Israel’s economic mood has been downgraded

In rather business-like language, as one would expect from a financial services company, Moody’s this month announced that it was downgrading the rating of Israel’s debt from A1 to A2, warning that the ongoing war in Gaza and a possible war in the north with Hezbollah could adversely affect the country’s economy.

Not only was this the first rating downgrade in Israel’s history, but it was also accompanied by a negative outlook indicating a possible further drop in its credit rating. There is little doubt that the war in Gaza has contributed to this worrying development in Israel’s economy, but the main reason lies with Prime Minister Benjamin Netanyahu and his government. In particular, its lack of a coherent end-of-war strategy, in addition to being packed with ministers who are parochial, anti-democratic and devoid of any understanding of economics, let alone how it functions globally.

In the short-term, the impact of this downgrade will be limited, but it sends a clear signal to the global financial markets that, if the war is to continue, Israel’s economy is not going to fare as well as in the past, making further downgrades likely. The immediate reasoning for the downgrade is understandable, as Moody’s envisages that Israel’s debt burden will be substantially higher than projected before the conflict. If this predicted trajectory proves to be accurate, it will lead to an increase in interest rates and, with that, an increase in the cost of financing public debt and an increase in the cost of living for everyone.

More significant is the negative outlook, as this suggests possible future downgrades for reasons that go well beyond the impact of the ongoing military conflict against the Palestinians and the economic and political risks that come with it. The finger is squarely pointed at the government’s reckless weakening of the “executive and legislative institutions and its fiscal strength, for the foreseeable future.” This deterioration in good governance and accountability did not start on Oct. 7, but more crucially with the formation of the sixth Netanyahu government, and it continues as carelessly as the war continues.

Netanyahu has further distorted the country’s economic foundations, as well as compromising Israel’s security

Yossi Mekelberg

In his attempts to perform a great escape from justice in his corruption trial and to stay in power indefinitely, Netanyahu has been prepared to put at risk his country’s democratic structures, including the separation of powers and the checks and balances on government actions. He has also handed over the mightily important Ministry of Finance to someone without even minimal qualifications for the job and has inappropriately distributed huge amounts of public money to satisfy his coalition partners. By doing so, Netanyahu has further distorted the country’s economic foundations, as well as compromising Israel’s security.

War is undeniably an expensive affair and every single day of Israel’s war in Gaza is reportedly costing its economy $260 million. As a result, total debt issuance has already reached about $58 billion, an increase of about a third on last year. In response to the credit rating downgrade, Netanyahu — in a feeble attempt to deflect from his administration’s contribution to the precarious state of the economy and its failure to prevent the Oct. 7 disaster and the ensuing war — claimed this was “nothing to worry about,” because “Israel’s economy is strong. The downgrade is not related to the economy, it is entirely due to us being at war.” His conclusion was that “the rating will go up the moment we win the war — and we will win.”

Yet, beyond the opportunity to sneak in another promise to win the war without defining what victory will look like, at what price it will come or what will happen in its aftermath, Netanyahu conveniently ignored that the grim outlook set by Moody’s was much more to do with his moves to disable the judiciary and his extreme-right, greedy and incompetent government, including the manner in which it is conducting the war. This will have long-term implications for how the country is perceived and treated in the region and by the rest of the international community.

The discrepancy between the American credit rating agency’s reasoning for its decision and Netanyahu’s response to it represents a willful denial of the reality that has been demonstrated time and again over the last four months. That is, without a peaceful resolution to the long-running conflict with the Palestinians, which must start with a plan for the aftermath of the war in Gaza, the state of Israel’s economy will remain perilous.

There is something about this government and this war that does not instill confidence, either at home or abroad

Yossi Mekelberg

The challenge goes beyond the current war itself to the chronic state of conflict that the current Israeli government is devoted to prolonging. Israel has experienced other severe outbreaks of violent confrontation since this credit rating began in 1998, including the damaging Second Intifada and the Second Lebanon War, without the credit rating being harmed. Yet, there is something about this government and this war that does not instill confidence, either at home or abroad.

Markets are always concerned by governments’ arbitrary behavior and the assault by the current Israeli government on the independence of the judiciary, along with the ruling coalition’s enshrining of corruption at the heart of public life, is destroying the economy and its prospects. But this is not the only distortion of the country’s economy and society inflicted by Netanyahu’s government; his coalition’s strong sectorial and parochial nature also inherently serves certain segments of the population and not others.

This is a coalition that, because of its composition, allocates more resources to the ultra-Orthodox, who contribute the least to the economy, and to settler communities that contribute most to perpetuating the conflict with the Palestinians and thereby are preventing peace and also the normalization of relations with more countries in the region. Built into Israel’s state budget are the so-called coalition funds — discretionary spending earmarked for the ultra-Orthodox and those who represent the settlers. When budgetary cuts were made to finance the current war, these items remained untouched.

Beyond the sums of money allocated to these sectors, this signifies the harmful whims of a government that is rewarding the unproductive elements in society at the expense of those who generate most of Israel’s wealth and, in times of war, unlike the ultra-Orthodox, also risk their lives by fighting in it.

Appropriately, the downgrading of Israel’s credit rating is a verdict on the government and how it is handling the war and the economy, and how it is wasting the country’s vast economic potential. But as with other ills afflicting Israeli society, seeing the back of Netanyahu and his political allies will allow Israel to claw its way back to being highly rated again by the international community.

• Yossi Mekelberg is a professor of international relations and an associate fellow of the Middle East and North Africa Program at international affairs think tank Chatham House. X: @YMekelberg