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Rating Action:

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

24 Apr 2020

London, 24 April 2020 -- Moody's Investors Service, ("Moody's") has today changed the outlook on the Government of Israel's A1 ratings to stable from positive. Concurrently, Moody's affirmed Israel's long-term issuer and senior unsecured ratings at A1, senior unsecured MTN programme and shelf ratings at (P)A1 and backed senior unsecured rating at Aaa.

The change in the outlook to stable from positive was driven by the following factors:

(1) Israel's impaired fiscal outlook given the recent deterioration in the budget deficit, which is amplified by the coronavirus outbreak; and

(2) Israel's weakening fiscal policy effectiveness, driven in part by a more polarized political environment.

The affirmation of the A1 ratings reflects Israel's robust medium term growth potential, strong external position and highly credible institutions, which Moody's expects will help its credit profile to withstand the impact of the severe but temporary crisis arising from the coronavirus outbreak. These strengths are balanced against a combination of longer-term demographic challenges and persistent geopolitical risks.

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[1].

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.

RATINGS RATIONALE

RATIONALE FOR THE CHANGE IN THE OUTLOOK TO STABLE FROM POSITIVE

FIRST DRIVER: IMPAIRED FISCAL OUTLOOK GIVEN DETERIORATION IN BUDGET DEFICIT

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.

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.

In particular, last year's fiscal target of a 2.9% of GDP deficit at the central government level was missed by a large margin as civilian expenditures were higher than budgeted at the same time as government revenues have been impacted by weak growth in indirect taxes and fewer one-off revenue windfalls relative to recent years. As a result, Israel's structural budget balance has materially worsened over the last two years, reaching a deficit of 4.5% of GDP in 2019, according to the Bank of Israel.

Furthermore, the current crisis prompted by the coronavirus outbreak will serve to amplify Israel's already worsening fiscal trajectory. Moody's expected a renewed rise in the government debt to GDP ratio even before the crisis and, given the sizeable fiscal response package and the expected economic contraction, Moody's forecasts the government debt burden to reach around 72% of GDP this year, which is around 12pp higher than the end of 2019.

A strong rebound in economic activity next year, together with only modest fiscal consolidation efforts in line with the evidence of recent years, will help reduce the budget deficit to 5.5% of GDP in 2021, from a deficit of 9% in 2020. That said, Moody's forecasts that Israel's government debt burden will remain elevated in the coming years, reducing the fiscal space to absorb future shocks. Indeed, while there remains a high degree of uncertainty around these forecasts given the evolving nature of the current crisis and policy response, Moody's expects that, even under optimistic scenarios, it would still take a number of years for the government debt burden to return closer to 2019 levels. Nevertheless, Israel's debt burden would still remain moderate relative to many other advanced economies, while Israel's overall fiscal strength will remain supported by its improved debt affordability.

SECOND DRIVER: WEAKENING FISCAL POLICY EFFECTIVENESS, DRIVEN IN PART BY A MORE POLARIZED POLITICAL ENVIRONMENT

The second driver of the decision to stabilize the outlook is Moody's conclusion that Israel's fiscal policy effectiveness, which has been negatively impacted by a more polarized political landscape, is weaker than was expected at the time of assigning the positive outlook in July 2018. Moody's considers fiscal policy effectiveness a Governance consideration under its ESG framework.

An increasingly polarized domestic political environment has resulted in an unprecedented three general elections in the space of a year, leading to a series of transitional governments since December 2018 and in turn delaying the passing of the 2020 budget. As a result, caretaker governments have lacked the authority to adopt material fiscal adjustment measures, even as Israel's structural deficit markedly worsened over the last two years amid weaker than expected revenue growth and above budget expenditure.

At the same time, Israel's fiscal rules have proved less effective than expected in encouraging fiscal discipline, with longstanding issues, such as largely reactive policy making and frequent revisions to fiscal targets, magnified by the political stalemate.

Moody's expects the domestic political environment in Israel will remain more polarized than in the past and, while a major shift in policy direction remains unlikely, is likely to continue to pose a headwind to prompt and decisive fiscal policy.

The recent agreement on the formation of a "national emergency" coalition government reduces the immediate risk of fourth elections, and paves the way for the passing of a budget to support the government's policy response to the coronavirus outbreak which had been slowed by the political stalemate. That said, Moody's expects the elaboration of an effective post-crisis fiscal strategy that would seek to bring the government debt burden quickly back to 2019 levels will be challenging given the likely impact of a more fractured political environment on policymaking. For example, there remains a significant risk of renewed political stalemate, particularly if the new government does not last beyond its initial narrow mandate to focus on the current crisis over the next six months.

As a result, the outlook period has revealed that Israel's fiscal policy framework does not demonstrate the degree of resilience to domestic political developments which would be consistent with the characteristics of an Aa-rated sovereign.

RATIONALE FOR THE AFFIRMATION OF THE RATING AT A1

The affirmation of the A1 ratings reflects Israel's robust medium term growth potential, strong external position and highly credible institutions, which are balanced against a combination of longer-term demographic challenges and persistent geopolitical risks.

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 favourable 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.

As such, while 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, and Moody's expects Israel's medium term growth potential will remain robust at around 3.5%. That said, long-term structural changes in the labour market, including the increasing share of the population expected to come from those groups who are underrepresented in the labour force for cultural reasons, will pose a headwind to achieving higher potential growth.

While government debt will rise, Israel's debt affordability has strengthened amid reduced funding costs in recent years given its deep and highly developed domestic market and exceptional access to external funding. Finally, the affirmation of the A1 rating also reflects that Israel will continue to face persistent geopolitical event risks inherent in the Middle East which can impact on the economy and public finances.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

Moody's takes account of the impact of environmental (E), social (S), and governance (G) factors when assessing sovereign issuers' economic, institutional and fiscal strength and their susceptibility to event risk. In the case of Israel, the materiality of ESG to the credit profile is as follows.

Environmental considerations currently exert limited impact on Israel's credit profile. Although Israel is exposed to environmental risk through rising temperatures, drought episodes and water scarcity given its geographical location in a semiarid climate zone, the authorities have taken a number of successful steps to address these risks, including through seawater desalination and wastewater recycling.

Social factors are material to Israel's credit profile. Moody's regards the coronavirus outbreak as a social risk under our ESG framework, given the substantial implications for public health and safety, and that the outbreak will have an adverse economic and fiscal impact for Israel. The country also faces a shifting demographic composition and the challenge of maintaining its competitive advantage in human capital because of large educational and productivity gaps among the country's various population groups, which could limit further improvements in Israel's growth potential over the medium to long term.

In terms of governance, Israel's institutions remain strong, as measured by the Worldwide Governance Indicators. Moody's considers policy effectiveness a Governance consideration under its ESG framework and the weakening in Israel's fiscal policy effectiveness is a key driver of the decision to stabilize the outlook. Furthermore, Israeli leaders have been at the center of a number of scandals involving bribery and abuse of power, eroding public confidence in the country's politicians. In addition, politicians have increasingly sought to challenge the country's judicial system which may, over time, reduce the effectiveness of the courts to act as a check on the exercise of government power.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

While unlikely in light of the economic and fiscal implications of the coronavirus outbreak, upward pressure on the rating could develop from a material improvement in the shock absorption capacity of government finances. This would likely entail not only a prompt restoration of public finances following the impact of the coronavirus outbreak, but also increased confidence that future governments would be willing and able to return government debt to its historic downward trend. Furthermore, continued healthy rates of medium-term economic growth and current account surpluses in the face of persistent geopolitical tensions would also likely be required to support an upward move in the credit rating.

Negative rating pressure could develop if the current shock arising from the coronavirus outbreak were to result in a prolonged deterioration in economic potential and/or public finances, leading to a continued upward trend in government indebtedness. This could arise from another prolonged period without a formal government in place, or from the formation of a coalition unable to advance policy measures to offset such a deterioration, signaling a marked further weakening in Israel's institutional capacity. Downward pressure on the rating could also develop 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.

GDP per capita (PPP basis, US$): 37,994 (2018 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 3.4% (2018 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 0.8% (2018 Actual)

Gen. Gov. Financial Balance/GDP: -3.6% (2018 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: 2.6% (2018 Actual) (also known as External Balance)

External debt/GDP: 25.3% (2018 Actual)

Economic resiliency: aa3

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

On 21 April 2020, 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 not materially changed. The issuer's institutions and governance strength, have decreased. The issuer's fiscal or financial strength, including its debt profile, has decreased. The issuer's susceptibility to event risks has not materially changed.

The principal methodology used in these ratings was Sovereign Ratings Methodology published in November 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1158631. Alternatively, 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 further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security 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.

The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.

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

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.

At least one ESG consideration was material to the credit rating action(s) announced and described above.

REFERENCES/CITATIONS

[1] U.S. Foreign Aid to Israel, Congressional Research Service, 07-Aug-2019

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
VP - Senior Credit Officer
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.
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