Moody's Warns of Economic Challenges in Israel - Potential Credit Rating Downgrade Looms

Moody's, the international rating agency, is set to release a report next month that paints a concerning picture of Israel's economy, hinting at a possible negative turn in its trajectory. While the agency is not expected to immediately lower Israel's credit rating, the likelihood of a significant rating downgrade in the future is increasing.

Moody's had previously downgraded the debt rating forecast of the State of Israel from positive to stable in mid-April of this year, citing concerns over legal reforms. Now, sources close to the agency suggest that Moody's may further lower the forecast on October 13, possibly shifting it from positive to negative, or at least issuing a warning to that effect in 2024.

The report follows a series of meetings held by Moody's economists with senior Israeli officials, during which several critical issues were discussed. These include the deteriorating high-tech sector, capital withdrawal from banks, challenges related to the integration of ultra-Orthodox and Arab communities into the labor market, and the significant weakening of the shekel.

Of particular concern to Moody's economists is the impact of legal reform legislation on Israel's economy. They express worry over the deepening societal divide and the direct damage it poses to Israel's economic strength, both in the short and long term. Moody's has made it clear that they are closely monitoring the legal reform procedures and decisions of the High Court of Justice pertaining to this government-promoted reform.

The potential weakening of the shekel also raises red flags for Moody's economists, as it could lead to higher inflation due to increased import prices. Surprisingly, the stability of Israel's banks, while acknowledged, also elicited some concerns from the rating agency.

Moody's economists warn that the political situation resulting from the enactment of legal reforms is already causing a turning point in the Israeli economy. While an imminent economic disaster is not predicted, Moody's highlights that the seeds for a future deterioration have been sown.

Another pressing issue noted by the agency is the potential inability of the Israeli economy to cope with the non-integration of ultra-Orthodox and Arab sectors into the labor market, given the rapid population growth in these communities.

Currently, Moody's credit rating for Israel stands at A1, considered relatively high and stable. This rating has remained unchanged during the COVID-19 crisis, in contrast to many other countries. The Israeli government's handling of the pandemic and vaccination efforts were lauded by rating agencies.

In April, Moody's projected a 3.5% growth in the Israeli economy for 2024, but this forecast is expected to be revised downward in the forthcoming report due to recent economic challenges.

It is noteworthy that Moody's had contemplated raising Israel's credit rating in 2022, praising the country's economic management in 2021 and 2022. However, their confidence seems to be waning due to current economic uncertainties.

Moody's economists had previously expressed the expectation that Prime Minister Benjamin Netanyahu would only advance legal reforms with broad agreement. However, recent announcements by the Prime Minister regarding unilateral action have raised concerns that this may negatively impact Israel's credit rating in the coming year.

The upcoming decision by the Bank of Israel regarding interest rates, scheduled for October 23, will also be influenced by the findings of Moody's report, potentially leading to a change in the base interest rate.

In the following months, another major credit rating agency, Standard & Poor's, is expected to release a report on Israel's economy. Fitch, in its recent report, refrained from downgrading Israel's credit rating, resulting in positive messages from Prime Minister Benjamin Netanyahu and Finance Minister Bezalel Smotrich regarding the state of the Israeli economy. However, Moody's report suggests a more cautious outlook.