Moody's Downgrades Israel's Outlook From Positive to Stable

Moody's Investors Service has changed the outlook of Israel's A1 ratings to stable from positive.

Simultaneously, Moody's affirmed Israel's long-term issuer and senior unsecured ratings at A1, senior unsecured Medium-Term Note Program (MTN Program) and shelf ratings at (P)A1 and backed senior unsecured rating at Aaa.

The change in outlook to stable from positive was driven by the weak financial outlook for Israel's recent deterioration in the budget deficit, which was intensified by the coronavirus outbreak.

Also, Israel's weak fiscal policy, driven in part by the more polarized political environment, pushed the rating agency to lower the economic outlook.

The A1 ratings, however, reflects Israel's strong medium-term growth potential, strong external position and credible institutions, which can help the small country to withstand the impact of the corona crisis.

The strong rating was then balanced with a mixture of long-term demographic challenges and persistent geopolitical risks in addition to lower growth, leading to the final classification.

"The Aaa rating on the backed senior unsecured bonds issued by the government was also affirmed. That rating reflects the debt guarantee provided by the United States Government (Aaa, stable) on these instruments, and the loan guarantee programme is currently authorized until end September 2023," Moody's wrote.

"Israel's Aa3/P-1 country ceilings for foreign currency bonds, A1/P-1 country ceilings for foreign currency bank deposits and Aa3 country ceilings for domestic currency bonds and bank deposits remain unchanged," the rating agency added.

The first driver of the decision to stabilize the outlook on the A1 rating is Moody's conclusion that Israel's fiscal performance has deteriorated since the time of assigning the positive outlook in July 2018, and that the fiscal outlook will be further impaired by the impact of the coronavirus outbreak.

Moody's concluded that Israel’s fiscal performance has deteriorated since the positive outlook was set in July 2018, and that the financial outlook will further weaken due to the impact of the coronavirus outbreak.

Israel's fiscal performance has materially worsened over the last two years, with the general government budget deficit reaching an estimated 4% of GDP last year, which compares with an average deficit of just over 1% between 2015 and 2017 and Moody's expectation at the time of assigning the positive outlook that the budget deficit would likely remain at or below 3% of GDP.

Israel's financial performance has deteriorated significantly over the past two years, with the budget deficit reaching an estimated 4% of Gross Domestic Product (GDP) last year, which compares to an average deficit of just over 1% between 2015-2017. Moody's forecasts that the budget deficit will likely remain at or less than 3% of GDP.

Moreover, Moody's expected that government debt would rise to its GDP ratio even before the crisis, and given the large fiscal response package and anticipated economic contraction, Moody's expects the government debt burden to reach about 72% of GDP this year.

Meanwhile, Israeli fiscal rules have proven less effective than expected in promoting fiscal discipline, with long-term issues, such as largely interactive policy-making and frequent reviews of financial goals, which are exacerbated by political rigidity.

"Israel's economy has demonstrated resilience to a range of domestic and external shocks, supported by its highly competitive tech sector which benefits from the country's strong capacity for innovation, while the start of production from the Leviathan gas fields at the end of 2019 will, over time, further enhance the country's already favorable external position. Furthermore, the country's well-developed macroeconomic policy environment and the central bank's strong record in maintaining macroeconomic and financial stability has allowed the economy to recover quickly after previous crises," Moody's wrote in an issued statement on Sunday.

Moody's forecasts the coronavirus outbreak to lead to a contraction in GDP growth of around 4% this year, the economy's underlying strengths position it to recover strongly from the crisis.

While government debt will rise, debt sustainability to Israel has been strengthened amid declining financing costs in recent years, given the deep and evolving domestic market and exceptional access to external financing.

Finally, the assertion of the A1 rating also reflects that Israel will continue to face the risks of the ongoing geopolitical events inherent in the Middle East that could affect the economy and public finances.