TEXT-Fitch affirms Israel's ratings; outlook stable

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April 25 - Fitch Ratings has affirmed Israel's Long-term foreign and local currency Issuer Default Ratings (IDR) at 'A' and 'A+' respectively. The Outlooks on the Long-term IDRs are Stable. Fitch has simultaneously affirmed Israel's Short-term IDR at 'F1' and Country Ceiling at 'AA-'. The rating balances Israel's strong institutions and solid recent macroeconomic performance, rich, diversified economy and strong external balance sheet against a high level of government debt and longstanding geopolitical concerns. "The Outlook remains Stable despite the uncertainties surrounding the Iran situation.

"The rating balances Israel's strong institutions and solid recent macroeconomic performance, rich, diversified economy and strong external balance sheet against a high level of government debt and longstanding geopolitical concerns"Specifically, the rating does not incorporate event risk in the shape of a possible attack on Iran's nuclear facilities," says Richard Fox, Senior Director in Fitch's Sovereign Rating Group. With tighter international sanctions against Iran only just taking hold, and talks between Iran and the international community recently resumed, near term hostilities seem unlikely. However, the longer the impasse continues, the higher is the risk of hostilities breaking out. In that event, it would likely lead to immediate negative rating action, with the final rating outcome depending on the extent of the economic and physical damage that Israel might suffer. "Conversely, the rating does not factor in the longer term benefits of Israel's newly discovered natural gas resources, as substantial benefits will only accrue beyond the rating time horizon," adds Mr Fox.

Geopolitics also pose a downside risk to growth, as do energy prices and the eurozone crisis. The quarterly trajectory shows a slowdown in GDP growth firmly underway, even though the headline figure for 2011 (4.8%) was robust and the same as that in 2010. However, initial data on real activity in early 2012 suggest the deterioration in growth has been arrested at the rate seen in Q411. Fitch's forecast for 2012 is for a moderate slowdown to 3%. The prospects for 2013 are brighter than for 2012 - Fitch is forecasting a growth rate of 3.5% - given that the global outlook is likely to improve and that Israel's recently discovered gas fields, which are expected to begin production for domestic use by mid-2013, will alleviate some of the pressure on the economy from high and rising fuel costs.

"Specifically, the rating does not incorporate event risk in the shape of a possible attack on Iran's nuclear facilities," says Richard Fox, Senior Director in Fitch's Sovereign Rating Group"However, there are longer term concerns about growth since the growth rate of the working-age population is likely to halve to 1.2% between 2010 and 2020 against 2.3% between 2000 and 2010. This will weigh on growth and public finances, making debt reduction even more difficult. Although the debt ratio improved slightly to 74.2% of GDP in 2011 from 76.3% in 2010, debt remains significantly above the 'A' range median (48% of GDP in 2011) and above the government's own target of 60% of GDP. Moreover, debt is not projected to fall over the medium term. Slower output and hence revenue growth, together with higher spending pressures on account of last year's social protests has led Fitch to expect the central government deficit to remain wider than targets.

Fitch is forecasting central government deficits of 3.7% of GDP in 2012 and 3% in 2013 (the internationally comparable general government figures include the inflation component of interest payments and are just over 1% of GDP higher, but this is reflected in Fitch's debt numbers). As a result debt is likely to stabilise at 74%-75% of GDP over Fitch's forecast horizon, where it remains high relative to peers. These high debt levels continue to constrain Israel's rating. High geopolitical risks also elevate defence spending and, other things being equal, argue for a lower public debt/GDP ratio than in other countries at a similar stage of development. Positive rating action would require the debt ratio to fall nearer to the government's own 60% of GDP target.

"With tighter international sanctions against Iran only just taking hold, and talks between Iran and the international community recently resumed, near term hostilities seem unlikely"Conversely, a prolonged rise in the debt/GDP ratio and/or sustained fiscal easing would prompt negative rating action. Revenues from the gas sector could eventually be used to pay down debt but the government has yet to decide the exact use of these proceeds. On current plans, 40%-50% of the gas revenues will accrue to the budget while the rest is likely to be set aside in a sovereign wealth fund. In any case revenues from gas will only grow to material levels (0.6% of GDP) by 2020. (Caryn Trokie, New York Ratings Unit)

Financials.