Senior economic officials, after meeting with economists from leading credit rating agencies Standard & Poor's and Moody's, warned that Israel's credit rating could face a swift downgrade if the conflict with Hezbollah, and potentially Iran, escalates into full-scale war.
The agencies expressed serious concerns over the ongoing violence in Gaza and along the Lebanese border, as well as doubts about the government's proposed budget cuts and their effectiveness in addressing the fiscal deficit.
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Prime Minister Benjamin Netanyahu and Finance Minister Bezalel Smotrich
(Photo: Reuters/Amir Cohen)
The agencies also highlighted worries over a significant increase in defense spending and the sharp decline in investment, particularly in Israel’s high-tech sector, coupled with growing capital flight.
Economists also raised concerns about the low labor force participation rates among ultra-Orthodox and Arab women, warning that without integrating hundreds of thousands more Israelis into the workforce, the economy would struggle with sustainability.
Officials noted that a major escalation in Lebanon could prompt at least one agency to downgrade Israel’s rating within days, with the likelihood of such a move currently estimated at 95%. Even without further conflict, a downgrade by both agencies is expected by early November.
Israel’s credit rating has already been downgraded once this year by all three major agencies, with the country’s borrowing now priced at a lower BBB level, signaling rising costs for government debt and potentially impacting public services and the broader economy.
While a senior government official acknowledged the concerns, they expressed hope that recent efforts to reduce the fiscal deficit and control defense spending could persuade rating agencies to hold off on further downgrades. "We remain cautiously optimistic," the official said.
In February, Moody's downgraded Israel's credit rating for the first time to A2. In April, Standard & Poor's adjusted Israel's rating to A+. Last month, Fitch downgraded Israel's rating from A+ to A.
What is a credit rating?
A credit rating is a metric assigned to countries, corporations and individuals, evaluating their capacity to fulfill future debt obligations. For countries, credit rating agencies, much like banks for individuals, assess various financial indicators including financial history, equity, asset conditions and other economic variables, alongside existing liabilities.
Who finds this important?
Primarily, it holds significance for potential lenders and investors considering engagement with these countries. Rating agencies evaluate the inherent risks and assess the ability of countries to meet their debt obligations to creditors.
Implications for investors
Entities or nations with higher credit ratings are required to offer lower yields to investors due to the associated lower risk perception. Consequently, lenders to countries like the United States or Germany would demand significantly lower interest rates compared to those lending to countries such as Peru. In extreme cases, severely distressed nations like Syria or North/South Sudan may struggle to find lenders altogether.
Practical implications:
Israel is currently experiencing increased interest rates on its borrowings, rising by half a percent to a percent compared to a few months ago, with expectations of further increases. These elevated interest rates are likely to impact the broader economy – initially, domestic companies will face higher borrowing costs, which they may pass on to consumers.
Additionally, a government burdened with more expensive debt will need to reduce expenditures on public services, leading to decreased support in welfare and health sectors, and budget cuts in education and other areas, which will affect citizens in the upcoming fiscal year.