S&P drops Israel's credit rating, citing geopolitical risk after Iran attack

Ratings agency S&P Global lowered Israel's long-term rating from A+ to A on Tuesday in an unscheduled ratings adjustment prompted by a "significant increase of geopolitical and security risks around Israel."

S&P maintained Israel's negative outlook on the long-term ratings, meaning that it could drop again.

The ratings drop follows by less than a week a drop by Moody's ratings which lowered Israel's credit rating by two notches, to the lowest ranking the country has ever received from the company.

The downgrade "reflects the fallout on Israel's economy and public finances from a worsening conflict with Hezbollah in Lebanon, including possible security threats in case of retaliatory rocket attacks against Israel," the agency explained.

S&P revised its predictions for Israel's growth, expecting that economic recovery will slow with real GDP growth of 0% in 2024 and 2.2% in 2025. This is compared to a previous expectation of real growth of 0.5% in 2024 and 5.0% in 2025.

For the deficit, the agency predicted that the 2024 deficit would be 9% and that this would reduce to 6% in 2025. The agency also predicted that " fiscal deficits are likely to average 5% of GDP over 2026-2027."

The agency's updated assumptions for Israel, on which they based their ratings update, were that there would be continued military activity in Gaza and more intense fighting with Hezbollha in 2025.

It also predicted that Hezbollah and other Iranian proxies would likely conduct retaliatory strikes against Israel, but the agency did not assume that there would be sustained damage on the ground or damage to critical infrastructure.

The third working assumption was that there would not be a wider sustained regional war directly involving Iran.

Evidence that these assumptions are not going to be met, such as escalation in the conflict with Iran or more intense fighting in Gaza, could cause the company to revise its rating further.

The negative outlook maintained by the agency "reflects the risks to Israel's growth, public finances, and balance of payments from the intensifying conflict against Hezbollah in Lebanon, including direct security threats in case of retaliatory rocket attacks against Israel," the company explained.

The agency said that a reduced likelihood of military escalation and moderation of broader security risks could cause them to revise the outlook to stable.

If the military conflicts it faces become "a bigger than anticipated detriment to Israel's economic growth, fiscal position, and balance of payments," the agency said it could lower Israel's rating in the next 24 months.

This could be caused by the spread of ongoing conflicts, rising risk of retaliatory attacks, or an increased prospect of war with Iran or a wider regional war involving Iran, the company explained. 

The agency praised Israel's "highly adaptable and diversified economy," calling this the most important of "key strengths."

"Israel has historically enjoyed strong growth rates and has rebounded briskly from previous crisis," said the company, noting that Israel also has high per capita income among other strengths.

The agency also highlighted the commitment of Israeli authorities to fiscal consolidation "via a range of measures."

Issue of debt

The lowered credit rating may mean that Israel must pay more on its debt. This is significant given how much Israel spends on interest payments - in 2022, interest payments cost Israel's government more than its primary and secondary school systems combined.

A lowered rating can also deter investors from investing in the country at all, and if the rating, and investor's confidence continue to drop, can limit Israel's access to capital markets.

Israel's Accountant-General Yali Rothenberg responded to the credit rating drop, attributing it to the continued war and increased geopolitical risk.

"As we stand strongly against our enemies, we must act to create maximum certainty to the market and investors in the country and around the world, and work to approve a budget for 2025 as soon as possible," said  Rothenberg.

This must be a budget that would rebuild fiscal reserves by capping the deficit at 4% of GDP, as well as encouraging investment in engines of growth, while meeting social and security needs, he added.