S&P downgrades Israel rating on heightened security risk

The ratings agency has warned of a delayed economic recovery

People take cover by the side of a road in Tel Aviv after Iran fired a salvo of ballistic missiles on October 1. Reuters

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S&P Global Ratings downgraded Israel's credit rating amid the escalation of hostilities with its Middle East neighbours, the third such action from a major ratings agency in a span of less than two months, while also warning of a delayed economic recovery.

The country's long-term sovereign credit rating was lowered to “A” from “A+", with a negative outlook due to “heightened security risk”, New York-based S&P said on Tuesday.

The “A” rating is considered upper-medium investment grade and is five levels above junk status on S&P's ratings scale. An investment-grade rating makes it easier for a country to access capital markets and raise funding when it seeks to borrow.

S&P also expects the recovery in Israel's economy to be held back by the conflict, with real growth forecasts now also downgraded to 0 per cent for 2024 and 2.2 per cent for 2025, down from previous estimates of 0.5 per cent and 5 per cent, respectively, S&P said.

With S&P's move, the so-called big three ratings agencies have now all downgraded Israel's credit rating: Fitch Ratings and Moody's Investors Service made similar decisions in August and last week, respectively.

On Tuesday, Moody's downgraded the insurance financial strength rating (IFSR) to Baa1 from A3 on Clal Credit Insurance, one of the two largest credit insurers in the Israeli market and a subsidiary of Clal Insurance Company. The outlook was changed to negative from stable.

“We believe that, longer term, Israel's economy will be more durably weakened by the military conflict than expected earlier, leading to some pressure on Clal's profitability, asset quality and capital adequacy,” it said.

The agency also downgraded to Baa2 from Baa1 the long-term senior secured ratings of Israel Electric Corporation, which is almost completely owned by the Israeli government.

Along with its war in Gaza, which has been going on for nearly a year, Israel has launched a ground invasion against Hezbollah in southern Lebanon and has threatened to retaliate to Iran's Tuesday missile attack.

“We see an increasing likelihood that Israel's conflict with Hezbollah, given the recent escalation of fighting, becomes more protracted and intensifies, posing security risks for Israel,” analysts at S&P wrote in their report.

“We now consider that military activity in Gaza and an upsurge in fighting across Israel's northern border – including a ground incursion into Lebanon – could persist into 2025, with risks of retaliation against Israel. The latter in particular has been highlighted by a missile attack on Israel by Iran at the beginning of October.”

Israel's economy grew less than expected in the second quarter of this year. The country’s gross domestic product expanded by 1.2 per cent in the April-June period, the Central Bureau of Statistics said last month.

The conflicts Israel have been involved in reflect the risks to its growth, public finances and balance of payments, including direct security threats in case of retaliatory rocket attacks, the S&P analysts said.

“The negative outlook also reflects the risk of a more direct war with Iran, although this is not in our current base case,” they added.

S&P said its sees two near-term implications of the recent conflict escalation for Israel: increased risk from retaliatory rocket fire from Hezbollah, other Iran proxies in the region or Iran itself, and a broader economic impact of the recent escalation.

“Under these assumptions, we expect Israel's real GDP to stagnate in 2024. We anticipate that higher security threats will dampen consumer and investor confidence, while tourism, construction and agricultural sectors will remain affected.”

A wider ground operation in Lebanon requiring a call-up of reservists could also constrain economic recovery in the short term, they added.

S&P also projects that an increase in defence-related expenditure may result in a government deficit of 9 per cent of GDP for 2024, before slowing down to 6 per cent of GDP next year.

However, despite the risks, S&P's ratings on Israel remain supported by “several key strengths”, including the country's balance of payments and its “highly adaptable and diversified economy”, which has historically strong growth rates and rebounded quickly from crises.

Israel has “high per capita income levels, and we note that the economy's concentration on exports of high-tech services also provides for higher ability for some employees to work remotely, mitigating the impact of security disruptions on the domestic economy”, S&P said.