The prominent credit rating agency Fitch Ratings released recently an overview of Israel's economic outlook for investors indicating a potential upgrade of the country’s credit rating from its current A+ status.
According to the report, the near-term outlook is displaying promising signs of improvement, despite recent market volatility and ongoing geopolitical tensions. The credit agency suggests that Israel's return to budget deficits from previous surpluses will not hinder the further reduction of Israel’s general government Debt to GDP ratios. Before 2022, Israel had a relatively low ratio of 68.9% (U.S. has a staggering ratio of 129% - even higher than Cuba), but Israel budget surpluses in 2022 decreased the country’s debt ratio even further: to 61.6%. Fitch Ratings projected a further reduction in Israel’s Debt to GDP ratio to 57.9% by 2024, which could potentially lead to positive rating action, such as a rating more in-line with “AA’ peers’ ratios.
In fact, Fitch expects the deficits over the next three years to be narrower than those experienced prior to the COVID-19 pandemic. Israel’s GDP grew in 2022 by 6.4%. Although weaker housing and stock markets are anticipated to contribute to a decline of approximately 2.3% in revenue in 2023, Israel's government Debt to GDP ratio is expected to continue its downward trajectory due to robust nominal GDP growth projected at an average of 6.9% over the next three years.
While Israel faces ongoing internal social and political tensions, the passage of Israel’s biannual government budget provides near-term political stability and government effectiveness. However, Fitch Ratings cautions that the advancement of certain policies favored by the governing coalition could exacerbate these strains and potentially influence the country's sovereign rating. In particular, judicial reform has been identified as having the potential to negatively impact Israel's credit profile, depending on its effects on governance indicators and policy outcomes.
As to Israel's capital markets, recent security related developments caused a disparity between economic reality and the capital market’s performance. After an increase of 6.6% between mid-April and mid-May while the coalition and opposition parties began discussing possible compromises, Israel’s stock market experienced a decline of 5.3%, signaling a return of fear among investors after a period of positive momentum. This volatility was primarily driven by security-related statements regarding the Iranian situation made by Army Chief of Staff Herzi Halevi during a conference in Herzeliya last week.
However, not everyone sees the situation as gloomy as some media outlets are trying to portray. In fact, one of the leading Israeli banks, Discount Bank, has recommended to its clients to start gradually increasing exposure to the stocks listed on the Tel Aviv Stock Exchange. The bank cites a reasonably stable economy, relatively cheap pricing of equities, and the belief that some potential risk events, such as the approval of the budget, have already passed. Based on the bank's assessment, the Price/Earnings ratio of the large-cap TA-35 index is 22.1% below its historical median.
Chart: Gap of Weighted Average of Expected Price/Earning vs. the Index’s Historical Median (globes.co.il)
In terms of the local macroeconomic situation, Discount Bank assesses it as reasonable and relatively good in certain parameters. Israel's GDP growth in the first quarter stood at 2.5%, surpassing market forecasts. Positive contributors to this growth include decreased imports, increased service exports, and higher consumption. While some segments may experience a slowdown, the overall data remains reasonably positive despite rising interest rates.
Therefore, the recent developments are giving us reasons to be optimistic. Based on the Israel's near-term economic outlook, there are clear signs of improvement despite market volatility and geopolitical tensions. The projected reduction in the government Debt to GDP ratio, stable governance indicators, and recommendations from financial institutions such as Discount Bank to increase exposure to the local stock market highlight the country's positive economic prospects. While challenges remain, Israel's reasonably stable economic situation and relatively cheap pricing in the stock market position Israel as an attractive investment opportunity.
Sources: Globes, Fitch Ratings
Photo: Credit to Gerd Altmann (geralt)
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