Israel's accountant general claims that the country's finances are in such good shape that it has no pressing need to tap the international capital markets. Joanne O'Connor finds out how this can be the case follwing Israel's invasion of southern Lebanon.
If investors minded when, on June 12, Israel launched strikes on Hezbollah targets in southern Lebanon, they scarcely showed it. While spreads on Lebanese debt and credit default swaps widened sharply, Israeli government debt and CDS were little affected in secondary trading. And Israel's debt even recovered to trade almost in line with its levels before hostilities started. The following month, Standard & Poor's affirmed its A+ rating for the State of Israel, citing the improved resilience of Israel's public finances and economy to geopolitical shocks, after a three year period of fiscal consolidation and strong economic growth.
The market's reaction to the invasion of southern Lebanon suggests it has become inured to political risks of this type in Israel — that risk is priced into Israel's debt already.
Yuval Bronstein, senior deputy of the accountant general in Tel Aviv, agrees. "We believe this is one of the best indications of Israel's economic soundness," he says. "This shows the strong confidence of investors in the Israeli economy. Israel has shown in the last two years that it can overcome such events [like] this operation in Lebanon very quickly."
At the end of 2005, Israel had $31bn in external public debt, the equivalent of 26% of the total government debt. It is, according to the accountant general, a low proportion. Israeli sovereign's debt is also characterised by a long maturity profile — at the end of June 2005 only 12.2% of external debt had an original term to maturity of less than five years — highlighting its status as a mature borrower, albeit one in what bankers describe as a "bad neighbourhood".
Unsurprisingly, US dollar denominated bonds comprise most of Israel's outstanding external public debt — at the end of June 2005 — dollar debt accounted for 90%.
The chief means of external borrowing for the sovereign remains the $9bn US loan guarantee programme. Launched in 2003, the programme accounted for 47.6% of Israel's foreign debt as of June last year. The programme was extended until 2008 and last month, Israel requested a second extension, which if granted, will see it continue until 2012. The extension will ease the pressure to issue under the US programme, under which Israel has issued $4.4bn so far. It had planned to borrow $1bn this year under the programme.
Israel also capitalises on the goodwill of Jewish retail investors across the diaspora through bonds issued by the State of Israel Bond Organisation. Established in the 1950s, the organisation has raised around $25bn, Bronstein says, and this year, the sovereign is targeting $1bn in issuance. Bonds issued by the organisation are not tradeable, helping contribute to the stability of the sovereign's debt.
"We're trying to take advantage of the fact that we can raise money from investors on a retail basis on a very narrow spread," says Bronstein.
The heavy focus on US dollar issuance has led the accountant general to make efforts at diversifying the currency denomination of government debt. Euro investors showed their enthusiasm for Israeli sovereign debt last year when, through bookrunners Deutsche Bank and Morgan Stanley, Israel priced its Eu750m 10 year Eurobond at just 53bp over mid-swaps — the tightest spread ever achieved by the sovereign as a standalone issuer.
The deal attracted a book of Eu4bn from 150 investors in 13 countries, a triumphant demonstration of Israel's credit and of its appeal to euro accounts. Before that deal, Israel last issued in euros in February 2002, when it had to pay 100bp over mid-swaps.
But despite the conspicuous success of the print, Israel hasn't rushed back to issue in the capital markets, largely, says Bronstein, because it doesn't need to.
For 2006, Israel planned to raise $2bn-$2.5bn in the capital markets, including $500m-$1bn as a standalone issuer in the international market. Says Bronstein: "Our original plan for 2006 was based on the assumption that the deficit will be 3% of GDP. This target will be achieved."
In the domestic market, the sovereign has three main sources of borrowing available to it — CPI-linked bonds, the non-indexed fixed rate Shaha bonds and floating rate Galilee notes. According to Bronstein, 20%-30% of issuance is in inflation-linked notes, while the remainder is in non-linked notes.
But, says Bronstein, as a result of the success of its fiscal reforms and the increase in the budget surplus, Israel has reduced its domestic bond issuance sharply.
In the international capital markets, Israel planned to raise between $500m and $1bn through the issue of new dollar bonds in 2006. Deutsche Bank and Morgan Stanley were mandated to run the books on the deal. However, the issue has yet to materialise and, says Bronstein, "we have not yet issued because of lack of financing needs.
"If there is an opportunity in the market and if there is need for finance, we will be in the market in Q4 2006."