TEXT-S&P affirms 'A+/A-1' FC ratings on Israel

Fri Sep 28, 2012 5:25am EDT

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(The following statement was released by the rating agency)

Sept 28 -

Overview

-- The Israeli economy continues to generate solid economic growth and enjoy a net external asset position, even though the current account has temporarily turned negative.

-- We note that there has been fiscal slippage on account of lower government revenues, although recent austerity measures and current growth levels should ensure that debt ratios modestly improve in the medium term.

-- We forecast that by the middle of the decade domestic natural gas production should contribute to improved external and fiscal balances.

-- We are therefore affirming our foreign currency sovereign credit ratings on Israel at 'A+/A-1'. We are also affirming our local currency ratings at 'AA-/A-1+'.

-- The stable outlook reflects our view that there is sufficient political will to prevent a sizable increase in the government's debt burden, and that major security risks will be contained.

Rating Action

On Sept. 28, 2012, Standard & Poor's Ratings Services affirmed its long- and short-term foreign currency sovereign credit ratings on the State of Israel at 'A+/A-1'. We also affirmed the local currency ratings at 'AA-/A-1+'. The outlook is stable. The transfer and convertibility (T&C) assessment remains at 'AA'.

Rationale

The affirmation reflects our view of Israel's economic policy flexibility as a result of consistent growth and careful macroeconomic management. Despite a weak global economic environment and a temporary slowdown in 2012 and 2013, Israel's gross government debt burden should modestly decline over the forecast horizon--to 71% of GDP by 2015. Furthermore, the production of natural gas by the middle of this decade is likely to strengthen the country's net external asset position. These favorable dynamics, combined with Israel's prosperous economy and strong institutions, support the ratings. Significant geopolitical risks, however, are a rating constraint.

While the government has been forced to revise its original budget deficit targets in light of revenue shortfalls, we believe the political consensus for containing public debt remains intact. We have seen this in recently passed austerity measures--a mix of tax increases and spending cuts--to limit the 2012 fiscal deficit to 4.0% of GDP. We believe this target will be met. We forecast an average deficit of 2.8% of GDP during 2013-2015.

Our forecasts for the fiscal deficit and modestly declining debt burden partly rest on our projection that Israel will attain average real per capita GDP growth of 1.8% through 2015 (7.0% overall). However, we recognize downside risks to these forecasts stemming from spillover effects from some highly leveraged holding companies of Israeli conglomerates, whose dividend income from operating companies has markedly fallen this year. Risks could also come from a rapid appreciation in housing prices, which could spill over to broader price increases. That said, we believe that the Israeli banking sector is adequately regulated and capitalized by international standards.

Israel's external position remains sound, even though we have forecast the first current account deficit in ten years (for 2012). Despite estimated current account deficits of -0.7% and -0.2% of GDP in 2012 and 2013 respectively, surpluses since 2003 have produced a comfortable net asset position of 26% of current account receipts (CARs). Over the same period, foreign exchange reserves have grown. We now estimate these at just over eight months of current account payments by the end of 2012. Gross external financing needs in 2012 (current account payments, amortization of long-term debt, plus stock of short-term external debt) account for 85% of the Bank of Israel's reserves plus CARs, a level we expect will remain flat in coming years.

The geopolitical situation continues to pose serious constraints on Israel's credit rating, in our view. In this regard, Israel's traditionally tense relations with Palestinians in the West Bank and Gaza are further complicated by the stand-off with Iran, lawlessness on Israel's shared border with Egypt, a civil war in Syria, and radicalized domestic groups eager to provoke confrontation. Any significant armed conflict with Israel could have a negative impact on the ratings, if it deters investment, weakens the economy's growth potential, or strains fiscal flexibility.

Outlook

The stable outlook reflects our opinion that Israeli governmental consensus about containing public debt will remain intact despite budgetary pressures and upcoming elections. We could consider raising our ratings on Israel if it makes material progress in defusing external security risks, as such progress would have positive repercussions on domestic stability, economic growth, and investor confidence. Conversely, we believe that any significant setback with regard to reducing the government's high net debt burden, a decline in growth prospects, a structural reversal in external performance, or a substantial deterioration of the security situation in Israel could put downward pressure on the rating.

Related Criteria And Research

-- The Syrian Conflict Is Ratcheting Up The Sovereign Rating Risks Of Its Neighbors, Sep. 18, 2012

-- Bulletin: Ratings On The State of Israel Are Unaffected By the Expanded Government Coalition, May 8, 2012

-- Israel (State of), Nov. 1, 2011

-- Sovereign Government Rating Methodology and Assumptions, June 30, 2011

Ratings List

Ratings Affirmed

Israel (State of)

Sovereign Credit Rating

Foreign Currency A+/Stable/A-1

Local Currency AA-/Stable/A-1+

Transfer & Convertibility Assessment AA

Senior Unsecured A+

Senior Unsecured AA-

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