Israel’s economy: weathering the storm

Source: Google Images
Source: Google Images

Much news and commentary you hear about the State of Israel has to do with geopolitics and the Arab-Israeli conflict (see my colleague Ben Moscovitch’s blog on this site for a nice selection.)  Settlements, will Abbas run or not, Iran’s plans to wipe Israel off the map, Israel’s thoughts about taking military action against Iran, the Goldstone Report on the war in Gaza, films about the war in Lebanon, and on and on. 

Not that this hyper-news about Israel is not important and interesting.  But, let’s step back and look at Israel from a “rising power” perspective — half highly indebted socialist country/half cutting-edge hi-tech and health sciences capitalist upstart.  Its economy has proven itself resilient to the intifada, to the tech bust of nearly a decade ago, and now to the US-led global meltdown. 

How so?  It’s about policy, stupid.  Sound economic policy, begun in the 1980s with a classic monetary stabilization program that reduced inflation, and deepened only a few years ago, by none other than Benjamin Netanyahu, as finance minister, with his Thatcherite restructuring of the economy (e.g., increasing the labor force participation rate by creating incentives for the religious to work) and his shift to a rules-based fiscal policy.  Israel still has a high government debt burden — above 80% of GDP.  But that is down from above 100% not long ago.  Meanwhile the rest of the world has caught up to Israel’s debt levels (with the U.S. now surging higher). 

On the external front, the country couldn’t look better — $60 billion in foreign exchange reserves, a current account surplus, and “net external creditor” status, that is, Israel’s claims on foreigners exceed foreigners’ claims on Israel (oh, how the U.S. would love to have that balance sheet!)

So, in spite its modest size, constrained by the country’s small population, the Israeli economy dwarfs those of many of its much poorer and poorly run neighbors.  Have a look at the Fitch press release below referencing a recent report on Israel and its sovereign credit outlook.

Fitch Affirms State of Israel at ‘A’/’A+’; Outlook Stable   
06 Nov 2009 8:22 AM (EST)


Fitch Ratings-London-06 November 2009: Fitch Ratings has today affirmed the State of Israel’s Long-term Foreign and Local Currency Issuer Default Ratings (IDR) at ‘A’ and ‘A+’ respectively with Stable Outlooks. The Short-term Foreign Currency IDR is affirmed at ‘F1’ and the Country Ceiling at ‘AA-‘.

“Israel has fared better than many other small, open economies in the recent global economic and financial downturn, suffering only a mild recession compared to rated peers in Europe and Asia,” says Paul Rawkins, Senior Director in Fitch’s London-based Sovereigns team. “Nonetheless, the downturn has exposed Israel’s key vulnerability to shocks, namely a high public debt ratio that looks set to exceed 80% of GDP in the wake of wider fiscal deficits in 2009-10.”

Fitch says an improved macroeconomic policy framework, coupled with structural reforms since the last recession in 2001-02, laid the foundations for strong growth in 2004-08, in line with the ‘A’ median of 5%, rendering the economy markedly more resilient to shocks. With the exception of Bahrain, China and Poland, Fitch expects Israel to be the only country in the ‘A’ range to escape an outright recession in 2009. This performance is attributed largely to aggressive monetary and exchange rate policies, aided by a relatively trouble-free banking sector and an absence of asset price bubbles. Structurally, Israel’s high-tech manufacturing and services sectors have proved unexpectedly resilient to declining global investment demand, presaging a near record current account surplus in 2009.

Israel’s high public debt ratio remains the key constraint on its sovereign ratings. The adoption of rules-based fiscal policy in the wake of the last recession has served Israel well; limits on the growth of public expenditure and a ceiling on the state (i.e. central government) deficit facilitated a contraction in general government debt to 78% of GDP at end-2008 from a peak of 100% in 2003. Even so, this ratio remains high relative to the peer group median of 37%, although it is not the most extreme (‘A-‘ rated Greece exceeds 100% of GDP). Moreover, considering the mildness of its recession and an absence of financial sector-related support, the current external shock has taken a heavy toll on the public finances, chiefly on the revenue side. Fitch expects Israel’s general government deficit to widen to 6%-7% of GDP in 2009-10, on a par with rated peers Malaysia and the Czech Republic, which have experienced much steeper recessions, while pushing general government debt up to over 84% of GDP by end-2010.

While Israel’s experience with fiscal rules has been mixed, the current framework has entrenched fiscal discipline and together with signs of a strong economic recovery, suggests Israel’s powerful public debt dynamics could reassert themselves by 2011, forestalling any further deterioration in the public debt/GDP ratio. The government envisages a sharp narrowing in the state deficit to 3% of GDP in 2011 (from 6% in 2009), but still hopes to adhere to tax cuts over the medium term. Fitch expects some revision to the fiscal rules, with greater prominence being given to the Maastricht public debt/GDP ratio of 60% of GDP. From a rating standpoint, a positive rating action would require a decline in the debt/GDP ratio to a level nearer to the ‘A’ median. Conversely, a prolonged rise in the debt/GDP ratio and/or sustained fiscal easing would prompt a negative rating action.

Externally, the Government of Israel became a net external creditor for the first time in 2008, although it still falls short of ‘A’ norms on this measure. Burgeoning international reserves – these have more than doubled to USD60bn since end-2007 – have been the key factor behind this status change for the sovereign, facilitated by a strong current account surplus and buoyant net capital inflows. The economy as a whole also passed a new milestone in 2008, registering a surplus of external financial assets over liabilities for the first time. Israel expects its standing on the international stage to be further enhanced by OECD membership in the near future.

Contact: Paul Rawkins, London, Tel: +44 (0) 20 7417 4239; Richard Fox, +44 (0) 20 7417 4357

Media Relations: Peter Fitzpatrick, London, Tel: + 44 (0)20 7417 4364, Email: peter.fitzpatrick@fitchratings.com.

Additional information is available on http://www.fitchratings.com.

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