Moody's downgrades Israel's credit rating from A2 to Baa1, to lowest rating ever

Moody announced on Friday that it was downgrading Israel's credit rating from A2 to Baa1 with a negative outlook.

This is the second time they had downgraded Israel's credit rating during the war, with the previous time being in February when it was downgraded from A1 to A2.

Moody's cited its view that the geopolitical risk "has intensified significantly further, to very high levels with material negative consequences for Israel's creditworthiness in both the near and longer term," as the key driver of the downgrade. The company also touched on domestic political risk as a factor.

Finance Minister Bezalel Smotrich said in response on Saturday evening to the downgrade that "We will pass a responsible budget with necessary restraint measures," Walla quoted him as saying. "Israel's economy bears the burden of the longest and most expensive war in the country's history. It is a war of existence that we must continue until victory, which will allow us many years of peace, security, and economic growth."

While the conflict with Hezbollah has escalated, prospects for a ceasefire in Gaza have receded, the ratings agency explained.

The agency said that Israel's economy will be "more durably weakened by the military conflict than expected earlier," adding that they "no longer expect a swift and strong economic recovery as in previous conflicts."

The agency also addressed Israel's political institutions and governance, saying that "the significant escalation in geopolitical risk also points to diminished quality of Israel's institutions and governance, which have not fully mitigated actions detrimental to the sovereign's credit metrics." 

Israel has been undergoing serious financial stress as a result of the war, which led to the government having to issue at least two emergency budgets for 2024.

Some experts have estimated that the war will cost a total of 10% of Israel's GDP, most of which will be paid for through borrowing.

Moody's rating downgrade will harm Israel's ability to borrow, increasing the cost of servicing debt and increasing the interest rate on new loans.

What does the change mean?

Moody's ratings are intended to give investors a simple gradation system for deciding which securities will be most reliable.

Ratings are broken into two major categories: investment-grade (Aaa-Baa3) and speculative-grade (Ba1-C), and are further broken down by the alpha-numeric system.

So, what does the rating change mean in practical terms?

According to Moody's, "Obligations rated A are considered upper medium-grade and are subject to low credit risk," while "Obligations rated Baa are subject to moderate credit risk. They are considered medium-grade and, as such, may possess speculative characteristics."

However, the downgrade was two-tier moving from A2 to Baa1, meaning that Moody's downgraded not only Israel's long-term credit outlook but also its short-term outlook.

Israel was downgraded in its short-term outlook from Prime-1 to Prime-2, meaning it went from having "a superior ability to repay short-term debt obligations" to having "a strong ability."

While still a moderate downgrade, it poses significant questions for Israel's financial future and challenges Netanyahu's legacy on the economy.

Israel spent many decades focusing on finance and the economy to achieve its previously high rating of A1. The cut to Baa1 means that Israeli credit is rated lower than it was in 1995.