Israel’s Economy Braces for Downgrades and Tech Sector Weakness Amidst Turmoil in Judicial Reforms
Israel’s economy is facing possible ratings downgrades, dwindling foreign investment, and a weakened tech sector as the country grapples with turmoil resulting from controversial judicial reforms, warn investors and analysts.
The government recently pushed through a series of laws aimed at curtailing the powers of Israel’s Supreme Court in favor of Prime Minister Benjamin Netanyahu’s executive branch. This move has sparked widespread protests, prompting workers from different sectors, including doctors and tech firms, to go on strike and take to the streets. In the aftermath, the shekel currency has depreciated over 2% against the dollar, marking a decline of more than 9% since the plans were first unveiled in January.
The rising uncertainty surrounding Israel’s economy is now a major concern for external investors. Hamish Kinnear, a senior analyst specializing in the Middle East and North Africa, has highlighted that the lack of a clear endpoint to the current situation leaves a question mark hanging over Israel’s economic prospects.
The uncertainty has also taken a toll on the country’s stock market. MSCI’s Israel index has significantly lagged behind major global stock indices, such as the MSCI All Country World, as domestic investors have shunned the market. However, until the end of June, foreign investment in Israeli equities remained strong due to the country’s favorable economic outlook.
Strong foreign investment can be attributed to Israel’s relatively low inflation compared to other countries, which has made it an attractive investment option. Nonetheless, ongoing civil unrest stemming from the judicial reforms could jeopardize this influx of cash.
Morgan Stanley has warned that unresolved domestic tensions could lead to a downgrade in the country’s economic growth. While GDP is projected to expand by approximately 2.5% this year and 3% next year, these figures could decline to 1.0% and 1.6%, respectively, if the internal tensions linger.
Roger Mark, a fixed-income analyst at fund manager Ninety One, highlights that the government’s pursuit of judicial reform undermines Israel’s attractiveness as an investment destination. Many investors and key ratings agencies had anticipated a greater compromise from the government in terms of the reform’s scope. In the absence of significant revisions, investors may be inclined to avoid the country altogether.
Netanyahu’s allies argue that the Supreme Court has been overly interventionist, necessitating a curtailment of its powers. This clash between the government and the judiciary could potentially lead to a constitutional crisis if the Supreme Court hears an appeal against the judicial reform law in September.
The primary concern arising from the ongoing unrest is the potential negative impact on Israel’s technology sector, which is a cornerstone of the country’s economy. The tech sector contributes nearly a fifth of Israel’s GDP, over half of its exports, and a quarter of its income tax revenues. The sector has experienced rapid growth for more than a decade, with innovations in cybersecurity, artificial intelligence, and other fields gaining global adoption.
However, the uncertain business environment has prompted up to 80% of new Israeli startups to register overseas by March this year, compared to only 20% in 2022. Tech firm fundraising has also declined by 65% in the second quarter.
The backlash against the judicial reform presents a significant threat to Israel’s economic growth prospects. Nicholas Farr, an economist specializing in emerging Europe, warns that this unrest could lead the economy onto a permanently lower growth trajectory.
Israel’s credit rating is also under scrutiny, with the main rating agencies, S&P Global, Moody’s, and Fitch, expressing concerns about the government’s policy direction. Moody’s has downgraded Israel’s sovereign credit rating, while S&P predicts lower economic growth due to the unprecedented protests. In May, S&P warned of a potential downgrade in Israel’s AA- rating if domestic or regional political risks escalate significantly.
Fitch, which already rates Israel one notch lower at A+, has noted that the judicial changes could negatively impact the country’s credit profile by weakening governance indicators, policymaking, and investor sentiment.
Natalia Gurushina, the chief emerging market economist at fund manager VanEck, believes that it is not unlikely for the country’s ratings or outlook to be cut amid these circumstances. Moreover, she asserts that the new laws could lead to a considerable deterioration in institutional quality, potentially affecting capital inflows into sectors like technology.
The developments surrounding Israel’s judicial reforms and the ensuing uncertainty pose substantial challenges to the country’s economy. The outcome will have far-reaching implications, not only impacting key sectors such as technology but also potentially affecting investor sentiment and credit ratings. As the Supreme Court prepares to address an appeal against the reform, the prospect of a constitutional crisis looms, leaving Israel’s economy and its future uncertain.
