Fitch Warns Israeli Political Instability May Delay 2027 Budget, Raise Debt

International credit rating agency Fitch Ratings issued a warning on Friday, stating that the results of Israel's recent elections could lead to a prolonged period of political instability. This instability, Fitch cautioned, may hinder the government's ability to manage economic policy, approve a new budget, and curb the rise in public debt. In an analysis document, which does not constitute a new rating decision, Fitch assessed that there is a risk a stable coalition with a 61-member Knesset majority may not be formed.

The agency's most likely scenario anticipates failed efforts to form a government, leading to the Knesset's dissolution in early January and new elections in early April 2027. While Fitch does not rule out the formation of a broad unity government, it does not consider this the central scenario. Israel's credit rating remains at 'A' with a negative outlook, reflecting the possibility of a future downgrade.

A significant consequence of the potential political crisis relates to the state budget for 2027. If a government with a Knesset majority is not established and a new budget is not approved, the country will have to operate under a continuing budget. This would limit government spending to the existing budgetary framework, potentially delaying new government programs and impeding long-term economic decision-making.

Fitch notes that expenditure limitations might temporarily reduce the deficit. However, the agency emphasizes that a deficit reduction stemming from an unapproved budget does not necessarily indicate fiscal improvement but could reflect the government's inability to advance economic policy. The agency projects a moderate continued rise in the government debt-to-GDP ratio, which remains a key factor in the negative rating outlook. This warning comes against the backdrop of increased public debt during the war years, with the debt-to-GDP ratio rising from approximately 60% before the war to around 70%.

Alongside high defense expenditures, concerns about prolonged governmental instability complicate the formulation of a plan to reduce the deficit and debt in the coming years. Fitch's assessments follow the conclusion of the 26th Knesset elections, which resulted in no majority for either of the two main blocs. Preliminary results show the Netanyahu bloc with 53 mandates, the Gantz bloc with 48, and Arab parties with 19, necessitating negotiations among parties with differing stances and leaving open the possibility of a broad government, a minority government, or further elections.