikov, S&P Global Ratings

The interview with Rybnikov, the main person responsible for determining Israel's credit rating, took place a few hours after the Minister of Justice together with the Prime Minister presented to the public the planned regime change - the weakening of the judicial system through the legislation of the superseding clause by a majority of 61. Rybnikov is updated on what is happening in Israel, including the smallest details.

How much do the headlines affect you these days? In the case of the UK you waited for actions to take place on the ground before sending a rating warning.

"There has been a lot of news coming from Israel related to the political front. It has been quite a rollercoaster in recent years. But we look at the overall picture when measuring a country's rating, which of course includes the economic aspects of the balance of payments (entry and exit of foreign exchange), fiscal (budgetary) aspects and at the same time the political trends."

Israel's opening figures for 2023 are very good.

"The basic data of the Israeli economy is good and very strong. Growth in 2022 was high, the current account surplus is expected to continue, budget balance, foreign exchange reserves that exceed the gross external debt. This is a very strong position. Israel's economy had a very good performance. These are the main factors that greatly strengthen Israel's credit rating today."

So where are the risks?

"There are two main types of risks for Israel in the future. The first risks are global in nature: first and foremost the predicted weak economic performance in the world's main economies in 2023. We anticipate a significant global economic slowdown and in this respect Israel is not expected to be any different. In a number of economies in the world, including some European countries and also in Britain - we expect a real recession this year. We expect a slight contraction in the American economy as well. Over 60% of Israel's trade in goods and services is destined for the USA and Europe, so the economic picture that emerges is weaker than we thought before. That is why we expect the Israeli economy to grow this year by only 2%, which is lower than most of the forecasts we have seen so far (the previous forecast was given in May and was 3.5%). Since Israel's population also grows by about 2% every year, we expect that the growth per capita will cease, and according to Israel's parameters, this is not a particularly strong performance. Especially compared to 2022, in which, according to our estimate, growth will be 6%. That is, when we deduct the year 2020, this is the lowest rate in many years (since 2009). Weaker growth could also negatively impact fiscal performance."

Your growth forecast is harsh. The Bank of Israel lowered the forecast to 2.8% and you even went further. What do you see from there that we don't see from here?

"Our growth forecast for Israel is indeed lower than most forecasts, including that of the Bank of Israel, which converged closer to our forecasts in the latest internal forecast of the research division in January 2023. The other risks that we follow closely and which may constitute downward risks to Israel's credit rating (toward a downgrade) are the political and geopolitical (regional) risks. It is important to clarify that we do not give ratings based on a particular party or politician in this or that office. For us, it is not the party or the political personality that is important, but the overall functioning of the institutional system in the country. And what we have seen, at least until recently, is that the Israeli political system, despite the volatility, was characterized by the existence of a system of checks and balances that was reflected in the policies implemented by all recent governments. The Israeli economy showed strength despite all the rounds of elections and the fiscal (budgetary) policy was responsible."

"We are closely following the developments surrounding the Supreme Court in Israel"

When Rybnikov was asked what the real concern is regarding Israel, he said: "If, contrary to the previous situation, the institutional system in Israel enters a consistent path of weakening, including damage to the system of checks and balances, and political power is concentrated too much in the hands of one person or one group, the public debate will also be damaged and it will lead to fiscal policy being less responsible - not just for one year, but become a feature of policymaking. All of these things could become a real rating risk. We're closely following developments around the Supreme Court and the potential implications of these changes. This is not good news for that institutional system that certain laws are changed in such a way to suit specific people in certain positions."

Can you be more specific?

"If it does appear that the political situation is deteriorating substantially, i.e. a worsening of local tensions in the form of events similar to those we saw in May 2021, or a consistent trend of weakening central and vital institutions or the system of checks and balances, these are things that could lead to an increase in the risk of downgrading Israel's credit rating."

Can you give more concrete examples?

"We have concerns about the fact that the entry of the extreme right into the coalition could cause a worsening of the situation in Gaza, the West Bank and also in relations with the Israeli Arabs. And it's not that the situation was simple before: the situation was already challenging and we saw what happened in Gaza and the West Bank. But our impression is that the risk on this front is increasing and maybe we will see some sort of escalation. This is an aspect we are following very closely."

And regarding the fiscal policy and the possible increase in government spending following the coalition agreements?

"So obviously we will have to see what will really happen. Nevertheless, even now, our basic forecast is that the budget deficit is expected to stand at 2% of GDP per year for the medium term, which corresponds with the Bank of Israel's latest forecast. That is, we have already included in our forecast the expectation of a fiscal loosening compared to the result in 2022. Part of it is explained by the planned increase in spending and part by the expected decrease in growth, that is, it is already in the forecast, so it is not a surprise from our point of view (the expected sharp increase in government spending).

"We are also following the coalition's statements regarding the planned fiscal policy. If it seems that a continuation of a substantial weakening in the medium term is expected, without restraints, which will lead to an increase in government debt levels compared to the continuation of the decrease as we still expect now - we will have to consider this and determine the impact on Israel's credit rating. At least so far, Israel's fiscal (budgetary) performance has turned out to be stronger than we previously expected, as evidenced by the budget surplus of the first 11 months of 2022."