Israel’s Economy Faces Uncertainty Amidst Controversial Judicial Reforms
Israel’s economy may face downgrades, falling foreign investment, and a weaker tech sector if the turmoil arising from the government’s contentious judicial reforms continues, warn investors and analysts. The government recently passed the first of a series of laws aimed at reducing the powers of Israel’s Supreme Court, favoring Prime Minister Benjamin Netanyahu’s executive branch. This move has sparked widespread protests, with various sectors, including doctors and tech firms, participating in strikes and demonstrations.
The shekel currency has experienced a decline of over 2% against the dollar since the plans were first announced in January, bringing its total decline to more than 9%. The main concern for external investors considering Israel is the uncertainty surrounding the situation. As long as this uncertainty persists, it will overshadow Israel’s economy, leaving many questions unanswered.
Israel’s stock market has also been adversely affected by the tumultuous environment, with MSCI’s Israel index significantly lagging behind global stock indices, such as the MSCI All Country World. Domestic investors have been avoiding the market, leading to a concerning underperformance. However, until the end of June, foreign investment in Israeli equities remained strong due to the country’s appealing economic prospects.
According to data from Copley Fund Research, a considerable percentage of global funds (35.5%) have exposure to Israel, the highest level since 2017. Additionally, the country has witnessed the largest increase in new ownership this year, with a 3.44% rise in the number of funds investing in Israel. The comparably low inflation rate in Israel, in relation to similar countries, has contributed to maintaining investment in the nation. Nevertheless, sustained civil unrest could hinder incoming investments.
Morgan Stanley has warned that if domestic tensions remain unresolved, the expected GDP growth of around 2.5% this year and 3% next year could decrease to just 1.0% and 1.6%, respectively. Despite Israel’s fundamentally attractive investment story, the pursuit of judicial reforms by the government poses a threat to this favorable trajectory. Roger Mark, a fixed-income analyst at fund manager Ninety One, believes that many investors and rating agencies anticipated more significant dilution of the reforms. The possibility of the government persisting with the reforms could influence investors to avoid the country, leaving bond and foreign exchange investors awaiting developments cautiously.
The government’s supporters argue that the Supreme Court has exercised excessive intervention throughout the years and needs to have its powers curtailed. However, the Supreme Court is set to hear an appeal against the judicial reform law in September, which may result in direct conflict with the government. Analysts express concern about the potential for an immediate constitutional crisis in the short term.
Major concerns regarding the upheaval lie in its impact on investment in Israel’s thriving technology sector. The tech industry, responsible for nearly a fifth of the country’s GDP, over half of its exports, and a quarter of income tax revenues, has been the fastest-growing sector in Israel for over a decade. Innovation in areas such as cybersecurity and artificial intelligence has been adopted worldwide. However, a recent survey from the Israeli Innovation Authority has shown that due to the uncertain business environment, up to 80% of new Israeli startups have registered overseas, compared to only 20% in 2022. Additionally, tech firm fundraising has experienced a significant slump of 65% in the second quarter.
This reform backlash has the potential to permanently impede economic growth, warns Nicholas Farr, an economist specializing in emerging Europe at Capital Economics. Israel’s credit rating is also under scrutiny, with all three major credit rating agencies, namely S&P Global, Moody’s, and Fitch, expressing concerns about the government’s policy direction. Moody’s has downgraded Israel’s sovereign credit to a dislike stance, while S&P has projected decreased economic growth this year in light of the widespread protests. Fitch, which already rates the country lower at A+, has stated that the judiciary changes may have a negative impact on the credit profile by weakening governance indicators, policy-making, and investor sentiment.
Natalia Gurushina, the chief emerging market economist at fund manager VanEck, anticipates potential credit rating downgrades or adjusted outlooks. The new laws may cause significant institutional deterioration, potentially affecting capital inflows into sectors such as technology. With a risk of capital flight and decreased investor confidence, Israel’s economy is at a delicate crossroads. The government’s pursuit of judicial reforms has far-reaching consequences, and it remains crucial to address the concerns and uncertainties to ensure a stable economic environment for the nation.
(This story has been auto-generated from a syndicated feed, and has been edited for clarity.)
