Fitch Ratings has downgraded Israel’s credit score from A+ to A, citing the ongoing conflict in Gaza and escalating geopolitical risks as primary factors. The agency has also maintained a “negative” outlook for Israel, indicating the possibility of further downgrades in the near future.
The downgrade follows the October 7 attack by Hamas, which led to a sharp decline in Israel’s stock market and currency. While both have since rebounded, concerns about the country’s economic stability persist. Earlier this year, Moody’s and S&P also reduced Israel’s credit ratings.
The conflict in Gaza has already resulted in more than 40,000 Palestinian deaths and has severely impacted the economy of the besieged enclave. Israel’s economy is feeling the strain as well, with declines in consumption, trade, and investment.
Fitch has also warned of the potential for increased military spending due to rising tensions between Israel and Iran. The Bank of Israel estimates that the war-related costs for the period of 2023-2025 could reach $55.6 billion, to be financed through a combination of increased borrowing and budget cuts.
The economic impact of the conflict is already evident. Israel’s Central Bureau of Statistics reported a 2.5 percent growth in output in the first half of 2024, down from 4.5 percent in the same period the previous year. Prior to the war, Israel’s economy was expected to grow by 3.5 percent last year, but it only achieved a 2 percent increase, thanks in part to the resilience of its tech sector.
Other sectors have been hit hard. In the final quarter of last year and the weeks following the outbreak of the war, Israel’s gross domestic product (GDP) contracted by 20.7 percent on an annualized basis. This was driven by a 27 percent drop in private consumption, reduced exports, and a significant decline in business investment. Although household spending rebounded early this year, it has since cooled.
The war has also led to a shortage of labor, particularly in the construction and agriculture sectors, as Israel imposed strict controls on the movement of Palestinian workers. Efforts to recruit workers from India and Sri Lanka have yielded mixed results.
According to business survey firm CofaceBDI, around 60,000 Israeli companies are expected to close this year due to manpower shortages, logistical disruptions, and weakened business sentiment. Investment plans have been delayed, and tourism remains below pre-October levels.
Government spending has surged due to the conflict. According to Elliot Garside, a Middle East analyst at Oxford Economics, military spending in the last three months of 2023 increased by 93 percent compared to the same period in 2022. This trend is expected to continue into 2024, with much of the increase funding reservist wages, artillery, and Israel’s Iron Dome defense system.
Garside noted that these expenditures have largely been financed through domestic debt issuance. Israel has also received $14.5 billion in supplemental funding from the United States this year, in addition to the $3 billion in annual aid from the U.S.
Despite the rise in military spending, there have been no major cuts to other parts of Israel’s budget, such as healthcare and education, although such cuts may be necessary after the conflict ends. Oxford Economics predicts that Israel’s economy will slow to 1.5 percent growth this year, and the combination of slow growth and rising deficits will further pressure Israel’s debt profile, likely leading to higher borrowing costs and reduced investor confidence.
Fitch expects Israel’s military spending to increase permanently by 1.5 percent of GDP compared to pre-war levels, impacting the public deficit. The agency’s recent report projected that Israel’s debt will remain above 70 percent of GDP in the medium term and that the deficit will rise to 7.8 percent of GDP in 2024, up from 4.1 percent last year. However, Israel’s Finance Minister Bezalel Smotrich has expressed confidence that the deficit will fall to 6.6 percent this year, despite Fitch’s predictions.
Speculation has arisen that Prime Minister Benjamin Netanyahu is delaying the 2025 fiscal package due to its potential unpopularity. Failure to pass a budget by March 31, 2025, would trigger snap elections. Israel’s Central Bank Governor Amir Yaron has urged Netanyahu to expedite the budget process to prevent further financial instability.
Fitch analysts have warned that Israel will likely need to implement austerity measures and tax hikes, though political divisions could hinder fiscal consolidation. The agency also cautioned that the conflict in Gaza could continue well into 2025, with the risk of it spreading to other fronts.
On the geopolitical front, U.S. Secretary of State Antony Blinken announced on Monday that Netanyahu had accepted a “bridging proposal” aimed at securing a ceasefire between Israel and Hamas while easing tensions with Iran. However, Hamas has rejected the proposal, accusing the U.S. of attempting to buy time for Israel to continue its military operations.
Netanyahu has maintained that Israel will continue its campaign against Hamas until the group is completely dismantled, despite the possibility of a ceasefire agreement. Recent events, including the assassination of key Hamas and Hezbollah leaders, have raised concerns that the conflict could escalate into a broader regional war.
Omer Moav, an Israeli economics professor at the University of Warwick, warned that a prolonged conflict could have severe economic consequences for Israel, including labor shortages, infrastructure damage, and the potential for international sanctions. Moav criticized the government for not considering the long-term economic costs of the war, suggesting that continued conflict may serve political interests rather than the national good.
