What Moody's missed when lowering Israel's credit rating - opinion

As we just celebrated Rosh Hashanah, I want to highlight several bright spots in the Israeli economy, many of them surprisingly strong, which might lift your spirits despite the gloom. Much of Israel’s economic success is often underreported, even as we face the ongoing burdens of war.

Let’s start with the bad news. Last Friday, Moody’s downgraded both Israel’s internal shekel-based credit rating and its external foreign currency-based rating by two notches – from A2 to Baa1. While this may seem drastic, it’s far from a professional assessment, as I will explain.

Everyone expected Israel’s credit rating to drop, especially after Fitch Ratings lowered it in August. Typically, such downgrades would lead foreign and Israeli investors to sell large amounts of Israeli bonds and shift their funds to foreign currencies, thereby weakening the shekel. However, contrary to expectations, since the downgrade in August, the shekel has strengthened by 1.9% against the dollar – and by 4.2% since October 7.

Moody’s claimed that the conflict with Hezbollah could harm Israel’s ability to repay its debts, increase uncertainty regarding security, and negatively impact the country’s long-term growth. However, much of their analysis revolves around the ongoing war in the North and the potential for a regional conflict with Iran.

Surprisingly, the report does not mention the substantial support from the United States: the continuous military assistance, the supply of ammunition and equipment through thousands of flights, the financial aid package worth $14.2 billion, and the ongoing diplomatic support. Instead, Moody’s warns that deteriorating relations with Israel’s allies could negatively affect the economy. Yet, US President Joe Biden’s strong endorsement after the elimination of Hezbollah leader Nasrallah proves otherwise.

It seems Moody’s analysts have ventured beyond their expertise, morphing into strategists, military and geopolitical analysts, and internal political commentators without the necessary training.

It seems Moody’s analysts have ventured beyond their expertise, morphing into strategists, military and geopolitical analysts, and internal political commentators – all without the necessary training. If they were such experts, why did they forget about the extensive US backing for Israel?

Even if Moody’s analysts ventured into unfamiliar territory, they should at least have understood the financial facts better. Israel doesn’t need to take on significant foreign loans or accumulate large external debts. The country has never defaulted on its obligations, even when it was far poorer. In fact, the Israeli economy lends more money to the world than it borrows.

At the end of the second quarter of this year, Israel’s net foreign assets rose to $265.74 billion, up from $227.75 billion the previous year – a remarkable 16.7% increase. Israel now holds the highest net foreign assets in its history.

What contributed to this rapid rise?

What contributed to this rapid rise? Two primary factors are the thriving high-tech sector, with major exits and sales of services and equipment, and the global trend of high interest rates, driven by the Federal Reserve’s flawed policies, which have been forced to maintain elevated interest rates. Israel’s net foreign assets now amount to 51.7% of its GDP, another all-time high – something that Moody’s failed to acknowledge.

Moody’s also missed an important point regarding Israel’s growth potential: Israel’s high-tech exports (seasonally adjusted) grew by 6.1% over the past year, reaching an annual total of $54.25 billion – an increase of $3.17 billion.

Remarkably, much of this growth occurred during the war. Overall, business services exports (seasonally adjusted) rose to $69.07 billion annually by July, adding $2.08 billion during this challenging period. One can only imagine what could be achieved after the war.

Moody’s has hinted that if the northern conflict with Hezbollah continues, it may consider another downgrade. The intensifying clashes with Hezbollah and Israel’s decision to return 60,000 evacuated residents to the Galilee could fuel further conflict, while the breakdown in ceasefire talks with Gaza adds more uncertainty.

According to Moody’s, these factors heighten both political and geopolitical risks. The agency even went as far as to argue that the Israeli government lacks a clear exit strategy from the war. Much of this commentary seems to stem from conversations with opposition figures and former officials who are out of touch with the current realities.

Moody’s analysis is overly pessimistic.

Despite these criticisms, Moody’s analysis of Israel’s fiscal health is overly pessimistic. The agency predicts that Israel’s economy will grow at an annual rate of 3% in the coming years, down from the previous growth rate of 4% – still stronger than many comparable countries.

They also project that the government deficit will rise to 7.5% this year, higher than the government’s estimate of 6.6% (for comparison, the EU’s deficit stands at 3%), and that Israel’s debt-to-GDP ratio will reach around 70% (while the EU’s debt-to-GDP ratio is 89%).

One of the biggest secrets Moody’s overlooked is that foreign investors have been returning to Israel even during the war.

Foreign direct investment (FDI) – investments that grant ownership rights, such as in buildings or shares – rose to $5.9 billion in the second quarter of this year, up from $1.96 billion in the first quarter. These figures, recorded during the peak of the Israel-Hamas war, mark a significant increase compared to $4.5 billion in the second quarter of 2023.

Furthermore, Israel’s total foreign direct investments hit an all-time high of $248.3 billion this year, surpassing the $232.6 billion recorded last year. Israeli high-tech companies raised $9 billion since the war started, ranking third globally, behind Silicon Valley and New York.

Just recently, the American company Salesforce acquired two Israeli high-tech companies for a combined $2.35 billion. This shows that Israel and its companies, on a net basis, do not need foreign credit. Additionally, Israel’s success in using advanced technologies, including artificial intelligence, in recent operations is expected to boost investments in the country’s cyber sector.

Moody’s also pointed out that Israel’s external debt-to-GDP ratio is 28.3% but failed to mention that Israel actually has a net surplus in global debts – a critical factor in determining a credit rating. Today, Israel’s need for credit is much less significant than it was decades ago.

The key figure that global financial markets look at when assessing a country’s strength is its balance of payments. As of June 2024, Israel’s current account surplus stands at $23.75 billion, representing 4.62% of GDP – a 15.3% increase over the previous year.

Few countries worldwide enjoy such a large current account surplus in relation to their GDP. Israel ranks 22nd globally in absolute terms, with the EU’s current account surplus being just 1.7%. This surplus, which has lasted for over two decades, primarily stems from Israel’s flourishing high-tech sector, which accounts for 19% of its GDP.

In addition, the discovery of natural gas fields such as Leviathan and Tamar has turned Israel into a net energy exporter, significantly contributing to its growing surplus. Moody’s report failed to mention any of these crucial factors.

In the second quarter of this year, GDP growth was slow, rising by only 0.2%, compared to 4% in the last quarter of 2023. However, this sluggish growth should be seen in the context of the ongoing war.

Recently, there has been a clear recovery trend in the Israeli economy. Tax revenues have risen by 10% since the beginning of the year, and VAT revenues have increased by 5% in the first eight months of the year, totaling NIS 87.6 billion. Exports have also grown, with industrial exports increasing by 24% annually, marking a significant improvement. Additionally, the construction and hospitality sectors have shown signs of recovery.

Despite the war, private consumption per capita rose by 4.6% annually in the second quarter, and the unemployment rate has dropped to 2.6%, one of the lowest in the world. Full-time employment increased to 78.2%, with job vacancies rising by 18% compared to last year.

However, in light of these positive trends, the government must not become complacent. Taxes should be raised at the start of 2025 to prevent further budget deficits and fund the defense system’s transformation. This will require at least NIS 30 billion per year, if not more.

Sadly, the current government is dragging its feet on finalizing the 2025 budget. A national unity government focused on the economy is needed. If the government does not act, the euphoria following Nasrallah’s elimination could quickly turn into economic despair.