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Rating Action:

Moody's changes Israel's outlook to positive from stable, affirms A1 rating

20 Jul 2018

London, 20 July 2018 -- Moody's Investors Service ("Moody's") has today changed the outlook on the government of Israel's A1 government ratings to positive from stable. Concurrently, Moody's affirmed Israel's long-term issuer and senior unsecured ratings at A1, senior unsecured MTN and shelf ratings at (P)A1 and backed senior unsecured rating at Aaa.

The change in the outlook was driven by the following factors:

(1) Favourable fiscal outcomes, which, if sustained, will further consolidate the shock absorption capacity of the government's balance sheet.

(2) Increasingly resilient economy with an expanding high tech sector, increased energy self-sufficiency and a strengthening external position.

The affirmation of the A1 ratings balances Israel's resilient economy, robust external position, strong institutional framework and favourable fiscal dynamics against a combination of longer-term demographic challenges and material geopolitical risks. The outlook horizon will allow Moody's to assess whether that balance will continue to shift in Israel's favour.

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 US government (Aaa, stable) on these instruments.

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. These ceilings represent the highest possible rating that an issuer domiciled in Israel can achieve.

RATINGS RATIONALE

RATIONALE FOR THE POSITIVE OUTLOOK

FIRST DRIVER: SUSTAINING FAVOURABLE FISCAL OUTCOMES WILL CONSOLIDATE SHOCK ABSORPTION CAPACITY

The first driver of the decision to assign a positive outlook is Israel's favourable fiscal dynamics, which, if sustained, for example by maintaining prudent budgeting, will further consolidate the shock absorption capacity of the government's balance sheet.

In particular, the general government debt ratio has declined by more than 10 percentage points since the last upward move in Israel's credit rating in 2008 to around 60% of GDP, reflecting in part a prudent budgetary framework and a robust growth performance. This contrasts sharply against trends in many other advanced country peers both before and after the global financial crisis. For example, Israel is one of only a handful of advanced economies (including Norway, Switzerland and Singapore, which are all rated Aaa with a stable outlook) with a lower debt to GDP ratio today than before the global financial crisis. Furthermore, central government deficits have remained below 3% of GDP over the past 4 years, despite repeated upward revisions of the government's own deficit targets.

Looking ahead, budget deficits which are likely to remain at or below 3% of the GDP will allow these gains to be preserved, with the debt burden remaining at around 60% of GDP or possibly nudging down gradually. Furthermore, the potential for further tax windfalls from foreign purchases of large tech sector companies, proceeds from privatisations and, further ahead, fiscal revenue gains from the gas sector, should help offset ongoing pressures for higher social spending and tax cuts.

Moody's expects that recently adopted commitment controls, such as the Numerator Rule that took effect in 2016, will continue to play an important role in increasing transparency in the budget setting process through a multi-year budget framework that limits the ability of the government to make new fiscal commitments without an identified budgetary source. Furthermore, the approval of the 2019 budget more than eight months before the start of the year also reinforces clarity of direction around the fiscal strategy going into an election year in 2019, which should help to mitigate spending pressures and promote political stability.

The positive outlook also reflects Moody's expectation that the government finances will remain highly resilient to shocks, benefitting from a large domestic market, exceptional access to external funding and low refinancing risks.

Israel's steadily reduced interest payments reflect both a lower debt burden and reduction in funding costs, with around 90% of government debt taken up by a deep and highly developed domestic market. Furthermore, the lengthening of average debt maturity should help keep annual financing requirements, which have been less 10% of GDP since 2014, low while the relatively small share of foreign currency debt will continue to mitigate exchange rate risks.

Israel's financing will also benefit from considerable foreign demand in its Israel Bonds program aimed at the Jewish diaspora which has shown a willingness to support in times of external shocks, as well as the direct benefits from the United States (Aaa stable) guarantee loan programme with approximately USD3.8bn available through to 2020.

SECOND DRIVER: INCREASINGLY RESILIENT ECONOMY WHICH IS LIKELY TO SUSTAIN MORE FAVORABLE GROWTH THAN PEERS

The second driver of the decision to assign a positive outlook is Israel's increasingly resilient economy, supported by the dynamism of the high tech sector, increased energy independence and a strengthening external position, which, if sustained, will continue to support more favourable growth rates than similarly rated peers.

Israel's economy has demonstrated robust economic growth since the last upgrade in the sovereign credit rating in 2008, with real GDP growth averaging 3.5% over the past decade, stronger than the median of A1 rated peers (2.9%). Growth has been supported by a well-developed and credible macroeconomic policy environment focused on maintaining economic and financial stability and in particular on lowering the government's debt burden to around 60%, which was accomplished in 2017. The combination of a favourable external environment and a supportive macro stance allowed the economy to reach full employment, with labour participation at around 80% among 25-64 years olds in 2017 and unemployment falling consistently since 2009 to below 4% this year.

Importantly, the economy has shown resiliency to a range of domestic and external shocks over this period, including domestic unrest, military conflict, and the global financial crisis without a single year's decline in real GDP. Notably, Israel's economy has proven more resilient than regional peers which experienced sharp contractions during the global financial crisis, which is reflected in lower growth volatility, 1.3% over the past 10 years, compared to A1 and Aa3 rated sovereigns.

The economy's resilience derives in large part from its diversified industries, ranging from agriculture to high-technology products and services, and a strong culture of innovation. The latter is reflected in the increasing share of the economy's value added from the Information and Communication Technology sector and Moody's expects the country's strong education standards and substantial R&D spending will likely continue to underpin the sector's role as a key productivity driver with positive spill-overs for the rest of the economy. This is also reflected in Israel's third place on the World Economic Forum's Global Competitiveness Index ranking for innovation, behind the United States and Switzerland.

The high tech sector has also contributed to Israel's robust external position, notably growth in services exports which have supported Israel's consistent current account surplus, averaging around 3% of GDP over the past decade. This sector is expected to continue to be the recipient of sizeable FDI inflows, supporting official reserves (which stand at record levels, around 32% of GDP at end 2017). As a result, the country's net international investment position has strengthened, reaching a net creditor position equivalent of around 40% of GDP last year, materially larger than the A1 median (around 28%).

These attributes will likely support an average growth rate of 3.4% to 2022, outpacing that of most advanced industrial economies into the next decade, while the external position continues to strengthen, helping to insulate Israel's open economy to future shocks. Moody's expects the completion of the first phase of development of the Leviathan gas field and the start of production with associated exports of natural gas from the end of 2019 will bolster growth, strengthen the external position, continue to improve Israel's energy independence and, over time, support government revenues.

RATIONALE FOR AFFIRMING THE A1 RATING

Israel's A1 rating balances its strengthening government and external balance sheets, faster growth than peers and robust institutional framework against longer term structural changes in the labour market and persistent geopolitical risks.

In particular, the increasing share of the population expected to come from Israeli Arab and Ultra-Orthodox groups who are underrepresented in the labour force due to cultural reasons will constraint its ability to grow above current estimates of potential growth (around 3.5%). According to estimates by Israel's Central Bureau of Statistics, these population groups are expected to comprise more than 40% of the total population by 2040 compared to around one-third currently.

Israel also faces persistent geopolitical risks, notably through ongoing tensions with Iran, the potential for Israel to be involved in low-scale conflicts in the region, as well as the risk of an escalation of tensions with Palestinians.

However, Israel has seen improvements in its security situation in recent years, benefitting not only from its strong military deterrent, military support from the United States, but also improving diplomatic and economic relations with neighbouring Arab countries such as Egypt (B3 stable), Jordan (B1 stable) and most recently Saudi Arabia (A1 stable), including agreements to supply some neighbouring countries with natural gas from the Leviathan fields. In addition, while defense spending still remains the government's largest spending item, recent agreements with the civilian authorities have helped stabilize the defense budget, which has been decreasing in relative terms.

WHAT COULD CHANGE THE RATING UP/DOWN

Israel's rating would be upgraded should the country's very high economic strength, robust institutions, fiscal metrics and strong external creditor position continue to demonstrate resilience against both domestic and external risks, consistent with the characteristics of a sovereign rating in the Aa range. Such resilience would likely include the maintenance of balanced or surplus primary fiscal positions that would keep the government debt metrics reliably below 60% and possibly falling further despite the forthcoming election period. Continued healthy growth and current account surpluses in the face of persistent geopolitical tensions would be credit positive in this respect. Furthermore, continued progress developing the Leviathan gas fields, which provides increased clarity on the potential size and timing of the economic and fiscal benefits, would also support an upward move in the credit rating.

The positive outlook signals that the rating is unlikely to move down over the next 12-18 months. However, the outlook could be stabilised if geopolitical developments materially disrupted Israel's economic stability, by deterring investment and likely requiring increased defense spending, with negative implications for the country's external position and fiscal accounts. Furthermore, an escalation of tensions with Palestinians which leads to increased international isolation, hurting Israel's export orientated economy, would also place downward pressure on the rating. Similarly, evidence that the government's demonstrated commitment to fiscal discipline, including a low debt burden, was to wane would be credit negative.

GDP per capita (PPP basis, US$): 36,340 (2017 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 3.4% (2017 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 0.4% (2017 Actual)

Gen. Gov. Financial Balance/GDP: -1.2% (2017 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: 3.1% (2017 Actual) (also known as External Balance)

External debt/GDP: [not available]

Level of economic development: Very High level of economic resilience

Default history: No default events (on bonds or loans) have been recorded since 1983.

On 16 July 2018, a rating committee was called to discuss the rating of the Government of Israel. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have increased. The issuer's institutional strength/ framework, have not materially changed. The issuer's fiscal or financial strength, including its debt profile, has increased. The issuer's susceptibility to event risks has not materially changed.

The principal methodology used in these ratings was Sovereign Bond Ratings published in December 2016. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Evan Wohlmann
Vice President - Senior Analyst
Sovereign Risk Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Yves Lemay
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Releasing Office:
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

No Related Data.
© 2019 Moody’s Corporation, Moody’s Investors Service, Inc., Moody’s Analytics, Inc. and/or their licensors and affiliates (collectively, “MOODY’S”). All rights reserved.

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