From A1 to Baa1: Understanding Israel’s Credit Rating Journey

Israel's credit rating was at A1 before it was downgraded to A2. The recent downgrades to A3 and then to Baa1 reflect the escalating economic and geopolitical challenges the country is facing¹².

Main Factors Behind the Downgrade

1. Geopolitical Risks:

The ongoing conflicts with Hamas in Gaza and Hezbollah in Lebanon have significantly increased geopolitical risks¹². The potential for a wider regional conflict involving Iran and other powers has further exacerbated these risks¹.

2. Economic Costs of War:

The financial burden of the prolonged conflict is substantial. Government spending has surged, and sectors like tourism, agriculture, and construction have been severely impacted¹². The estimated war costs through the end of next year are around $66 billion, which is more than 12% of Israel's GDP¹.

3. Budget Deficit and Debt:

Israeli's budget deficit is projected to reach 6% in 2024 and 7.5% in 2025, significantly surpassing previous targets². The debt-to-GDP ratio is expected to rise to 70%, a stark contrast to the pre-war goal of reducing it to 50%².

Impact on Borrowing Costs

The downgrades have a direct impact on Israel's borrowing costs, especially during wartime:

A downgrade to Baa1 reflects a lower creditworthiness, which makes Israel a riskier borrower in the eyes of international investors. This means that investors will demand higher returns (interest rates) to compensate for the increased risk.

This is particularly problematic in wartime, when Israel may need to increase borrowing to fund its defense efforts, but the cost of doing so is rising significantly.

- Higher Interest Rates:

Lower credit ratings typically lead to higher interest rates on government bonds, increasing the cost of borrowing.

- Investor Confidence:

The downgrades can erode investor confidence, making it more challenging for Israel to attract investment.

- Economic Recovery:

Moody's has expressed doubts about a rapid financial rebound once hostilities end, suggesting a more prolonged economic recovery¹.

4. Increased Government Debt Servicing Costs:

With higher borrowing rates, the cost to service existing and new debt will increase. Israel's budget will face greater pressure, as more funds will be directed toward interest payments rather than essential services or defense.

5. Reduced Access to Capital Markets:

Lower credit ratings can reduce access to international capital markets, as some institutional investors (like pension funds) are restricted from investing in bonds rated below a certain threshold. This could reduce Israel's ability to raise funds quickly, exacerbating liquidity issues during the war.

6. Strain on Domestic Economy:
With rising interest rates, the domestic borrowing costs for businesses and households also increase, potentially leading to a reduction in business investment and consumer spending. This could lead to a recession, which would further erode tax revenues and economic stability.

7. Pressure on Israeli Bonds:
Israeli bonds are likely to see declining prices, as existing bondholders sell off holdings in response to the credit downgrade. This would push yields (and therefore borrowing costs) higher, compounding Israel's financial challenges.

Conclusion
The downgrade of Israel’s credit rating by Moody’s is a reflection of the significant economic and geopolitical risks the country faces, particularly amid the ongoing war. This downgrade means that Israel will face higher borrowing costs, further straining its budget and potentially limiting its ability to respond effectively to both the war and future economic challenges.

The longer the conflict continues, the more severe the financial implications will become, impacting Israel's ability to recover economically in the post-war period.

The downgrade also signals growing concern in the international community about Israel's overall stability, which could have long-term consequences for its economy and political landscape.

Source:
(1) Moody’s Downgrades Israel Again as Economic Costs of War Mount. https://finance.yahoo.com/news/israel-downgraded-moody-again-war-204259787.html.
(2) Moody’s downgrades Israel’s credit rating by 2 levels amid economic .... https://www.ynetnews.com/business/article/skbmzjn0c.
(3) Moody's cuts Israel’s rating, signals potential drop to 'junk' amid .... https://economictimes.indiatimes.com/news/international/business/moodys-cuts-israels-rating-signals-potential-drop-to-junk-amid-ongoing-geopolitical-concerns/articleshow/113754471.cms.
(4) Moody's Cuts Israel's Rating, Warns of Drop to 'Junk' - U.S. News. https://money.usnews.com/investing/news/articles/2024-09-27/moodys-cuts-israels-rating-warns-of-drop-to-junk.

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