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Israel’s judicial reform controversy is continuing to drive concerns about the Israeli economy, prompting warnings from leading credit rating agencies. While Israel’s economic fundamentals remain strong, one expert told Al-Monitor that Israel’s long-term outlook is dependent on future political developments, relations with the Jewish diaspora and other factors.
Background: On Wednesday, the New York-based credit rating agency Fitch affirmed Israel's “A+” rating and said its outlook on the country is “stable,” meaning Fitch is confident in Israel’s ability to meet its financial obligations. Fitch noted Israel’s strong gross domestic product growth rate of 6.4% in 2022 and declining debt, and predicted inflation will slow to 3% by the end of this year, according to a press release.
At the same time, Fitch warned that the Israeli government’s judicial reform efforts could “weaken” the country’s credit profile.
"Fitch believes the reform could have a negative impact on Israel's credit profile by weakening governance indicator or if the weakening of institutional checks leads to worse policy outcomes or sustained negative investor sentiment,” said the firm.
The Israeli government under Prime Minister Benjamin Netanyahu, who retook office last December, is pushing a reform bill that would exert greater legislative control over the judiciary. Specifically, the reform would reduce the Supreme Court’s power to overturn legislation and apply stronger political control over judicial appointments. Netanyahu and his allies say the reform is needed to express the “will of the people.”
The Israeli right has long held the Supreme Court in contempt for blocking its plans. For example, the court blocked the appointment of Netanyahu ally Aryeh Deri to the government in January over his tax fraud conviction. In 2022, the court halted the eviction of Palestinian residents from the flashpoint neighborhood of Sheikh Jarrah.
Critics of the proposal allege that it would erode Israeli democracy and hurt the country’s image abroad, and there have been large protests against the reform in recent weeks. The legislation is still being debated in the Knesset.
Other institutions have issued similar assessments. In February, Wall Street giant JPMorgan and the British bank HSBC both warned that the judicial reform could hurt Israel’s economy. The Israeli news site Ynet also reported last month that billions of dollars have been moved from banks in Israel to banks in the United States and Europe over judicial reform concerns. The reform is particularly unpopular among Israel’s large high tech sector.
Fitch is one of the “big three” credit rating agencies along with Moody’s and S&P Global Ratings.
Analysis: Ryan Bohl, a Middle East analyst at RANE Network, said that the judicial reform saga is “weakening positive sentiment” about Israel following its quick COVID-19 vaccine rollout and recent tech sector growth. “It’s taking some of the luster off of Israel’s reputation after the pandemic, the quick vaccines, the tech giant year in 2022,” Bohl told Al-Monitor. “That’s all being undermined by the perception that the balance of power within Israel’s institutions is about to be reshaped.”
Bohl also referenced the growing number of US Jewish groups speaking out against the Israeli government. There are worries that "there might be a split in the diaspora, which will expose [Israel] to political pressure in places like the US and Europe where the diaspora is key to maintaining that relationship,” he said.
However, whether Israel receives a credit rating downgrade will depend on how the agencies choose to assess the country, according to Bohl.
“Some agencies look more at the fundamentals, which are strong, low debt, low unemployment, good COVID recovery, etc. Others are more worried about the long-term trajectory and are willing to signal that,” said Bohl, who pointed out that S&P downgraded the United States back in 2011.
S&P analyst Maxim Rybnikov told Israeli tech news outlet Calcalist in January that the “weakening” of state institutions could lead to a credit rating downgrade for Israel. “We have concerns about the fact that the entry of the extreme right into the coalition could cause a worsening of the situation in Gaza, the West Bank and also in relations with the Israeli Arabs,” Rybnikov told Calcalist.
The trend of Israeli tech companies relocating to the United States could also affect Israel’s economic outlook. The shift actually predates the judicial reform and has accelerated in the past few years, but the issue is receiving more attention in the Israeli press this year due to the political situation in the country.
Bohl said whether large numbers of Israeli tech workers and firms leave will depend on Israel’s political trajectory.
“I think over the next five years you could see a trickle of both workers and companies relocating from Israel. If your far-right scenario continues and the Israeli government is able to hold itself together, which in Israeli history is tough to do, that will cause a brain drain,” he said.
Israel, which has a British parliamentary style of government, has had five elections since 2019.
“I find it unlikely people will move out very quickly,” added Bohl. "Many Israelis sat tight during the second intifada and I think many will sit tight during this government with the expectation that eventually it will fall apart.”
Know more: Israeli business reporter David Rosenberg wrote in an Al-Monitor PRO memo last month that Israel’s tech sector rebound hinges on the judicial reform outcome. As was the case in other countries, Israel’s tech sector experienced massive layoffs and financial difficulties last year.
