Credit-ratings agency Moody's Investors Service affirmed Israel's A1 credit rating on Thursday, praising the country's economic and financial resilience to weather the global meltdown. However, the rating would be stronger if Israel could resolve its conflict with the Palestinians and reduce military spending, Moody's said in its annual report on Israel. "The modest contraction in the economy and signs of an incipient recovery are evidence of the economy's underlying flexibility and exceptional resilience in the face of various shocks, which reflects in part the lack of toxic assets in the country's banking sector and the absence of a housing bubble," Anthony Thomas, a senior analyst at Moody's in London, said in the report. "Indeed, against a backdrop of numerous challenges over the past decade - such as the collapse of the hi-tech bubble, disengagement from Gaza in 2005, Operation Cast Lead - the global financial crisis could almost be categorized as 'more of the same.'" Gross domestic product rose by 1 percent in annual terms in the second quarter of 2009 after contracting by 3.2% in the first quarter of the year. "This is another vote of confidence by an important credit-ratings agency regarding the Israeli economy and the budgetary and economic policies of the government," Finance Minister Yuval Steinitz said Thursday. "It is evidence that the Israeli economy has succeeded to weather the global economic crisis in a respectable manner, when many countries around the world are suffering from significant credit downgrades." Although "the recession now appears to be over for Israel," Moody's said, a more robust recovery would have to come from global rather than domestic developments, given that Israel is a small, open economy. Overall domestic growth for the economy would depend on hi-tech exports to its main markets - the US and the EU - although Israel has made meaningful progress in new market areas, notably China, the report said. In the longer term, the country's growth model appears to be intact, Moody's said. "That the economic model is intact is fortunate," Thomas said in the report. "The economy's lack of natural resources and small size leave it few alternatives to being an innovative exporter." While economic and financial risk appeared to be low, the political risk - namely the security situation - is more serious, the report said. Israel has the highest military expenditure per capita in the world, which contributes to its government debt over time and represents the main constraint on its ratings, it added. "Renewed efforts to improve Israeli-Palestinian relations would be important validation of the country's A1 government ratings," Moody's said. Israel's total defense budget in 2008 amounted to more than 8% of GDP, compared with nearly 4% in the US, 2.5% in NATO countries and below 2% for NATO's European members, the report said. "The US's new administration has shown heightened interest in the peace process with Palestine, but Israeli-Palestinian tensions are unlikely to ease enough to reduce defense spending meaningfully," Thomas said in the report. "If defense spending could be reduced, all else equal, the government's debt metrics would improve. This is particularly important in Israel, given the role its relatively high debt/GDP and debt/revenue ratios have played in limiting the upside to its ratings outlook." Ongoing friction with Iran and, to a lesser extent, Syria would probably limit any defense budget cuts, Moody's said.