New fiscal plans undermine Israel’s risk profile

Higher spending, lower taxes: Finance minister Moshe Kahlon (far left) has taken a bold step, but will the public – and credit rating agencies – approve?

Israel, on 65.8 points from a possible 100 in Euromoney’s country risk survey, remains a low, A-rated default risk.

The country is enjoying rare political stability, and economic indicators are mostly favourable.

GDP growth accelerated in the second quarter, to 2.9% year-on-year in real terms, there is mild deflation encouraging consumer spending, the hi-tech sector is booming, unemployment falling and sovereign debt fell for a sixth successive year in 2015 to just below 65% of GDP.

Yet more than half a point was shaved off Israel’s country risk score during the first half of 2016 as investor confidence in the sovereign diminished.

Having fallen one place in the global rankings this year, and two on a 12-month basis, Israel is now approaching the bottom of tier two in Euromoney’s country risk survey, one of five risk categories synonymous with an A- to AA rating:

Israel remains safer than Poland, the lowest tier-two sovereign, and Slovenia, the highest in tier three, but the question is whether its stable A1/A+ ratings from Moody’s and Standard & Poor’s are justified, or whether Fitch, rating Israel A, is closer to the mark.

What has changed?

The government’s two-year fiscal plans represent a dash for growth, raising public spending and simultaneously cutting taxes before elections are held that are not officially due until November 2019, but have a habit of occurring sooner in view of the unstable coalitions Israel has become accustomed to.

The question is whether this gamble will pay off, or it will merely undermine fiscal consolidation.

Bank Leumi, contributing to Euromoney’s survey, believes the government will easily meet its 2.9% of GDP fiscal target this year based on the available data through to July.

Tax revenue is higher than expected thanks to rising real wages boosting income tax receipts. Improving real disposable incomes are also spurring housing demand and vehicle imports, raising even more tax revenue and highlighting the transition from exports towards consumer-led growth.

In that light, the fiscal deficit will be 2.6% of GDP, or even smaller this year, Bank Leumi predicts.

However, the government is planning to lift the public expenditure ceiling in 2017 and 2018, and corporate and personal income taxes are to be lowered, affecting the fiscal deficit targets.

“According to the proposed budget framework, a higher budget deficit of 2.9% of GDP is expected in each of the years 2017 and 2018, and only in 2019 is the deficit expected to decline to 2.5%,” says Bank Leumi’s Yaniv Bar.

These forecasts are vulnerable to tax revenue falling, which in turn depends on how the economy performs.

“Failing to achieve the deficit target will be considered a negative factor in terms of the fiscal risk profile and the credit rating of Israel,” Bar concludes.

Moody’s has already issued a warning: Israel is treading a fine line. Unless the economy exceeds expectations, or the government tailors its budget spending programme, it might not be long before Israel’s credit ratings are brought into line with its moderately declining risk score.

The sovereign is a reasonably safe investment, but is not quite as safe as it was before the government loosened the purse strings.

This article was originally published by ECR. To find out more, register for a free trial at Euromoney Country Risk.