Israel’s credit rating has faced another blow as the global credit rating agency S&P downgraded the government’s rating by one notch from A+ to A, with a negative outlook. This follows an earlier downgrade by Moody’s, signalling increasing concerns over Israel’s economic and geopolitical stability. The negative outlook added to the new rating suggests that further downgrades could be on the horizon, reflecting deeper apprehension about Israel’s fiscal health and security risks.

S&P’s decision comes in the wake of escalating conflict with Hezbollah in Lebanon, coupled with the looming threat of direct hostilities with Iran. Just before the missile attack from Iran on Tuesday night, S&P pointed to the heightened risk of conflict with Hezbollah as a key factor in the downgrade. While a direct confrontation with Iran is not their base scenario, the agency cited it as a serious risk, contributing to the negative forecast for Israel’s economic future.

The agency’s statement emphasizes the growing security threats Israel faces, particularly missile and rocket attacks, which could further destabilize the region and strain the economy. S&P had already flagged security concerns earlier this year following assassinations of key figures in Beirut and Tehran, which they feared could lead to severe retaliations against Israel.

S&P also raised alarms about Israel’s economic outlook. The agency forecasts zero growth for 2024, a stark contrast to the Israeli Treasury’s more optimistic prediction of 1.1% growth. For 2025, S&P projects only 2.2% growth, significantly below the previously expected 5%. This dramatic reduction highlights the increasing uncertainty surrounding Israel’s ability to sustain economic growth amid security threats and internal challenges.

Moreover, the fiscal deficit is expected to climb to 9% of GDP in 2024 before decreasing to 6% in 2025. These figures, which focus on the broader government deficit rather than the typical budget deficit monitored by the Finance Ministry, paint a concerning picture of Israel’s fiscal stability. The prolonged conflict and delayed approval of the 2025 budget further complicate efforts to address the deficit and stabilize the economy.

While S&P’s statement does not explicitly criticize the Israeli government’s economic policies, there is an implied scepticism regarding its handling of fiscal matters. The agency highlights the importance of freezing tax rates as part of the government’s commitment to balancing the budget, but this is framed more as an obligation than an achievement. S&P had originally planned to review Israel’s credit rating in November, but due to the rapidly deteriorating geopolitical situation, they opted to bring forward the downgrade.

In response to the downgrade, Israel’s Accountant General, Yehli Rotenberg, acknowledged the impact of the ongoing conflict on the economy but emphasized the strengths of the Israeli financial system. He pointed out that Israel’s economy is diverse and has demonstrated resilience in past crises. Rotenberg also noted that Israel continues to maintain a robust balance of payments and significant foreign exchange reserves, which provide a cushion for the economy during turbulent times.

Rotenberg stressed the need for swift action in passing the 2025 state budget, which he said would help rebuild fiscal reserves, limit the deficit to 4% of GDP, and ensure the economy returns to a path of reducing the debt-to-GDP ratio. He highlighted the importance of investment in growth engines, infrastructure, and social needs while ensuring Israel’s security requirements are met.

Despite the downgrade, Israel’s credit rating remains above Moody’s, which had previously lowered the country’s rating to Baa1. Analysts expect that Fitch, another major credit rating agency, may soon follow suit with a downgrade of its own. The dual pressures of growing security threats and a weakening economic outlook have put the Israeli government in a difficult position as it seeks to balance defence spending with fiscal discipline.

Image credit: S&P Global. Brendan McDermid/Reuters