The ratings agency, Fitch, downgrades Israel's credit rating

The governor of the Bank of Israel has Yaron has repeatedly called on the government to adopt a responsible fiscal policy in the face of a rise in war spending. (By Adobe).

Israel faces a downgrade of its credit rating by Fitch. Ahmed Abdel-Rahman explains how the country is handling the war with Hamas and its impact on the economy.

As the financial burden of the war has mounted, Israel has come under increased scrutiny from ratings firms. Fitch downgraded Israel's credit rating to A from A+, with a negative outlook, due to the impact of the ongoing war on Gaza, and the increasing geopolitical risks in the region since Hamas movement launched the Al-Aqsa Flood operation on October 7 and Israel's retaliation against Hamas.

The agency said in a report that the war and military spending had damaged Israel's public finances. Moreover, it expected a budget deficit of 7.8 percent of GDP in 2024, up from 4.1 percent in 2023. and that debt would remain above 70 percent of GDP in the medium term by the end of 2025. Fitch noted that this reflects the increase in large deficit spending related to military operations, containing economic damage, and the costs of resettling people in the north of the country.

Fitch pointed out that geopolitical risks support the negative outlook, as it believes that the war on Gaza may continue until 2025, with the risk that it will extend to other fronts.

In addition to the human losses, this could lead to increased military spending- it expects the government to permanently increase military spending by about 1.5 percent of GDP compared to pre-war levels- destruction of infrastructure, and continued damage to economic activity and investment, which will lead to further deterioration in Israel's credit indicators. The agency also said that regional tensions continue to escalate between Israel, Iran, and its allies.

For the 2025 budget, Fitch expects the deficit to reach 4.6 percent of GDP amid a fall in military spending and higher revenues. However, the agency also says that the deficit could be larger if the war continues in 2025. Fitch expects Israel to maintain a stronger presence along its borders than in the past, with plans to expand conscription and increase domestic military production, which will also lead to increased spending.

Debt-to-GDP

Fitch expects Israel's debt-to-GDP ratio to rise to 70 percent in 2024 and to 72 percent in 2025, surpassing the peak of 71 percent during the COVID-19 pandemic. However, if military spending increases on a sustained basis and macroeconomic uncertainty persists, it expects debt will continue to rise after 2025 Fitch said that Israel's debt is above the average expected for its A-rated peers, which is estimated to be 55 percent for 2025.

Intensified scrutiny from ratings firms

Other ratings firms are also putting Israel under the spotlight. In February, Israel received its first-ever sovereign rating downgrade — from A1 to A2 — from Moody's Investors Services. S&P Global Ratings also downgraded the country's rating last month.

However, the agency noted that state revenues rebounded in the first half of 2024 to a level higher than the revised budget, and it expects them to remain strong throughout the rest of the year.

USD67 billion cost of the Gaza war

Last May, the Bank of Israel governor Amir Yaron said that the cost of the Gaza war would reach 250 billion shekels (about USD67 billion) by 2025. He also noted that it is impossible to give a blank check for security spending. He has repeatedly called on the government to adopt responsible fiscal policy in the face of rising war spending.

Yaron explained during the "Israeli Economy after October 7" conference, that these financial estimates address the effects on the state budget and were calculated based on a loss of 40 billion shekels (USD10 billion) in tax revenues, and increased military spending such as salaries for reserve forces, purchasing ammunition, and civilian aid.

After seven months of war, Israel has incurred costs of 60 billion shekels (USD16 billion), bringing its budget deficit close to exceeding all of 2024's target. Data from Israel's finance ministry showed the 12-month fiscal deficit ballooned to 7 percent of GDP in April, higher than the government's 6.6 percent estimate for all of 2024.

Fitch said the increased budget spending would push-up inflation, which is nearing the top of the government's target range of 1 percent to 3 percent. Before that, inflation had been rising for two months. Yaron has repeatedly called on the government to adopt a responsible fiscal policy in the face of a rise in war spending.

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Sunday, 13 October 2024