Moody's downgraded Israel's credit rating. Furthermore, they actually lowered the outlook to "Negative," meaning they do not anticipate improvement in the near future but rather the possibility of further downgrades.
So what is a credit rating, how is it determined, and how will Moody's dramatic decision affect us?
What is a credit rating?
A credit rating is a score given to countries, companies, and individual people to reflect their ability to repay their debts (i.e., the risk level in granting loans to those countries, companies, and people).
The score is based on various economic and financial parameters, both present and past, and includes economic and financial performance.
The most stable credit rating is AAA, which indicates a high ability to repay debts, and it can go as low as C, which means there is a very high chance of an investment in a country or company being lost, and D, which means a company or country is not fulfilling its obligations and is likely to default in the future.
What is the purpose of a credit rating?
Credit ratings are used by investors to determine the level of risk involved in investing in the same company/country.
The required return or interest rate for the investment is determined based on the level of risk. The lower the rating, the higher the risk for investing in a country or larger company, and therefore investors will require a higher interest rate for their investment.
Who are these rating agencies?
International companies that specialize in credit rating for countries and companies worldwide, such as Standard & Poor's, Fitch, and Moody's, continuously engage in credit rating and data analysis, updating ratings according to developments.
Investment bodies around the world follow these ratings, and some financial instruments are obligated to adhere to them. For example, a fund that is obligated to invest in investment-grade ratings of BBB and above.
What is Israel's credit rating today?
Currently, Israel's credit rating stands at various companies as follows:
- S&P: AA with a negative outlook.
- Fitch: A+ with a negative outlook.
- Moody's: A2 with a negative outlook, after previously standing at A1 with a negative outlook as well.
These ratings indicate that the rating agencies have assessed Israel as a country with economic stability and good economic parameters. Moody's decision, however, indicates a concerning change in trend, and it is possible that other agencies will follow suit.
What is the significance for Israeli citizens?
When a country's credit rating decreases, it is required to pay higher interest on the loans it has taken.
For example, Israel is expected to take about NIS 130 billion in additional loans this year, so a decrease in its credit rating leads to an increase in the interest the country will pay on the debt, resulting in less money for the various services it needs to provide to its citizens. This means less welfare, infrastructure, education, healthcare, and more.
In addition to reducing services to citizens, the government will also be forced to raise taxes to fund its activities.
Tax hikes can come in the form of increasing VAT, which raises the price of all products consumed by citizens, reducing tax benefits to businesses that will be forced to raise their prices and pass on the burden to consumers, and increasing existing taxes that will reduce consumers' purchasing power.
The importance of this event is also psychological because the impact on citizens' wallets has already occurred even before the downgrade, as markets did not wait for the actual downgrade and demanded higher interest rates before the announcement.
In other words, the market has already priced in the interest rate reduction and the risk premium of Israel's credit rating being traded at a lower rating even before Moody's decision was published. Thus, the actual damages are already happening and are not waiting for the downgrade.
How is the process actually carried out and what is the connection to the war?
Credit rating companies' activities are divided into stages, where in the first stage they change the perspective (for example, from positive to stable) and only in the second stage do they change the actual rating, alongside publicizing scenarios in which they will update in the future.
The war and the Israeli economy's management in its aftermath created deeper recession. Alongside other factors such as geopolitical risk and the fiscal management of the government, credit rating companies were led to examine Israel's economy following recent developments and decide whether to approve the current rating or change it.
The companies already announced last October that a multi-front war could lead to an actual downgrade of the rating, expressing dissatisfaction with the government's unwillingness to make adjustments to its economic management as a result of the war.
Moody's was the first rating company to publish its findings, after its representatives stayed in Israel to collect data, information, and conduct interviews.
The writer is the vice president of marketing and sales at Ayalon Trust Funds.