Growth is good, but not good enough
S&P: Fiscal consolidation is taking hold in Israel, following the passage of the 2013-2014 budget.
On Friday, Standard & Poor's Ratings Services (S&P) affirmed its A+ foreign currency credit rating for Israel with a "Stable" outlook. It also reaffirmed its local currency A-1 sovereign credit rating. "Fiscal consolidation is taking hold in Israel, following the passage of the 2013-2014 budget and, as a result, we expect a modest decline in the general government debt burden," says S&P.
S&P says that its "Stable" outlook reflects its view that the government will continue to consolidate government finances and that the impact of security risks on the Israeli economy will remain contained.
S&P believes that Israel's economy is prosperous and diverse and that natural gas production will have a positive medium-term impact on the external account and contributes to the government's considerable monetary flexibility. It adds that geopolitical risks and relatively weak, albeit improving, government finances constitute the major rating constraints.
S&P forecasts real GDP per capita growth of 1.2% for 2013. This is similar to the growth rate in 2012, but, after the contribution of natural gas is excluded, it implies that overall economic activity is weakening. The rating agency forecasts that per capita growth will gradually increase again to an average of 1.7% in 2014-16, in line with a modest recovery in Israel's key export markets.
Commenting on S&P's reaffirmation of Israel's credit rating, Minister of Finance Yair Lapid said, "This is further proof that we should continue the responsible economic policy of the 2013-14 budget."
Accountant General Michal Abadi-Boiangiu said, "Responsible management of the government debt and the commitment to lowering the debt-to-GDP ratio over time are an important part of Israel's economic soundness."
S&P also mentioned the latest GDP data published by the Central Bureau of Statistics on September 8, following the change in its methodology, which resulted in a 6.9% increase in GDP for 2012. It says that about half the increase is attributable to the inclusion of investment in intellectual property and income from financial brokerage services. "We are waiting for a more complete dataset before incorporating the revised data in our analysis. We do not expect the revised data to have an impact on Israel's current sovereign ratings, although we note that increased GDP is a positive development," it says.
S&P expects general government debt to rise by 4.4% of GDP in 2013, and that the average increase in 2013-16 will be 3.3% of GDP. "Nevertheless, we expect Israel's net government debt burden to modestly decline over the forecast horizon - to below 65% of GDP by 2016, from 68% currently. This is due to the increase in nominal general government debt over the period being slightly lower than the increase in nominal GDP," it says.
"Israel's external fundamentals remain strong. We expect its net asset position to reach 30% of GDP (70% of current account receipts [CARs]) this year. We project external debt will fall below official reserves and financial sector external assets by 42% of CARs in 2016," says S&P. "We base our projection on the current account returning to surplus in 2013 at 1% of GDP, and continuing to rise. We estimate that the country's gross external financing needs will continue to decline and stay just below 80% of CARs and usable reserves in 2013.
"We consider monetary policy flexibility to be a credit strength. The Bank of Israel has indicated it will relieve upward pressure on the shekel by purchasing foreign exchange in line with its assessment of the effect of natural gas production on the balance of payments. A largely balanced current account and net inward foreign direct investment exceeding 3% of GDP in recent years have pressured the shekel, which has complicated the Bank of Israel's task of containing inflation and tempering credit flows to the housing market."
No Bank of Israel governor is a risk
S&P cautions, "We see risks stemming from leadership uncertainty at the Bank of Israel, where half the positions on the Monetary Policy Board, including the governor, have no designated successors since resignations were announced in July 2013. In our view, the bank has sufficient institutional depth to manage the situation and we expect selections to be completed soon.
"We consider Israel's institutions to be generally effective with a satisfactory degree of transparency and accountability," S&P's statement says, but adds, "The political system is prone to instability and policy predictability is limited. Furthermore, the impact of external security threats exacerbates political uncertainty by inserting another dividing line in the electorate and distorting policy debates."
As for geopolitical risk, S&P says that they are a rating constraint. It cites the recent skirmishes on the Golan Heights and the outbreak of hostilities with Gaza in November 2012 as examples of how easily Israel can be drawn into or ignite armed conflict. "In this respect, relations with the Palestinians, the war in Syria, and instability in Sinai signal possibilities for deterioration in the medium term. Any significant armed conflict with Israel could have a negative ratings impact if such conflict were to significantly deter investment, weaken the economy's growth potential, or strain external, monetary, or fiscal flexibility," it says.
S&P concludes, "We could consider raising its ratings on Israel if it makes material progress in defusing external security risks. In our view, progress would have positive repercussions for domestic stability, economic growth, and investor confidence. Conversely, we believe that a significant setback in reducing the government's high debt burden, a significant decline in growth prospects, or a substantial deterioration of the security situation in Israel could put downward pressure on the rating."
Published by Globes [online], Israel business news - www.globes-online.com - on September 29, 2013
© Copyright of Globes Publisher Itonut (1983) Ltd. 2013
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