Rating Agencies Signal Potential Downgrade for Israel if Conflict Escalates with Hezbollah

Senior officials in Israel’s economy, after meeting with economists from Standard & Poor’s and Moody's, have raised concerns that an all-out war with Hezbollah—and potentially Iran—could lead to an immediate downgrade of Israel’s credit rating. These meetings highlighted the rating agencies' apprehension about the continued conflict in Gaza and along the Lebanese border and the increasing strain on Israel’s fiscal stability.

The economists expressed concerns about Israel's growing defense budget, as well as the risk of proposed budget cuts being insufficient to control the widening deficit. They also noted a significant decline in foreign investments,

Economic Concerns Grow as War Expands

particularly in the high-tech sector, and warned of increased capital flight from Israel. The rating agencies emphasized that Israel’s long-term economic sustainability is jeopardized by the low participation of ultra-Orthodox and Arab women in the labor market.

“There is deep concern about the future ability of the Israeli economy to sustain itself without the integration of hundreds of thousands more citizens into the workforce,” said a senior economist.

 Inflation and Living Costs Worsen Economic Outlook

The discussions also raised alarms over Israel's rising inflation and cost of living, which could hinder the country’s ability to secure additional loans. With the cost of financing the war increasing, Israel may face even more expensive borrowing options, straining the nation’s budget further.

A senior Israeli economic official noted, “It’s highly likely that an escalation into an all-out war with Lebanon would prompt at least one major rating agency to downgrade Israel’s credit rating within days. The probability of this happening is 95%, and a downgrade is anticipated even without a broader war by early November.”

Credit Downgrade Already in Progress

Israel’s credit rating has already been downgraded by all three major agencies. In February, Moody's lowered Israel’s rating to A2, while Standard & Poor’s followed in April, downgrading the nation to A+. Just over a month ago, Fitch also downgraded Israel from A+ to A. Although Israel’s official credit rating still hovers around an "A" grade, loans taken by the Israeli government are already priced closer to a BBB level—considered a low rating for developed nations.

A senior government official attempted to maintain optimism, stating that upcoming government plans to reduce the deficit and manage the defense budget more efficiently could still persuade rating agencies to hold off on further downgrades. However, the outlook remains bleak.

Impact of Credit Rating Downgrade 

The credit rating of a country reflects its ability to repay loans in the future. Countries with higher ratings, like the U.S. or Germany, enjoy lower borrowing costs due to their perceived financial stability, while nations in financial trouble, like Syria or South Sudan, struggle to attract lenders at all.

Israel has already seen a sharp increase in interest rates, paying between half a percent and one percent more on loans taken out just months ago. A further downgrade could exacerbate these costs, making borrowing even more expensive for businesses and citizens alike. This could result in companies passing on these costs to consumers, and the government may be forced to cut expenditures in areas such as healthcare, welfare, and education to manage the increased financial burden.

As the war intensifies, the cost of credit and its ripple effects on Israel’s economy will be felt across all sectors, affecting both businesses and citizens shortly.