Moody's Investors Service has placed Israel's “A1" long-term foreign and local currency issuer ratings on review for a downgrade as the war with Hamas continues to escalate in Gaza.
The outlook for the country's debt was previously stable, Moody's said in its latest report on Israel's sovereign rating.
“Israel's credit profile has proven resilient to terrorist attacks and military conflict in the past. However, the severity of the current military conflict raises the possibility of longer lasting and material credit impact,” Moody's analysts Kathrin Muehlbronner and Dietmar Hornung said.
“While a short-lived conflict could still have credit impact, the longer lasting and more severe the military conflict, the greater its impact is likely to be on policy effectiveness, public finances and the economy.”
Moody's potential downgrade follows similar move by Fitch Ratings, which placed the country's Iong-term foreign and local currency issuer default ratings of “A+” on a negative watch earlier this week.
Fitch cited “the heightened risk of a widening of Israel's current conflict to include large-scale military confrontations with multiple actors, over a sustained period of time”.
The reports come amid a new bout of geopolitical uncertainty as the war between Israel and Hamas, which governs the Gaza Strip, continues to rage.
The fighting began after Hamas staged a surprise attack in southern Israel and killed about 1,400 people.
More than 4,000 people have been killed in the conflict, which has continued for two weeks, with at least 3,875 deaths in Gaza alone.
Israeli Prime Minister Benjamin Netanyahu has already spoken of a long war as his troops gather on the Gaza border for a full-fledged ground invasion.
Protests erupted in the occupied West Bank and in several Middle East cities after more than 500 Palestinians were killed in an air strike on a Gaza city hospital on Tuesday.
“The military conflict is increasing Israel's already relatively high exposure to geopolitical risks,” Moody's said.
The ratings agency said it would assess, during the review period, whether the conflict is expected to move towards resolution or is headed for significant escalation over an extended period.
The debt rating review will also assess the Israeli government's ability to put in place policies to mitigate the economic and fiscal impact of the conflict, and manage a future recovery from the crisis, it said.
Israel, which spends about 4.5 per cent of its gross domestic product on defence, has typically increased defence expenditure around episodes of violence in the past and will probably do so during the current conflict, Moody's analysts said.
“Higher defence spending would add to the deficit, which Moody's expected to stand at around 2 per cent of GDP prior to the attack,” they added.
An estimated 8 per cent of the Israeli working population is drafted into the military effort and, given the severity of this conflict, there is a risk of a “diversion of resources, drop in investment and loss of confidence, which would undermine Israel's economic outlook”, Moody's said.
Israel has called up 360,000 reservists – one of the biggest mobilisations in the past 50 years – since the escalation of the conflict with Hamas.
Moody's will downgrade Israel's ratings if it concludes that the current military conflict is likely to “materially weaken Israel's institutions, in particular the effectiveness of its policymaking, its fiscal and/or its economic strength”, the rating agency said.
Moody's would most likely reach that conclusion if the military conflict were to escalate significantly, or were to spread further beyond Israel's borders, it said.
“The extent of any rating impact would depend on the severity of the impact to Israel's credit profile over the medium term,” Moody's said.