Fitch Ratings has placed Israel's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDR) of 'A+' on Rating Watch Negative (RWN). The Short-Term Foreign- and Local-Currency IDRs of 'F1+' and the issue ratings of 'A+' on Israel's long-term foreign currency senior unsecured bonds have also been placed on RWN.

A full list of rating actions is at the end of this rating action commentary.

KEY RATING DRIVERS

Geopolitical Risk Drives RWN: The RWN reflects the heightened risk of a widening of Israel's current conflict to include large scale military confrontations with multiple actors, over a sustained period of time. This could include Hezbollah, other regional militant groups and Iran. While not our base case, such large-scale escalation, in addition to human loss, could result in significant additional military spending, destruction of infrastructure, sustained change in consumer and investment sentiment and thus lead to a large deterioration of Israel's credit metrics.

Initial Shock Compatible with Rating: In our view, the combination of Israel's dynamic, high-value added economy, the record of resilience to regional conflict, preparedness for military confrontations, solid fiscal and external metrics and cash buffers make it unlikely a relatively short conflict largely confined to Gaza will affect Israel's rating.

Escalation Risks Have Risen: In our view, the risk that other actors hostile to Israel, such as Iran and Hezbollah, could join the conflict at scale has risen significantly, as indicated by regular fire exchanges on the Israel-Lebanon border and declarations from high-ranking officials in Iran and from Hezbollah. Nevertheless, the cost of such escalation would be high for Iran and Hezbollah, as underscored by warnings by the US and Israel.

Major Escalation Could Move Rating: In our view, a major escalation could result in negative rating action. This could take the form of a wider and longer conflict, resulting in a sustained fiscal drain, both from higher spending and lower tax collection, as well as loss of human and material capital and severe economic disruption.

ESG - Governance: Israel has an ESG Relevance Score (RS) of '5' for Political Stability and Rights and '5[+]' for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption. Theses scores reflect the high weight that the WBGI have in our proprietary SRM. Israel has a high WBGI ranking at the 69th percentile, reflecting its long record of peaceful political transitions, strong institutional capacity, effective rule of law, low level of corruption but unstable governments and a hostile external and security environment.

RATING SENSITIVITIES

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

- Structural: Significant escalation of the conflict that would have a material and prolonged impact on the economy and public finances.

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

- Structural: De-escalation of the conflict, limiting the risk of material and prolonged impact on the economy and public finances.

SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)

Fitch's proprietary SRM assigns Israel a score equivalent to a rating of 'A+' on the Long-Term Foreign-Currency (LT FC) IDR scale.

Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to SRM data and output, as follows:

- Structural: -1 notch to reflect the hostile external environment, highlighted by the war with Hamas and heightened tensions with Iran, Hezbollah and other militant groups. Although there is currently a national unity government, it also captures our view that domestic political fractiousness is likely to re-emerge post-conflict.

- External Finances: +1 notch to reflect that Israel's strong net external creditor position relative to peers' is not captured in the SRM.

Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.

COUNTRY CEILING

The Country Ceiling for Israel is 'AA', 2 notches above the LT FC IDR. This reflects the absence of material constraints and incentives, relative to the IDR, against capital or exchange controls being imposed that would prevent or significantly impede the private sector from converting local currency into foreign currency and transferring the proceeds to non-resident creditors to service debt payments.

Fitch's Country Ceiling Model produced a starting point uplift of +2 notches above the IDR. Fitch's rating committee did not apply a qualitative adjustment to the model result.

 

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG CONSIDERATIONS

Israel has an ESG Relevance Score of '5' for Political Stability and Rights as WBGI have the highest weight in Fitch's SRM and are highly relevant to the rating and a key rating driver with a high weight. As Israel has a percentile rank below 50 for the respective governance indicator, this has a negative impact on the credit profile.

Israel has an ESG Relevance Score of '5[+]' for Rule of Law, Institutional & Regulatory Quality and Control of Corruption as WBGI have the highest weight in Fitch's SRM and are therefore highly relevant to the rating and are a key rating driver with a high weight. As Israel has a percentile rank above 50 for the respective governance indicator, this has a positive impact on the credit profile.

Israel has an ESG Relevance Score of '4[+]' for Human Rights and Political Freedoms as strong social stability and voice and accountability are reflected in the WBGI that have the highest weight in the SRM. They are relevant to the rating and a rating driver. As Israel has a percentile rank above 50 for the respective governance indicator, this has a positive impact on the credit profile.

Israel has an ESG Relevance Score of '5' for International Relations and Trade due to hostility from some neighbouring countries and the inability to trade with many countries in the region, which has a negative impact on the credit profile, is relevant to the rating and a rating driver.

Israel has an ESG Relevance Score of '4[+]' for Creditor Rights as willingness to service and repay debt is relevant to the rating and is a rating driver for Israel, as for all sovereigns. As Israel has a percentile rank above 50 for the respective governance indicator, this has a positive impact on the credit profile.