By Steven Scheer
JERUSALEM (Reuters) -Israel's sovereign credit rating could be cut if the war with Palestinian Islamist group Hamas expands to other fronts, but if this does not happen it should be able to weather the war's economic fallout if it makes needed budget changes to offset higher spending, an S&P Global Ratings director said.
S&P in October affirmed Israel's 'AA-' rating but revised Israel's outlook to "negative" from "stable", citing risks that the Israel-Hamas war could spread more widely with a more pronounced impact on the economy and security situation in the country.
"The negative outlook on the ratings implies that we currently see at least a one-in-three chance of a downgrade over the next one to two years," said Maxim Rybnikov, director of EMEA Sovereign & Public Finance Ratings at S&P, told Reuters in e-mailed comments.
He said that if Israel's security and geopolitical risks increase due to an escalation of the conflict - a direct confrontation with Hezbollah in Lebanon or Iran - that could lead to a downgrade.
"We could also lower the ratings if the impact of the conflict on Israel's economic growth, fiscal position, and balance of payments proves more significant than we currently project," Rybnikov said. He said S&P projects Israel's economy will grow by just 0.5% in 2024 and have a cumulative budget deficit of 10.5% of GDP in 2023-2024 "but there are downside risks to these assumptions."
He said he was following discussions on the 2024 budget, which was reopened to include billions of shekels of spending on the war.
The cabinet this month passed a disputed 2024 state budget with amendments adding 55 billion shekels ($15 billion) of spending. It still needs parliamentary approval.
"The big question for us is what happens next," Rybnikov said.
Critics of the budget, including the Bank of Israel, are seeking a cut in nonessential spending and to raise some taxes to offset the war-related costs. Also, some planned cuts to health and internal security were scrapped to ensure passage of the budget in the cabinet.
Some 20 billion shekels a year for defence has been added to the budget.
Bank of Israel Governor Amir Yaron has urged the government not too spend excessively and to offset spending increases needed for the war with reductions elsewhere, along with tax hikes - items that government leaders have dismissed.
"Given Israel’s other credit characteristics, a temporary deterioration in the fiscal position can be weathered," Rybnikov said. "However, if ... the budgetary position turned out to be persistently weaker beyond 2024, without offsetting measures, this could erode Israel’s fiscal room to manoeuvre."
He said his base scenario is that the conflict will be resolved soon and the budget deficit will move back to 3% of GDP in 2025, from 4.2% in 2023 and a projected 6.6% in 2024, but that there were substantial risks of a lingering or escalating conflict.
"It is already clear that defence spending will be higher in the years to come and the longer-term impact of the war on FDI (foreign direct investment) flows, investor sentiment and other areas remains uncertain," said Rybnikov.
"A persistent, as opposed to temporary, increase in net general government debt without offsetting measures could pose risks. That’s one of the reasons why the ratings are currently on a negative outlook."
He said the ratings outlook could move back to stable if the conflict is resolved, resulting in a reduction in regional and domestic security risks without a material longer-term toll on the economy and public finances.
Credit ratings agency Moody's (NYSE:MCO) declined to comment. Moody's in October placed Israel's A1 ratings on review, citing the conflict with Hamas.
Fitch Ratings put Israel on rating watch negative in October. Fitch did not immediately respond to a request for comment.
($1 = 3.6832 shekels)