Four months of war take an economic toll on Israel

Since its birth in 1948, the State of Israel had only seen its credit rating rise. Economic, arms and technological power well above its population weight, the country has been overcoming – with the help of the West – recurrent outbreaks of violence and global financial crises, after leaving behind the socialist heritage of the Zionist pioneers and orienting itself to export. (civil and military) and to attract foreign investment. This Friday, after more than four months of war in Gaza that have scared away investors and tourists and in which Israel has mobilized some 300,000 reservists and foots the bill for some 200,000 displaced people from the borders with the Strip and Lebanon, Moody's has become the first international credit rating agency to lower its grade: from A1 (medium-high) to A2. Furthermore, it changes the economic horizon to “negative”. “There is nothing to worry about,” responded Prime Minister Benjamin Netanyahu. Analysts are not so sure. At the moment, the two main indices of the Tel Aviv Stock Exchange have fallen moderately this Sunday, the first day of the week in Israel: 0.61% and 0.74%.

Like the rest of the risk assessment agencies, Moody's has been evaluating Israel for about three decades. The score has been rising despite the Second Intifada (2000-2005), a war with Hezbollah in Lebanon (2006), the covid pandemic or the impact of the conflict in Ukraine. If it does so now, it is not only because the country is immersed in its biggest conflict in half a century, but because the future looks ugly.

What does the discount mean to you? To begin with, it will be more expensive for it to finance itself in international markets, just when it is going to issue bonds to feed the war machine. Companies also obtain funds from abroad.

In its report, Moody's underlines that “the main factor” behind its decision is the “assessment that the ongoing military conflict with Hamas, its aftermath and its broader consequences significantly increase political risk for Israel and weaken its executive institutions.” and legislative, and its fiscal strength in the near future.” With an important addition: “Even if the armed confrontation in Gaza decreases in intensity or stops, there is currently no agreement to put a lasting end to hostilities, nor a long-term plan that will fully restore, and eventually reinforce, the security of Israel.”

13% of GDP

The Bank of Israel estimates that the conflict will cost Israel between the years 2023 and 2025 about 255 billion shekels (about 64 billion euros or 69 billion dollars), 13% of the estimated GDP for 2024, both due to the increase in civil and defense spending as well as the decrease in tax collection. Moody's estimates that the Defense budget will end 2024 doubling compared to 2022 and will increase it by half a point of GDP in the coming years.

That is not, however, what most worries the agency, which recognizes in its report the solidity of the national economy and has done so de facto by taking four months to lower the bond rating, while in other conflicts it is immediate. It is more about the feeling that no one knows when he will arrive or what exactly the “total victory” to which Netanyahu aspires consists. The prime minister said this Sunday that he is “within reach”; a week before, that it will be achieved in “months”, not years. At the moment, he is preparing the forcible transfer of more than half of the 2.3 million Gazans to invade the Rafah area.

Moody's, whose experts met for months with official Israeli representatives, mention these uncertainties in their report: that “it is not clear” whether the second ceasefire will go ahead, with an exchange of prisoners for hostages that the mediators have been negotiating for weeks. ; that Israel rejects the plan drawn up by the United States for the day after in Gaza; and that the political crisis and social polarization that Netanyahu's judicial reform brought to light will probably resurface as soon as (it does not seem that it will be long) the concentration government created is fractured. expressly for the war. More and more people are asking in the streets to call early elections. Fitch, another of the main agencies of rating, plans to publish its findings in early March; Standard & Poor's, in three months, but could bring them forward.

These are minor problems compared to the prospect of war with Hezbollah. Israel and the Lebanese militia hold measured skirmishes daily, but one misstep can lead to an escalation. Since October, Israel has relocated some 80,000 residents of the border area to hotels or apartments. It will only return them if “the security equation” changes. And, as Defense Minister Yoav Gallant threatens every week, it will only happen in two ways: through diplomacy (several countries negotiate behind the scenes an agreement to keep Hezbollah away from the border) or by force of arms. Moody's, in fact, sees the risk of a large-scale conflict with Hezbollah, a much larger and more armed militia than Hamas, as “significant,” “although both parties are aware of its very negative consequences.” It would mean “a much higher risk for Israeli territory”, due to the foreseeable damage to infrastructure, the remobilization of reservists and the limbo in which the evacuees would be left. All that is a lot of money. So much so that the Ministry of Finance estimates that, instead of growing by 1.6%, it would decrease by 1.5% this year if that war breaks out.

However, Netanyahu has downplayed the report. Former Finance Minister aware of the importance of Israel's international image, he took the unusual decision of issuing a statement in sabbath to underline the “strength” of the national economy. “The downgrade has nothing to do with the economy. It is only because we are at war. It will go up again the moment we win it. And we will win it,” he noted.

The Minister of Finance, the far-right Bezalel Smotrich, adopted a different tone. He called Moody's document a “political manifesto” that lacks “serious economic arguments” and is based on a “pessimistic and absurd geopolitical vision that shows a lack of faith in Israel's national security and strength.” He further complained that he does not use the term terrorist organizations when mentioning Hamas and Hezbollah.

High technology

Erez Maggor, a professor in the Department of Sociology at the Ben Gurion University of the Negev and a doctorate from New York, who specializes in the political economy of Israeli innovation, believes that those who will suffer the most from the downgrade of the credit rating are the high technology, already punished by the instability generated by the judicial reform. “It is a sector that depends much more on foreign investment, which pays attention to what the rating agencies say,” he says by phone. Israel only began to attract it significantly two decades ago, so it was not a concern in previous major wars, he adds.

High technology contributes more than 10% of employment, around 15% of GDP, 25% of income tax collection and half of exports. So he will receive a hu
ge pile of public money, but it is just an issue that Moody's mentions. The public deficit, which already shot up to 4.8% of GDP in January, is expected to end the year at 6.6% (it was going to be 2.5%). Parliament has just approved in first reading the draft budget for 2024, which includes an additional spending package for the war of 584 billion shekels (148 billion euros).

Ori Greenfeld, chief economist and strategist at the investment firm Psagot, also predicted this Sunday on national public television Kan that the Bank of Israel will reverse the reduction in interest rates that it had initiated. While the United States Federal Reserve and the European Central Bank have not yet dared to reverse the trend, last January the Bank of Israel became the first in the world to lower rates (from 4.50% to 4.50%). 25%), after raising them since 2020.

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