Moody's downgrades Israel’s credit rating by two notches over war

Moody’s downgraded Israel’s credit rating late on Friday, lowering it by two levels from A2 to Baa1, citing serious concerns over the country’s economic management amid escalating war expenses.

The decision, which comes with a negative outlook, highlights the agency’s concerns about the government’s ability to handle the financial fallout from the ongoing conflict.

This downgrade marks the first time Moody’s has cut Israel’s credit rating by more than one notch, underscoring the severity of the situation.

The report accompanying the downgrade noted that Israel’s government has not adequately responded to the economic challenges posed by rising war costs, leading to increasing doubts about its financial strategy.

Moody’s pointed to delays in the budget process for 2025, where Finance Minister Bezalel Smotrich proposed a plan to cap the deficit at 4%.

However, it remains uncertain whether the government can implement the necessary austerity measures, which include freezing public sector wages and adjusting tax brackets.

The agency warned that Israel’s budget deficit could reach 6% in 2024, surpassing the 6.6% target for this year and possibly rising to 7.5% next year.

This spike is largely attributed to slow economic growth and significant spending on reservists and civilians evacuated from conflict zones in northern Israel.

Additionally, Moody’s predicted that the debt-to-GDP ratio would climb to 70%, far above the pre-war target of 50%.

Israeli economic officials reacted with shock to the downgrade, describing it as a crisis.

A senior government source noted that a double downgrade could take years to recover from, criticising the government's slow response to the worsening economic situation.

Efforts by Israel’s Prime Minister’s Office and the Finance Ministry to reassure Moody’s that the government would reduce the deficit to 4% proved unsuccessful.

The credit rating agency expressed doubts about whether the proposed economic measures would be effective, given the ongoing conflict and its associated costs.

Yali Rothenberg, Israel’s Accountant General, criticised Moody’s decision, calling it “excessive and unjustified.”

He argued that the downgrade does not accurately reflect Israel’s economic strength, despite the impact of the war.

He emphasised the need for swift approval of the 2025 budget, focusing on rebuilding fiscal reserves, maintaining a 4% deficit target, and reducing the debt-to-GDP ratio.

Yali Rothenberg also highlighted the importance of investment in infrastructure and addressing Israel’s social and security needs.

“Israel’s economy remains strong and resilient,” he said, expressing confidence that the country will navigate the financial challenges posed by the conflict.

This is the second time this year that Moody’s has downgraded Israel’s credit rating.

The agency warned that if the conflict continues to intensify, another downgrade could follow.

It raised concerns about long-term economic damage, including labour market disruptions, restrictions on Palestinian workers, and frozen investments due to heightened business risks.

Moody’s report also noted a significant rise in geopolitical risk, which now poses serious challenges to Israel’s creditworthiness.

The agency pointed to a decline in the effectiveness of Israel’s institutions and governance, questioning their ability to manage these mounting economic pressures.

What is a credit rating?

A credit rating assesses a country’s or company’s ability to repay loans.

For nations, credit agencies evaluate various financial indicators and liabilities, similar to how banks assess individuals.

Countries with high credit ratings are able to borrow at lower interest rates, while those with lower ratings face higher borrowing costs.

What does this mean for investors?

A higher credit rating suggests lower risk for investors, meaning countries like Israel, which has been downgraded, will now have to offer higher interest rates on loans.

This could increase borrowing costs for businesses in Israel, which are likely to pass on these expenses to consumers, affecting the cost of goods and services.

What does this mean in practical terms?

With higher borrowing costs, Israel’s government may be forced to reduce spending on public services such as welfare, healthcare, and education.

This could have a direct impact on Israeli citizens in the next budget cycle, as the government faces increasing financial strain due to the ongoing conflict.