Moody's: Israel's rating may drop if Hamas war escalates

The judicial reform led by the government will not be pushed forward even after the war - this according to the estimation of the credit rating agency Moody's in their annual report on Israel's economy published on Monday. In light of the prospect of the reform moving forward, the agency's economists had previously reduced Israel's institutional strength rating from AA to A, but now they express cautious optimism that the legislation that was halted with the outbreak of the war, will not be promoted after it.

A month ago, Moody's announced that Israel's credit rating had moved to "negative watch" following the war in Gaza. According to Moody's, Israel's credit rating will be downgraded in the event that the current military conflict escalates significantly or spreads beyond Israel's borders. However, the company states that it is likely that the credit rating will remain at its current level of A1 if the military conflict is resolved without any lasting and substantial damage to Israel's economic strength.

However, in the report, Moody's conveys a message to the government according to which a decision on whether to downgrade Israel will be influenced not only by the development of the war, but also by the government's conduct in navigating the economy during the war. They explained that they will examine the government's ability to promote policies that will reduce the economic and fiscal implications and encourage a rapid recovery from the crisis.

Moody's estimates that the deficit in Israel will stand at 3% at the end of the year, and will deepen next year to 7% in light of the expected war and reconstruction expenses on the one hand, and an expected decrease in state revenues on the other hand. On the positive side, they point out that past experience shows that Israel is able to recover quickly from situations of increased debt and deficit and return to the desired course within a limited time.

The company also noted that other challenges may affect the credit rating, including income inequality, which is one of the highest in the OECD: "This is due to the duality of the economy, with a significant high-tech sector where wages have grown much faster than in other sectors."

They also pointed out the disparities in education and salary levels in different groups in the population, including the ultra-Orthodox and Arabs. The share of these two groups is expected to increase significantly to 50% of the working age population by 2060, compared to 30% today. "These challenges increase social risks," they noted.

On the other hand, what may have a positive effect on the ranking is the decision of Prime Minister Benjamin Netanyahu and Finance Minister Bezalel Smotrich to extend the tenure of Bank of Israel Governor Prof. Amir Yaron. Moody's refers positively to the monetary policy led by Yaron, noting that they appreciate the effectiveness of the monetary policy, that the Bank of Israel conveys credibility and independence in its conduct, and that it acted quickly to address inflationary pressures.

In addition, Moody's notes positively the ability of the Israeli economy to demonstrate significant resistance to local and external shocks in the past, among other things thanks to growth supported by the high-tech sector. Also, the company notes the consistent surplus in the balance of payments and the high foreign exchange balances of the Bank of Israel.

They also positively note the high level of income in Israel, the high amount of household savings, and the low level of debt.