The credit rating companies may soon announce that in the shadow of the war, Israel’s credit rating is going down. Beyond the threatening headlines, the economic risk in the decision is the increase in the cost of raising Israel’s debt in international markets. The alternative is a greater reliance on the domestic capital market in order to increase the debt, and it seems that this is definitely an option that can be implemented.
In an interview with ‘Davar Mesfar’ Avi Kimchi, the investment manager at the old pension fund ‘Gilad’, explains that there is currently a great appetite for bonds issued by the government. This is due to the high interest rate environment at the moment, alongside the holdings rate of the institutional bodies in bonds, which in Israel is historically low. This situation can allow the government to relatively easily finance an increase in the debt.
“For the next year or even ahead, I think there is an excellent absorption capacity in the market for government debt raising. The economy has entered a very solid state, with a growth level above the OECD average and a lower debt-to-product ratio than most OECD countries. So when talking about the large deficit that will raise the ratio The debt, it should be brought in proportion.”
The forecast for Israel’s credit rating predicts a decline, but according to Kimchi, the impact of the rating mainly concerns debt raising abroad, which is a minority of the government’s total capital raising.
Israel’s debt to GDP ratio for 2023 (Ministry of Finance)
According to him, the government’s capital raising abroad reflects an increase in the risk premium and increased interest payments, while in the local market, credit rating issues have less impact, and the local entities are interested in participating in the issuance of government bonds.
Kimchi emphasizes the difference between the credit rating of Israel’s debt in foreign currency, and the domestic debt in shekels. “For us, as Israelis living in this country, the government’s credit rating is triple A. This means ‘no credit risk’ in professional parlance.” These fundraisings are 75% of the government’s total capital raisings last year, and are therefore the most important parameter in terms of increased financing capacity at this time. The total fundraising in the last year jumped to 160 billion shekels, but after deducting the discharge of old debts, it is a net raising of 55 billion shekels, beyond refunds.
The need to finance the war through the deficit increased the pressure on the government to dramatically increase its capital raising in the market, but according to Kimchi the change comes at a very favorable opportunity in terms of market conditions.
“Before the war, the government mobilized at a rate of 4-8 billion shekels per month. Since the outbreak of the war, the rate increased to 14 billion per month, only in shekels. The mobilization in January will be approximately 18 billion shekels, because December was somewhat limited.”
The interest on bonds denominated in foreign currency already means a downgrade of the credit rating
Kimchi came to the Gilad Fund two months ago, with extensive experience gained in investment management at the Phoenix Company, Bank Hapoalim, Bank of Jerusalem and Menora Mvittaim. He has been working in the capital market for 22 years. “I’m not tired,” he says, “I come to work with fire and passion.”
He explains that the share of government bonds in the aggregate investment portfolio of institutional entities in Israel has consistently decreased over the past 20 years, and the change in direction comes at a good time.
According to him, the downturn in these holdings came as a result of the Corona crisis. The interest rates of the central banks were zero and the real interest rate was negative, which hurt the attractiveness of government bonds. “We entered the war with a low scope of exposure in historical terms, and also a relatively high interest rate environment. These two parameters indicate that the institutional market can absorb the rate of issuances discussed in the Treasury. The question is for how long.”
Another issue is the coverage ratio of the issue – how much greater is the demand for the bonds in a given issue compared to the supply. “The coverage ratios of these issuances remained high. This indicates the appetite of the investors, at least for the beginning of January.”
For the most part, an institutional body will hold the bond until it expires, and will be entitled to receive the nominal interest with the fund, but now there is another consideration – the interest rate trend of the Bank of Israel, which allows the sale of the bonds at a profit even before they expire. “Institutional bodies like us, who see the central bank, make personal assessments of where the interest rate will go in a year or two. If the interest rate goes down, there is a certain potential for capital gains. As of the last few months, it is relatively attractive.”
According to Kimchi, the exposure rate of institutional entities to Israeli government bonds dropped to a low of almost 9% at the end of 2023, compared to a jump in the holding rate of cash deposits and MCM (short-term lender of the Bank of Israel), which climbed from 8%-10% to -15%-16%. Another phenomenon that has occurred recently is the ‘normalization of the yield curve’, which means that the interest rate on a bond increases the further away its maturity date is, which may incentivize institutional entities to increase their exposure to bonds, at the expense of holdings in deposits and MCM.
On the less positive side, the increase in the cost of Israel’s capital raising abroad, in bonds denominated in foreign currency, is evident. There, according to Kimchi, the interest rate already represents a de facto credit rating downgrade. “There is uncertainty in the war. You know how you’ll get in and you don’t know how you’ll get out, and you don’t know how much time will pass in between.”
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