Fitch Ratings Agency
Fitch Ratings AgencyReuters

The international credit rating agency Fitch announced on Tuesday the reaffirmation of the State of Israel's credit rating at an A+ level, the removal of the "Negative Watch" and an update of the rating outlook from "Stable" to "Negative."

According to the company, "Geopolitical risks associated with the war in Gaza remain elevated and escalation risks remain present, but Fitch believes the risks to the credit profile have broadened and their impact may take longer to assess, so has removed the RWN on Israel's 'A+' rating."

Regarding the update of the rating outlook, the company mentions that "The Negative Outlook reflects the combination of uncertainties around the fiscal trajectory and the war's duration and intensity, including the risk of regional escalation. We expect a near-term jump in debt/GDP and persistently higher military spending in the context of fractious domestic politics and uncertain macroeconomic prospects, which could limit Israel's ability to bring down debt in the future."

"Risks of a widening of Israel's current conflict to include large-scale military confrontations with multiple actors - over a sustained period of time - remain high. This could include Hezbollah, other regional militant groups and Iran. This is not our base case, but such large-scale escalation, in addition to human loss, could result in significant additional military spending, destruction of infrastructure, sustained change in consumer and investment sentiment, and thus lead to a large deterioration of Israel's credit metrics," Fitch wrote.

"Israel has announced its intention to enter the city of Rafah in the south of Gaza, and we expect the war to continue in 2Q24 with a risk of intense operations continuing beyond. This implies continued high spending on immediate military needs, and disruptions to production in the border areas and in tourism and construction. Israel has demobilised most of its reservists, reducing the impact on the workforce."

It was also noted that, "Continued operations in Gaza also keep the risk of a widening of the conflict at an elevated level. The Israeli army and Hezbollah have exchanged fire repeatedly and neither side has chosen to escalate to an all-out war, while an escalation remains possible. A widening of the conflict could include other regional militant groups and Iran."

Fitch estimates that Israel will end 2023 with a deficit of 6.8% GDP and reach a deficit of 3.9% in 2025. Additionally, the debt-to-GDP ratio, as determined by the company, is expected to rise but still be lower than in 2021.

The report noted the effects of the war on foreign investor sentiment: "Investor sentiment will be important for the high-value-added high-tech sector which relies heavily on foreign investors and contributed to the buoyance of government revenue in recent years. Israel has experienced a sharp drop in funding raised by start-ups from the peak of 2021 and of greater magnitude than the US, the EU and Asia. Deals have continued to go through in 4Q23 and 1Q24, albeit at a slower pace. A sustained negative perception of Israel as an investment destination could harm potential growth, as could an outflow of skilled workers."

Fitch also made note of Israel's political situation: "An emergency government was formed to include parties beyond the original coalition and form a war cabinet which includes National Unity party leader Benny Gantz. The emergency government is likely to be dissolved once the intense phase of the war passes or earlier, and the original coalition will return to power. It could remain until the next elections in October 2026, although coalitions rarely last a full term and this one will face pressure for early elections, given the events of October 2023. The upcoming legislation on exemptions to military conscription could also prove divisive within the coalition. The precariousness of government coalitions has hindered fiscal consolidation in the past. The 2024 budget amendment included some coalition-related spending despite the surge in deficit."

Finance Minister Bezalel Smotrich responded, "The Israeli economy is robust and will continue to be so, with God's help. Keeping the rating at A+ during a war is an expression of confidence in the Israeli economy and the economic policy we are pursuing."

"We are in the midst of a war that was forced upon us and naturally the war generates many challenges for the economy. We are acting and will continue to act in a comprehensive manner to prevent and minimize the risks and to return to rapid growth that will realize the potential of the Israeli economy. God willing, we will end the war victorious, restore security, recover the hostages, and quickly return the Israeli economy to a path of growth and strength."