AnalysisHas Israel become too risky for foreign capital?
Analysis
Has Israel become too risky for foreign capital?
Credit downgrades and rising CDS rates highlight deepening economic woes.
Israel's credit downgrading rating from A+ to A by Fitch - considered the most forgiving and optimistic toward Israel's economy - makes it the third credit ratings agency to downgrade Israel’s credit rating, following Moody's and S&P. All three have also projected a negative outlook, meaning they intend to downgrade again within the next year to a year and a half. Now, it’s impossible to argue that any one agency is "exaggerating," as the government tried to claim in February when Moody's first announced their downgrade.
If that weren't enough, the situation in the capital market is even worse. There, they explain that the yield gap between Israel's 10-year government bonds compared to equivalent U.S. bonds, as well as the level of CDS’s (Credit Default Swaps, which serve as a measure of government risk premium), reflect a credit rating below A. According to the consensus, it's at BBB, and in some cases even lower, meaning at least three grades below the official rating.
For example, Israel's 5-year CDS closed on August 12 at 144.7 points. The CDS for a similar period for Mexico, rated BBB with a negative outlook, closed at 114.8, about 20% less. Even the CDS of Romania, Hungary, and Kazakhstan is lower than that of Israel, despite these countries having a rating of BBB or BBB-. According to Bloomberg data, Israel's CDS recorded the highest jump in the world over the past year at 164%.
The fact that future downgrades for Israel are already priced into the market is far from a badge of honor. Furthermore, it is now on the cusp of an investment grade. Many institutional financial bodies, including pension funds, are not allowed to invest anywhere with a lower rating. This means that a downgrade directly threatens foreign investments in Israel at a time when investors are already distancing themselves due to the war and protests against it.
"The pricing of Israel's risk in the markets (according to the CDS level) even points to a rating level significantly lower than the current level, which indicates a substantial overreaction by global markets," explains Dr. Gil Bufman, the chief economist at Bank Leumi. Furthermore, the credit rating of Israeli government bonds affects the rating of Israeli corporate bonds.
Moody's is expected to release a credit rating update in the coming days, as they do every six months. S&P said their next update is expected in early November. However, rating agencies can release updates at any moment. Background conditions suggest that more downgrades are coming.
According to the Treasury, the government deficit in June amounted to 8.1% of the GDP – one of the highest in the country's history and far from the 6.6% ceiling that is legally permitted. The government was supposed to approve the 2025 state budget yesterday, but there’s no sign of that happening. According to Finance Minister Bezalel Smotrich, work on the budget will only begin following the high holidays in October.
