ECONOMIC INFORMATION ABROAD - Circular # 5-96 - 01-Aug-96

THE INTERNATIONAL DIVISION

ECONOMIC INFORMATION ABROAD - Circular # 5/96

August 1, 1996

Standard & Poor's - Press Release

Israel's Local Currency Rated AA-; Foreign Currency Debt Ratings Affirmed

Standard & Poor's today has assigned its 'AA-' long-term and 'A-1+' short-term ratings to the State of Israel's shekel (NS)-denominated debt.

Approximately NS 116 billion of local currency debt (US$36 billion), including NS90 billion of inflation-indexed bonds (US$28 billion), is affected.

In addition, Standard & Poor's has affirmed its 'A-' long-term and 'A-1' short-term ratings on Israel's foreign currency debt. The outlook is stable.

Israel's higher local currency rating reflects:

The government's greater capacity to service shekel-payable debt, owing to its powers of taxation and control over the domestic monetary system. Increasing support for the central bank's disinflation efforts, which despite this year's rebound in inflation to above the annual target of 8%-10%, should contain increases in consumer prices to single digits beyond 1996.

A domestic political consensus behind fiscal restraint robust enough to ensure that the government's favorably-structured, but high, shekel debt burden, at 85% Of GDP in1996, continues to decline.

Ratings of Israel are also supported by:

A diversified, well-developed economy with improved growth prospects, underpinned by a highly-skilled labor force, increasing labor market flexibility and buoyant foreign and domestic investment. High rates of growth projected at over 5% this year and next support ongoing fiscal consolidation and should help reduce further the size of the general government sector from close to 50% of GDP in 1996.

An increasingly secure geopolitical position, with remaining external security risks largely offset by strong diplomatic and financial support from the U.S.

Creditworthiness continues to be constrained by a heavy government debt burden - at 115% of GDP in 1996, the highest among similarly rated sovereigns, which limits fiscal and balance of payments flexibility. Israel's net public external debt burden, at 48% of exports in 1996, on the other hand, is manageable and benefits from low average interest costs and a favorable-term structure. Total external debt service (including short-term debt) is just 30% of exports.

OUTLOOK: Stable. The Likud government's commitment to disciplined fiscal and monetary policies should help lower fiscal imbalances and inflation going forward. However, the slow pace of deficit reduction envisaged under the medium-term fiscal consolidation program, and possible slippages along the way, imply a gradual reduction in the government's debt burden. Current account deficits, in turn, are expected to remain over 4% of GDP in 1996 and 1997, but should be financed increasingly by foreign equity inflows. The Bank of Israel's current high interest policy should lower inflation to under 10% in 1997, but maintaining single-digit inflation hinges on meeting fiscal targets and more effective demand management. The Likud government's cautious approach towards Palestinians and Syria likely will slow, but not reverse, advancements in the peace process over the long term.