Major fears are sweeping into Israel’s economy

Israel's proposed judiciary overhaul would be a 'complete revolution': former central bank official

Hundreds of anti-Netanyahu protesters gathered outside a hair salon on Wednesday after the prime minister’s wife Sara was spotted at a nearby hair salon.

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New concerns about Israel’s economy are causing global investors to question the money they have in the country.

Massive protests have intensified in recent weeks as Israel’s parliament, the Knesset, moves closer to creating a law that would fundamentally change the way the country’s justice system works. Critics – who polls show represent the majority of Israel’s population – say the changes will threaten the country’s democracy.

The law would transform Israel’s judicial system by giving incumbent governments full control over the appointment of judges. It would also weaken the country’s Supreme Court to the point where it would effectively end its role of oversight over the executive and legislative branches.

In a sign of the seriousness of opposition to the proposed law, graduates of elite military programs and reservists in key sections of the Israeli army have threatened not to show up for duty and have petitioned to protest the changes.

In a recent report, Treasury Department Chief Economist Shira Greenberg wrote that “rating agencies are likely to react to these developments.”

So far, all three rating agencies – S&P Global, Moody’s and Fitch – have held steady and kept Israel at a strong credit rating, giving global investors some level of reassurance.

You can’t separate Israel’s unicorns and startups and scale-ups from the stock market. If funding slows down, we will see the impact on the stock market and it is happening now.

Stefan Schoenfeld

CEO, MarketVector

Fitch reiterated its rating on Wednesday but included a special section in its statement on the economic risks of judicial reform. The firm warned that proposed judicial reform “could have a negative impact on Israel’s credit profile if governance indicators are weakened or if the weakening of institutional controls leads to poorer policy outcomes or persistent negative investor sentiment.”

Fitch pointed to the adoption of similar rules in other countries, which would have led to a “significant weakening of the World Bank’s governance indicators”. These indicators play an important role in shaping the ratings assigned to countries.

Fitch pointed out that the judicial proposal had met “strong civil and political opposition” in Israel, which in turn was dividing Israeli society. Israel is the second largest economy in the Middle East after Saudi Arabia in terms of GDP.

Moody’s: Changes ‘would be clearly negative’

In a previous report, the rating service Moody’s raised similar concerns about the legal system, writing that “the implementation of such changes would be clearly negative for our assessment of the strength of institutions and governance, which we have hitherto viewed as a positive feature of Israel’s sovereign credit profile.”

A decline in Israel’s credit rating would increase borrowing costs and hamper fundraising. Both are critical as Israel requires external investment from institutions based in the United States, Europe and elsewhere.

Much of Israel’s economy is pegged to the value of the Israeli shekel against the US dollar. In February, the shekel plummeted, ending the month down almost 10% from where it was on February 3rd. This in turn hurt critical parts of Israel’s economy, including real estate, as businesses and individuals converted their money into US dollars and other currencies.

The shekel’s fall also caused investor confidence to fall. The Tel Aviv Stock Exchange plunged about 8% in February.

Steven Schoenfeld, the CEO of MarketVector, said he believes investors’ concerns about the situation in Israel are justified. MarketVector maintains stock indices, including the Blue Star Fund, which Schoenfeld established to track Israeli stocks.

“The biggest concern is Israel’s important venture capital and private equity areas,” Schoenfeld said.

“You can’t separate Israel’s unicorns and startups and scale-ups from the stock market,” he added. “As funding slows, we will see the impact on the stock market and that is happening now.”

Yaron tries to calm the executives down

Bank of Israel Governor Amir Yaron has tried to calm markets and business leaders.

A source with direct knowledge of the matter told CNBC that Yaron warned at a meeting hosted by Prime Minister Benjamin Netanyahu last week that the political crisis could turn into an economic one and that “the problem needs to be addressed.”

Members of Netanyahu’s cabinet claim that a compromise is still possible – although critics dispute this claim. Insiders told CNBC that government officials are in contact with key Israeli business figures to help mitigate the impact on the economy.

Through the central bank, Yaron declined an interview for this report. However, he said in a statement last week that “the shekel has devalued” which would force the government to act with “tremendous responsibility” on the budget.

The budget is another aspect that rating agencies have identified as potentially problematic for Israel’s economy.

The government could come under pressure to make spending aimed at select sections of the population that are part of the current coalition base.

Otherwise, Israel faces a sixth election in less than four years.