Equity Research Report: Israel Downgrade by S&P Global Ratings
Company Ticker: iShares MSCI Israel ETF (EIS)
Price Movement: EIS -3.14% (as of Oct. 1, 2024, 6:01 PM ET)
Sector: Middle East Geopolitical and Economic Risk
Investment Highlights
- S&P Global Downgrades Israel’s Credit Rating: S&P Global Ratings downgraded Israel’s long-term foreign currency debt rating from A+ to A, citing increased security risks and political instability. The downgrade reflects heightened threats from the country’s escalating conflict with Hezbollah and broader regional geopolitical risks.
- Economic Growth Revision: S&P revised Israel’s 2024 growth forecast to 0%, down from previous positive estimates, and lowered the 2025 outlook to 2.2%. These changes signal a marked slowdown in Israel’s economic activity, driven by rising defense spending and the conflict’s negative impact on consumer and investor confidence.
- Widening Fiscal Deficit: S&P anticipates widening fiscal deficits in both the short and medium term, primarily due to increased military expenditures and the cost of managing ongoing conflicts. Rising defense spending will further strain Israel’s fiscal policy, already under pressure from continued hostilities with Hezbollah and tensions in Gaza.
- Geopolitical Escalation: The conflict has intensified following Iran’s recent launch of approximately 200 missiles targeting Israel, signaling a sharp escalation. The situation deteriorated further after an Israeli Defense Forces strike that killed Hezbollah leader Hassan Nasrallah, heightening the risk of a broader regional war.
Economic Impact Analysis
2024 Real GDP Forecast: 0%
Israel’s 2024 GDP growth forecast has been cut to 0%, reflecting the immediate economic toll of the conflict. This compares unfavorably to the prior expectation of 2.5%. Key sectors like technology and tourism are suffering from security concerns, leading to a broader contraction in business activity, reduced domestic consumption, and an exodus of investors due to geopolitical risks.
2025 Real GDP Forecast: 2.2%
A modest recovery to 2.2% growth is projected for 2025, but this remains below pre-conflict expectations. Recovery will likely be slow, driven by defense spending, infrastructure rebuilding, and export growth, assuming a de-escalation of regional tensions. However, persistent instability could derail these moderate projections.
Fiscal Deficit
- Short-Term Deficit: Israel’s fiscal deficit is expected to widen significantly, with estimates ranging from 5% to 6% of GDP for 2024. Defense spending will rise substantially as the government prioritizes national security over fiscal consolidation, further straining resources allocated to social services and infrastructure.
- Medium-Term Deficit: Over the medium term, deficits are projected to remain high, with improvement contingent on conflict de-escalation and the normalization of economic activity. Should tensions persist, Israel’s ability to maintain fiscal discipline will be severely challenged.
Inflation & Interest Rates
- Inflation Pressure: Rising security risks and supply chain disruptions are expected to push inflation higher, particularly in energy and food sectors, where Israel is vulnerable to external shocks. Inflation is forecast to rise to 4.5% in 2024, up from 3.2% in 2023, exacerbating pressures on domestic consumption and business investment.
- Monetary Policy Response: The Bank of Israel may be forced to raise interest rates to combat inflation, though this would risk further dampening economic activity. Higher rates would also increase borrowing costs for both consumers and businesses, intensifying economic headwinds.
Geopolitical Risk Assessment
Iran and Hezbollah Escalation
Iran’s missile attacks and the death of Hezbollah leader Hassan Nasrallah have sharply increased the likelihood of a broader military conflict. A prolonged confrontation involving Israel, Hezbollah, and Iran poses significant risks to the stability of the Middle East and global markets. Key sectors such as energy, technology, and defense could face disruption, while global supply chain bottlenecks may worsen.
Implications for Israel’s Defense Sector
- Increased Defense Spending: Israel’s defense sector is expected to benefit from a significant increase in government contracts, creating opportunities for both local and international defense firms. However, increased spending could strain government finances and crowd out private sector growth.
- Strategic Partnerships: In response to rising tensions, Israel may seek to deepen military cooperation with allies like the U.S. and other Western nations, leading to further integration of technology and defense solutions.
Market and Investment Implications
Impact on iShares MSCI Israel ETF (EIS)
- Recent Price Movement: The iShares MSCI Israel ETF (EIS) declined 3.14% as of October 1, 2024, reflecting investor concerns over Israel’s deteriorating security situation and economic outlook. Given the ETF’s exposure to Israeli equities, ongoing geopolitical instability presents downside risks for the fund in the short term.
- Sectoral Impact: Key sectors such as technology and financial services face significant challenges due to uncertainty, declining consumer confidence, and reduced investment flows. However, defense-related stocks are likely to outperform as government military spending increases.
Investment Outlook for Institutional Investors
- Near-Term Risk: Institutional investors should maintain a cautious approach, as Israel’s security situation remains volatile. The combination of geopolitical risks, stagnant economic growth, and widening fiscal deficits presents a challenging environment for equity performance in the near term.
- Potential Long-Term Opportunities: For long-term investors, Israel still offers attractive opportunities in sectors such as technology and defense, especially if tensions de-escalate. Selective capital allocation toward companies with strong balance sheets and exposure to government defense contracts, or those less reliant on domestic consumption, could be prudent.
Conclusion and Recommendation
S&P Global’s downgrade of Israel’s credit rating reflects the significant security and economic challenges posed by the ongoing conflict with Hezbollah and Iran. With GDP growth flat for 2024, widening fiscal deficits, and rising inflation, we recommend that institutional investors remain cautious in the near term, focusing on defensive sectors like defense and aerospace.
For those with a higher risk tolerance, a potential rebound in Israeli equities driven by defense spending and conflict de-escalation may present selective long-term buying opportunities. In the interim, investors should closely monitor developments in the geopolitical landscape.
Disclosure: This report is for informational purposes only. Investors should consult their financial advisors before making any investment decisions.
