Fitch downgrades Israel's credit rating to A amid geopolitical tensions and ongoing conflict

Israel's credit rating was dropped from A+ to A with a negative outlook by Big Three ratings agency Fitch Ratings late Monday.

A country’s credit rating is a score given to it based on how the rating company perceives its ability to pay back debt. This rating can give investors an idea of how risky it is to invest in the debt of a particular country (such as buying the state’s bonds). Higher perceived risk in investing in a country increases the interest that it must pay on debt, making it more expensive for the country. Higher perceived risk could also lead to investors avoiding investment in it entirely.

Fitch's downgrade was driven by heightened geopolitical risk and the impacts of the continued Israel-Hamas war, which the company predicted could last well into 2025 and broaden to additional fronts.

The ratings company also touched on political obstacles to necessary financial reforms meant to handle the economic implications of the war, saying that these could present a risk to their forecast, meaning it could drop further.

While the current forecast assumes that the country will take fiscal consolidation measures, including a 1% rise in VAT, "political fractiousness, coalition politics, and military imperatives could hinder consolidation plans and present a risk to [the] forecast," said the company.

Fitch forecasts rising debt and budget deficit

Fitch predicted Israel would have a budget deficit of 7.8% of gross domestic product for 2024, and said that debt is likely to remain above 70% of Israel's GDP in the medium term.

 It predicted that the debt-to-GDP ratio would be at 72% in 2025 which the company emphasized was above the 71% peak in 2020 during the coronavirus pandemic.

This debt ratio would remain on an upward trend beyond 2025 in the case of higher permanent military spending and uncertain macroeconomic trends, the company added.

The company also predicted that Israel's World Bank Governance Indicators are likely to deteriorate, which the company said would weigh on Israel's credit profile.

These World Bank Group indicators are measures of how “good” the governance of a country is. They evaluate how effective the government – its regulatory quality, control of corruption, political stability, absence of violence or terrorism, and the rule of law – is. Further, they assess how much of a voice the public has.

Greater confidence that the debt-to-GDP ratio will return to a downwards trend, possibly as a result of fiscal reforms, could lead to a ratings upgrade, the company said, further highlighting the necessity of Israel's government showing an ability to advance necessary reforms and countermeasures to the damage of the war to Israel's economy.

The ratings explanation also touched on regional tensions between Israel and Iran and its allies, saying that these remain high. It cited the attack on Majdal Shams, and Israel's involvement and suspected involvement in recent assasinations of Hamas and Hezbollah leaders as highlighting high levels of regional tension.

The company predicted a permanent increase in military spending to 1.5% of GDP as Israel maintains a "stronger military presence along its borders than in the past."

It also predicted a budget deficit of 4.6% of GDP in 2025, expecting lower military spending and revenue growth, but emphasizing that this deficit could grow if the war continues.

This prediction is up from the company's April prediction that this deficit would stand at 3.9% in 2025.

Accountant General Yali Rothenberg responded to the ratings drop saying that while Israel's economy is strong and can contend with the challenges the country is facing, Israel must work to create as much certainty as possible for the economy, investors, and ratings companies.

"In order to do so, a responsible budget for 2025 must be advanced as soon as possible," he said.

This budget must be based on rebuilding financial reserves but gradually decreasing the debt-to-GDP ratio, he added saying that this must come with "advancing engines of growth, investing in infrastructure, meeting social needs, and a well-defined and organized answering of security needs."

The ratings drop follows an April Fitch decision to affirm Israel's rating at A+ while dropping its outlook from stable to negative. Also in April, Big Three ratings company S&P dropped Israel's rating from A+ to AA- in an unscheduled rivision that was permitted due to the significant increase in geopolitical and security risk in Israel the company saw.