Moody’s, one of the leading credit rating agencies in the world, announced on Friday that it has downgraded Israel’s credit rating from A1 to A2 and changed its outlook from stable to negative. This is the first time in Israel’s history that its rating has been lowered by Moody’s.
The agency said that the decision was based on its assessment that the ongoing military conflict with Hamas in Gaza and its aftermath have materially raised political risk for Israel and weakened its executive and legislative institutions and its fiscal strength. Moody’s also warned of the risk of an escalation with Hezbollah, the Iranian-backed terrorist group that operates along Israel’s northern border.
Moody’s said that the war in Gaza, which started on October 7, 2023, after a devastating Hamas-led attack that killed some 1,200 people, mostly civilians, and took 253 hostages into the Gaza Strip, has exposed the fragility of Israel’s security environment and implied higher social risk. The agency also noted that the war has undermined the credibility and effectiveness of Israel’s government and increased the polarization and fragmentation of its political system.
Israel’s public debt ratio expected to rise significantly due to war costs
Moody’s also pointed out that Israel’s public finances are deteriorating and that the previously projected downward trend in the public debt ratio has now reversed. The agency estimated that the direct fiscal cost of the war will amount to about 1.5% of GDP in 2023 and 2024, and that the indirect fiscal cost from lower tax revenues and higher social spending will be even higher.
Moody’s projected that Israel’s public debt ratio will increase from 72.6% of GDP in 2022 to 77.5% of GDP in 2024, and that it will remain above 75% of GDP in the medium term. The agency said that this level of debt is materially higher than the median of A-rated sovereigns, which is around 50% of GDP. Moody’s also said that Israel’s debt affordability will deteriorate, as the interest payments will consume a larger share of the government revenues.
Israel’s economic resilience and growth potential remain strong despite the war
Moody’s acknowledged that Israel’s economy has shown remarkable resilience in the face of the war and the COVID-19 pandemic, and that it has strong growth potential supported by its dynamic and innovative private sector. The agency said that Israel’s GDP growth is expected to rebound to 5.5% in 2023 and 4.5% in 2024, after contracting by 2.5% in 2022.
Moody’s also recognized that Israel’s external position is robust, as it has a large and diversified export base, a sizable current account surplus, and ample foreign exchange reserves. The agency said that Israel’s external vulnerability is low, as it has a low level of external debt and a positive net international investment position.
Moody’s could revise Israel’s outlook to stable if political and fiscal stability improves
Moody’s said that it could revise Israel’s outlook to stable if there is evidence of a lasting improvement in the security situation, a reduction in political uncertainty and polarization, and a credible and effective fiscal consolidation plan that would put the public debt ratio on a downward path.
However, Moody’s also warned that it could lower Israel’s rating further if there is a deterioration in the security environment, a prolonged political deadlock or instability, or a failure to address the fiscal challenges posed by the war and the pandemic.