Standard & Poor's Ratings Services today lowered the long- and short-term local currency sovereign credit ratings on the State of Israel to 'A+/A-1' from 'AA-/A-1+'. At the same time, S&P affirmed the long- and short-term foreign currency sovereign credit ratings at 'A+/A-1'. The outlook is stable.
"The lowering of the local currency rating results from recent fiscal slippage, highlighting the gap between fiscal performance and other key metrics such as economic performance, external balances, and monetary policy flexibility. These continue to be relatively strong. Under our criteria, we do not distinguish between local- and foreign-currency sovereign ratings when a government's fiscal position is a disproportionate credit constraint," S&P's statement said.
"Our affirmation of the foreign currency ratings reflects our view of Israel's prosperous and diverse economy as well as the medium-term impact of natural gas production on the external account. The stable outlook reflects our opinion that Israel's governmental consensus about containing public debt will reemerge despite current fiscal consolidation pressures.
"We could consider raising our ratings on Israel if it makes material progress in defusing external security risks, since such 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 decline in growth prospects, or a substantial deterioration of the security situation in Israel could put downward pressure on the rating," the announcement concluded.
Minister of Finance Yair Lapid issued a statement in response to S&P's downgrade of its local currency rating for Israel saying, "The rating downgrade at this time is no surprise. This is a late response to the situation that we are now trying to correct. We have to look at ourselves in the mirror and honestly say: 2013 and 2014 are the years in which we shall close the overdraft, and as we fix it, we shall start to take off. We are now changing our order of priorities. The working person will be at the center; the cost of living will fall. Only that way can the economy grow and continue to maintain its standing.
"We are now taking responsible steps, and as long as I am minister of finance this responsible policy will be maintained. In the meeting I held yesterday with the Governor of the Bank of Israel, he repeated his support for the Finance Ministry policy that aims at a deficit target of 3% in 2014, and at the public spending framework determined by the law."
This comes against the background of the finance minister's announcement earlier today that he intends to raise the fiscal deficit target for 2013 to 4.9% of GDP, compared with an original target of 3%.
On Israel's fiscal and economic position, S&P states, "The immediate challenge of fiscal consolidation is formidable, in our view. The 2012 general government deficit was 4.5% of GDP (relative to expenditures amounting to 42.1% of GDP) and the 2013 budget balance will be worse absent policy change. The government intends to reduce the fiscal gap with a blend of measures slightly biased toward expenditure cuts, versus tax increases. Given that the details remain subject to political negotiations and will not take effect until the middle of this year, we forecast the 2013 deficit to be larger than last year's. The budget plan should lower deficits thereafter so that the 2013-2016 average annual change in general government debt would be 3.6% of GDP, and by 2016 net general government debt would stabilize around 65% of GDP and general government interest to about 10% of revenues.
"Our base-case scenario assumes Israel's annual real GDP growth reaching 3.5% over the forecast period, which would mean the long-term per capita growth rate declining to just above 1.6% annually. We would still consider this high given the country's wealth levels. While the beginning of natural gas production in the Mediterranean Sea should make a consistent contribution, there are offsetting external and domestic risks to economic growth. In the short term, demand for Israeli exports could drop due to economic weakness in core markets, especially in Europe and less so North America. This risk is compounded by the potential for continued currency appreciation, which could hurt Israel's competitiveness. Israel's recent decision to establish a sovereign wealth fund that will invest some of the natural gas proceeds externally could mitigate some of these risks.
"Israel's penchant for innovation and its ability to produce ever-higher-value products also contributes to less elastic demand for its exports. A domestic risk is the housing market, where price appreciation in second-half 2012 has generated concerns. In response, the Bank of Israel has passed measures requiring higher down-payments on mortgages (especially for second-home or speculative buyers) and raising capital requirements on mortgage lending by banks. In our view, these measures should contain credit growth to the housing sector and prevent an asset bubble.
"Israel's external fundamentals remain strong. We forecast the current account will turn positive again in 2013 at 0.9% of GDP. The country's gross financing needs continue to decline and stand just below 80% of current account receipts (CARs) and usable reserves. Israel continues to improve its net creditor position vis-à-vis the rest of the world with narrow net external debt, which equals 38% of CARs. A balanced current account, strong FDI, and volatile financial account flows have, however, placed upward pressure on the shekel and complicated the flexibility of monetary and foreign exchange policy, which we otherwise consider to be a credit strength."
Published by Globes [online], Israel business news - www.globes-online.com - on May 2, 2013
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