USD/NIS and Israeli Market Bonds

The recent statement by the President of the United States, Joe Biden, regarding not inviting Prime Minister Benjamin Netanyahu to the White House has caused a stir in the Israeli market. Following Biden's statement, the value of the dollar jumped by 0.9% to NIS 3.56, while the euro rose to NIS 3.86.
The political and legislative environment will continue to increase the volatility of the shekel in the short term.

The proposed judicial reforms in Israel have raised concerns among global rating companies, including S&P, Moody's, and Fitch. S&P, in its latest report, kept Israel's rating at AA with a "stable outlook." However, an analyst from S&P warned that the reforms could hurt the rating in the future if they lead to a trend towards weakening Israel's existing institutional arrangements and checks and balances. Moody's, in its periodic reports, has complimented Israel, but warned that if the reforms are fully implemented, they could have a negative effect on credit. Fitch, in its routine update, left Israel's credit rating at A with a "stable outlook," but warned against the possible consequences of the reforms, which could harm Israel's institutional strength and its credit rating.

In the short term, the devaluation of the shekel may continue due to the political and legislative environment, but the economic data in Israel remains stable, with a surprising improvement in employment data and the expected drop in interest rates by the Bank of Israel. The volatility of the shekel in the short term will be influenced by various factors, including the development of the dollar globally. However, in the medium and long term, the fundamentals of the economy will support the shekel, albeit to a lesser extent.

the Israeli shekel and USD linked bonds in the Israeli market are facing a period of uncertainty due to recent political and legislative developments, including proposed changes to the country's judiciary system. The proposed changes have been criticized by civil society groups, opposition politicians, and the international community and could weaken the strength of the judiciary and negatively impact the country's credit profile.

However, despite these challenges, the Israeli economy continues to show stability, with positive economic data and a state budget that has been approved in the first reading. Additionally, the Bank of Israel is expected to announce a drop in interest rates, which could give a boost to the economy.

It is important to note that one-day movements in the shekel do not imply anything about future trends, and the political and legislative environment will continue to increase the shekel's volatility in the short term. However, the fundamentals of the economy and the development of the dollar in the world will support the shekel in the medium and long term.

In conclusion, while the current political and legislative developments may cause short-term uncertainty for the shekel and USD linked bonds in the Israeli market, the long-term outlook remains positive based on the stability of the Israeli economy and the expected drop in interest rates.

Moody's On January 4th, 2023, the Israeli coalition government presented a package of reforms aimed at revising the country's judiciary system. The reforms have received widespread criticism from various sectors, including civil society groups, opposition politicians, and the international community, due to their scale and the speed with which the government aims to pass them through parliament. Since January, Israel has seen continued large-scale protests.

According to Moody's Investors Service, the proposed reforms risk weakening Israel's institutions and governance, which could have a negative impact on the country's sovereign credit profile. If implemented in full, the reforms could materially weaken the strength of the judiciary and could pose longer-term risks for Israel's economic prospects, particularly for the high-tech sector.

The proposed reforms include the introduction of an "override clause" that would allow the Knesset to re-enact any law rejected by the Supreme Court, changes to judicial appointments, the cancellation of the "test of reasonableness", and the transformation of ministerial legal advisors into political appointees. The bill has passed its first reading in the Knesset and has returned to the committee stage before its second and third readings. Prime Minister Netanyahu has pledged to engage in dialogue, while the Israeli President has offered to broker a compromise.

Moody's has assigned a score of "a1" to Israel's institutions and governance, which is higher than several EU member states, including Spain, Italy, and Poland. However, if the proposed judicial reforms are implemented in full, there could be downward pressure on these scores. Over the longer term, judicial changes could also damage Israel's strong economic growth potential and raise geopolitical risks.

At present, Moody's does not expect the reforms to have a material economic impact in the short term. However, currency volatility has increased since the reforms were unveiled and could slow the expected easing in inflationary pressures. Greater economic uncertainty could also delay investment decisions. If the reforms fundamentally weaken the attractiveness of Israel as an investment destination, it could eventually change Moody's view of the sovereign's economic strength. The country's high-tech sector, which accounts for 49% of total exports and generates around 15% of GDP, is a key engine of growth for the economy and a magnet for foreign direct investment. Any reduction in investment or funds from the sector could negatively impact the government's budget, with a quarter of all income tax estimated to be paid by employees of high-tech companies.

FitchFitch Ratings has recently affirmed Israel's Long-Term Foreign-Currency Issuer Default Rating (LTFC IDR) at 'A+' with a Stable Outlook. The rating balances Israel's diversified, high-value added economy and strong external finances against its high government debt-to-GDP ratio, elevated security risks, and a history of unstable governments that have hindered policymaking. Despite global challenges and monetary policy tightening, Fitch expects Israel's GDP growth to remain robust at 2.9% in 2023, supported by strong exports from the tech and defense industries, population growth, and increasing government spending. Inflation is expected to peak in the first quarter of 2023 and recede to around 3% by the end of the year.

Fitch notes that some members of the Knesset and government have proposed curtailing the independence of the central bank, which could reduce the credibility of Israel's policymaking and be a negative factor for the country's credit profile. The government is currently operating under a technical budget with capped monthly spending until a coalition budget is passed, likely in the second quarter of 2023. The budget is expected to result in a deterioration of the central government's fiscal balance by 1.8% of GDP, with further deterioration expected in 2024.

Fitch projects government debt-to-GDP to continue declining, with limited deficits and strong nominal growth. However, a proposed judicial reform that would curtail the powers of the Supreme Court and grant more power to the government could weaken Israel's credit profile. The country is also constrained by geopolitical risks, including tensions with Iran and the absence of a resolution to the Palestinian conflict. Despite these challenges, Israel has a strong external position, with a current account surplus of 3.6% in 2023 and a high net external creditor position of 52% of GDP.

In terms of ESG considerations, Israel has a Relevance Score of '5' for Political Stability and Rights and '5[+]' for the Rule of Law, Institutional and Regulatory Quality, and Control of Corruption, reflecting the country's strong institutional capacity and effective rule of law. The country has a Relevance Score of '4[+]' for Human Rights and Political Freedoms and Creditor Rights, and a score of '4' for International Relations and Trade due to the hostile external environment.

Factors that could lead to a negative rating action or downgrade include a persistent rise in government debt-to-GDP, a decline in Israel's institutional strength as a result of reforms weakening judicial oversight, and materialization of political and security risks. Factors that could lead to a positive rating action or upgrade include reducing the government debt-to-GDP ratio, sustained easing in political and security risks, and improved creditworthiness.