OREANDA-NEWS. Fitch Ratings has affirmed Israel's Long-term foreign and local currency Issuer Default Ratings (IDR) at 'A' and 'A+', respectively. The Outlooks are Stable. The issue ratings on Israel's senior unsecured foreign and local currency bonds have also been affirmed at 'A' and 'A+', respectively. The Country Ceiling has been affirmed at 'AA-' and the Short-term foreign currency IDR at 'F1'.

KEY RATING DRIVERS

Israel's IDRs balance a strong external balance sheet, robust institutional strength, solid macroeconomic performance and high financing flexibility with a high government debt/GDP ratio and elevated geopolitical risks.

The affirmation reflects the following key rating drivers:-

Israel's general government deficit is consistently larger than peers'. The deficit has narrowed so far in 2015 reflecting the use of an expenditure rule due to the absence of a budget, and is forecast at a seven-year low of 3.1% of GDP in 2015 (the central government deficit is forecast at 2.6% of GDP). Tax cuts announced in the final quarter of 2015 will cause the deficit to widen to a forecast 3.5% of GDP in 2016 (with a central government deficit of 3% of GDP). With non-defence spending among the lowest in the OECD and the ruling coalition constrained by a small parliamentary majority, near-term fiscal consolidation is unlikely.

We forecast government debt/GDP to remain stable at around 67%, well in excess of the peer median of 44%. Financing flexibility is high, with deep and liquid local markets, access to international capital markets and an active diaspora bond programme and US government guarantees in the event of market disruption. The structure of debt is favourable.

Domestic politics can be turbulent, with coalition governments often not lasting their full term. The new ruling coalition, formed in May 2015 after elections in March that followed the collapse of the previous coalition, holds only a one seat majority in the Knesset. Fitch considers that the small majority is constraining policymaking under the new administration. A recent wave of security incidents highlights underlying tensions; Fitch expects little progress in the peace process with the Palestinian Authority.

Geopolitical risks weigh on Israel's ratings. Some neighbouring countries do not formally recognise Israel's existence and there are intermittent conflicts with military groups in surrounding countries and territories. Tensions with Iran are high. The conflict in Syria poses risks to Israel and to other neighbouring countries that could impact Israel, although direct spill-over has so far been negligible.

The external balance sheet is a strength and Fitch forecasts it will improve. Gas production should ensure sustained current account surpluses, which we forecast to average over 5% of GDP over 2015-2017. Likely large inflows of FDI will further bolster reserves and Israel's net creditor position, from 35.6% of GDP at end-2014, compared with the 'A' range median of 7.9% of GDP.

Growth has slowed in recent years, partly reflecting weak world trade growth, but is in line with the peer median. Growth is forecast at 2.7% in 2015, which would be the second consecutive year of sub-3% expansion for the first time in over a decade. High frequency data show an improvement after growth of just 0.3% (seasonally adjusted, annualised) in the second quarter due partly to a strike in the chemicals sector. It is too early to form a view on the potential impact of recent security incidents. An improving external economic environment, investment and tax cuts are forecast to lift real growth back over 3% in 2016 and 2017.

Inflation is below peers and has been negative so far in 2015 due to lower commodity prices, currency strength and measures to stimulate greater competition. Fitch expects a strengthening of the economy and the dropping out of one-off factors to push inflation into the lower end of the 1%-3% target range by end-2016.

Israel's well-developed institutions and education system have led to a diverse and advanced economy. Human development and GDP per capita are well above the peer medians and the business environment promotes innovation, particularly among the high-tech sector. However, Doing Business indicators, as measured by the World Bank, have slipped below peers and government intervention risks setting back development of the gas sector.

RATING SENSITIVITIES
The main factors that could, individually or collectively, lead to a positive rating action are:

-Sustained progress in reducing the public debt/GDP ratio towards the category peer median.

-A sustained easing in geopolitical risk.

-A continued strengthening of the external balance sheet.

The main factors that could, individually or collectively, lead to a negative rating action are:

-A sustained deterioration of the public debt/GDP ratio.

-A serious worsening of geopolitical risk.

KEY ASSUMPTIONS

Current regional conflicts and tensions are assumed to continue, but their impact on Israel is not expected to worsen materially. Fitch does not expect a military conflict between Israel and Iran. Fitch assumes the civil war in Syria will continue without directly spilling over into Israel.

Renewed conflict with Hamas in Gaza is not ruled out, despite a serious degradation of the latter's military capacity. The tolerance of the rating and Outlook depends on the economic and fiscal implications of any conflict. Fitch does not assume any breakthrough in the peace process with the Palestinians or a pro-longed serious deterioration in domestic security conditions.