Fitch downgrades Israel’s credit rating to ‘A’ amid heightened tension in the Middle-East

Credit rating agency Fitch Ratings downgraded Israel’s credit rating to ‘A’ from ‘A+’ in a move primarily driven by the continuation of the war in Gaza.

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It also maintained a negative outlook which means a further downgrade is possible as well.

While the downgrade reflected the hit that public finances had taken due to the war, impacting the budget deficit and the country’s debt, the negative outlook underscored Fitch’s concerns that the conflict could potentially extend into 2025 leading to even more military spending, infrastructure damage and economic disruptions. 

It said:

In our view, the conflict in Gaza could last well into 2025 and there are risks of it broadening to other fronts. In addition to human losses, it could result in significant additional military spending, destruction of infrastructure and more sustained damage to economic activity and investment, leading to a further deterioration of Israel’s credit metrics.

Tensions with Iran and its allies, particularly following recent attacks and assassinations, exacerbate these risks and could further damage Israel’s credit profile, the agency said. 

Both Israel and the US are expecting Iran or its proxies to launch an attack very soon, with the US predicting the strike to happen this week itself. 

Earlier this year, Moody’s and S&P Global also cut their credit rating for Israel, citing elevated geopolitical risks.

Impact of Gaza conflict on Israel’s economy 

According to Fitch, the ongoing conflict has severely impacted public finances, with a projected budget deficit of 7.8% of GDP in 2024 which is a substantial increase from 4.1% in 2023.

In May, Bank of Israel governor Amir Yaron warned that the war with Hamas was slated to cost the country $67 billion in defense and civilian spending between the years 2023 and 2025.

Fitch projected Israel’s debt-to-GDP ratio to rise to 70% in 2024 and 72% in 2025, exceeding the pandemic peak of 71% in 2020. 

Despite solid funding conditions in 2024, with $8 billion issued on public markets and additional private placements, Israel’s debt remains higher than the ‘A’ peer median forecast of 55% for 2025.

Significantly, Fitch expects the government to “permanently” increase military spending by close to 1.5% of GDP versus pre-war levels. 

“Israel is likely to maintain a stronger presence along its borders than in the past, plans to widen mandatory draft and to increase domestic military production, which would also add to spending.”

Strong external metrics

Despite the domestic and geopolitical challenges, Fitch said, Israel’s external balance sheet remains robust. 

The net external creditor position was 64.2% of GDP at the end of 2023, compared to 51.6% in 2022, and significantly higher than the peer median of 5.1%. 

The Bank of Israel’s foreign exchange reserves increased to $213.4 billion in July 2024, up from $204.7 billion at the end of 2023. Current account surpluses are forecasted at 4.3% of GDP in 2024 and 3.9% in 2025.

Impact of the downgrade and future prospects

The Israeli government said the downgrade was a “natural” response to the war and the geopolitical risks it was creating. 

Israel finance minister Bezalel Smotrich said in a statement, 

“The downgrade following the war and the geopolitical risks it creates is natural. We will pass a responsible budget that will continue to support all the needs of the war, while maintaining fiscal frameworks and promoting growth engines.

Even so, the downgrade underscores the significant impact of the ongoing Gaza conflict and heightened geopolitical tensions on the nation’s economic stability. 

With a projected budget deficit, rising debt levels, fiscal challenges, and domestic political instability, Israel faces a challenging economic outlook.

However, its strong external balance sheet and governance metrics could provide resilience amidst these uncertainties.