Does Fitch's ratings drop show a gov't failure to manage war economy?

Big Three ratings company Fitch's drop of Israel's credit rating from A+ to A late Monday was seen by some as a natural result of the Israel-Hamas war and prompted criticism of the government's handling of the economic impact of the war from others in the political echelon and civil society.

The rating is a score given to Israel based on the company's perception of the country's ability to pay back debt. A lower rating indicates higher risk in investing in a country and can raise interest rates that must be paid on Israeli debt (such as Israeli bonds) or prevent investors from investing if the perceived risk is too great.

"The ratings drop due to the war, and the increased geopolitical risk it creates is natural," said Finance Minister Bezalel Smotrich, adding that "Be'ezrat Hashem (with the help of God)," the war will be won, the ministry will take the economy "from war to a growth track," and a responsible budget will be passed.

Then "the credit rating will quickly return to going up," he said.

The Prime Minister's Office echoed this sentiment, saying that the ratings drop "is a result of Israel's handling a multi-front war it was forced into. The rating will go up again when we win - and we will, indeed, win."

Opposition party heads called the credit rating drop an indication that the government has failed at managing the financial fallout of the Israel-Hamas war and emphasized the failure to cut coalition funds, and need to do so now.

"At least 12 unnecessary ministries must be closed immediately, coalition funds must be canceled, growth engines must be advanced instead of supporting those who don't work, and a balanced and responsible budget that meets the needs of the market and not political needs must be passed," said Opposition Head Yair Lapid.

"When we told the prime minister and finance minister that a huge correction must be made in the budget, they were not even willing to close the unnecessary government ministries and stop coalition funds," said National Unity Head Benny Gantz, adding that the ratings drop is the result of prioritizing political interests over national ones.

Civil society organization The Movement for Quality Government in Israel also called the ratings to drop a "resounding failure of the government in managing the economy" and demanded that a budget for 2025 be presented and a long-term economic plan proposed.  

There is a strong lack of confidence in the current government's economic management over the war.

Smotrich, as head of Israel's Finance Ministry, and the rest of the government along with him have been criticized over past months for a revised 2024 budget that did not cut coalition funds and an apparent failure to advance a 2025 budget at all, leading to decreased certainty and confidence in Israel's economy for investors.

While the war and geopolitical situation do have a major natural impact on Israel's rating, the government's action and inaction are also impacting this rating, said Ben Gurion University Senior Lecturer Dr. David Lagziel.

There are a few things the government is doing that impact the credit rating, "the first and most serious is that there are no discussions on the 2025 budget," he said.

The rating explanation from Fitch touches on this, saying that while there is general talk about actions that must be taken by Israel to handle the economic implications of the war, there is doubt that given the current political climate, Israel will be able to enact needed changes, he said.

"If the government does not discuss the budget and does not make adjustments [needed because of the war], then confidence in it drops," he said.

"Israel's government has not made adjustments; it just has not happened. It's hard to say something has been done," he added.

"There have not been spending cuts, ministries have not been cut, taxes have not been raised," he offered as examples.

"There are things that can be done. treating the situation as fate is simply wrong," said Lagziel, stressing that the idea that nothing can be done is simply untrue and that the government must take responsibility.

Even after the ratings drop, Israel's credit rating is higher than what is reflected in the market, said Lagziel, explaining that this means that "we are still at a higher rating compared to what the public think of Israel's debt," he explained, adding that the markets have reflected the increased risk in investing in Israel for a while, meaning that in some ways the ratings drop is symbolic

It can still have an impact, he added, explaining that some investors, such as some institutions or funds, do not invest in entities with ratings under a certain level.

BGU Professor Moshe Justman gave additional perspective on the impact of the rating cut, highlighting that when it comes to buying Israeli debt, the main question is whether or not the country will pay back its debts.

Historically, Israel has a perfect record when it comes to paying back debt, Justman emphasized, saying that this was true even when Israel's financial situation was much worse, with much bigger debts and a much weaker economy.

Justman also pointed to the debt-to-GDP ratio as a signal of Israel's economic health, saying that this ratio is low compared to other countries, given the impacts of the coronavirus and of the war.

The driving factor behind the ratings cut was the security situation, said Justman.

"I don't think that there is anyone who thinks that Israel will not pay back loans because its deficit is high," he said, explaining that the credit drop mostly reflects the increased risk of a disastrous security situation, which he said is the only factor that would impact whether or not Israel defaulted on a loan.

"A country whose economy is destroyed might not have a choice but to ask for discounts" on loan, he said, offering as an example the hypothetical case where Iran's attack on Israel had succeeded in tripling its economy.

The probability of such an occurrence is not big, Justman predicted, saying that its slight increase is what is impacting Israel's perceived ability to pay back debt.

In this situation, while the ratings drop has an impact, it is not the end all be all, he explained, adding that big lenders have their own assessments and the interest rate is determined in international markets. 

Former INSS head Prof. Manuel Trajtenberg said last month that a lack of strategy to handle the economic fallout of the war is discouraging to investors and rating companies who need to see a light at the end of the tunnel.

The economic signals Israel is sending are not good, said Trajtenberg. "For example, there are no budget discussions for 2025. There were supposed to be, and they were canceled," he said, explaining that without discussions, there will be no decisions such as raising taxes, which he says will be necessary to handle the war's economic fallout.

Contrary to the PMO and Smotrich's statements on the ratings drop reversing quickly when the impacts of the war on Israel's economy are stabilized, Trajtenberg said that it is "very easy to hurt the investor's trust in the economy and very hard to get it back. It takes a very long time."