Analysis: Netanyahu Judicial Action Creates Economic, Political Risks

  • The reforms raise risks for the economy and Netanyahu
  • Further changes could affect the shekel, growth, and high-tech sector
  • Government ignores 'major warning signs’ – economist
  • Moody’s sees negative economic effects
  • Netanyahu: Economy is strong, only facing a 'calculation reaction’

JERUSALEM, July 25 (Reuters) – A day after Prime Minister Benjamin Netanyahu proposed controversial changes to the judiciary, an ad covered the front pages of all of Israel’s leading newspapers in black, reading: „A black day for Israel’s democracy.”

Analysts say the paid advertising by a group of high-tech companies protesting against Netanyahu’s judicial policies has unleashed several risks for both Israel’s economy and his own political future.

On Monday, Netanyahu’s nationalist-religious coalition gave parliamentary approval to a new law that would limit some of the Supreme Court’s powers, despite mass street protests and stiff opposition from the opposition.

Israel’s shekel moved through parliament’s every twist and turn as efforts to reach a judicial compromise intensified and finally fizzled.

But volatility in the shekel, which has weakened about 10% against the dollar since Netanyahu’s government announced judicial plans in January, has been one of the economic downsides so far, fueled by foreign investor unrest.

For now, Israel’s economy is relatively strong, with growth this year at 3% and an unemployment rate of 3.5%. The high-tech sector is an important growth engine, accounting for 14% of jobs and nearly a fifth of GDP.

Netanyahu’s government will be vulnerable if it pursues further changes seen as compromising what is seen abroad as an even stronger and independent judiciary.

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Already on Tuesday, Morgan Stanley downgraded Israel’s sovereign debt to „aversion status.”

„Recent events point to continued uncertainty, and thus the potential for higher risk premiums, leading to weaker FX and higher borrowing costs,” Morgan Stanley said.

„Such economic shocks lead to weaker GDP growth due to lower business investment and private consumption growth.”

Credit rating agency Moody’s said in a report on Israel that the law would continue political tensions and could have negative consequences for Israel’s economy and security situation.

Ahead of the report’s release, Netanyahu attempted to cover the damage, issuing a statement: „This is a temporary reaction, and when the dust settles it will be clear that Israel’s economy is very strong.”

’On a cliff’

„The future of the Israeli economy is not very bright at the moment,” said Yitzhak Ross, an economist at the Hebrew University in Jerusalem.

Economists and serving officials have urged Netanyahu’s coalition not to pursue judicial reforms without broad consensus.

„They’re ignoring even bigger warning signs, and they’re driving us over the cliff,” Ross said.

Even if Netanyahu chooses to scrap plans for further judicial reforms, the damage will be difficult to repair.

The high-tech sector, which is generally silent in political debates, has been a driving force in protests against government actions. Israel’s nearly $500 billion economy is fueled by its technology sector, which accounts for more than half of the country’s exports and a quarter of its tax revenue.

Many tech companies have announced they are moving funds out of Israel, while foreign inflows have fallen sharply. New startups are increasingly settling abroad.

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A study by the Israel Innovation Authority found that 80% of startups founded so far this year opened outside of Israel, and that companies are looking to register their future intellectual property abroad.

„It’s hard to reverse trends like registering a company abroad or launching new start-ups outside of Israel,” said Avi Hassan, CEO of Start-Up Nation Central.

Because companies need a reliable legal system to protect their intellectual property, the tech industry has a lot to lose if more controversial judicial changes come.

„The biggest concern is that these reforms are the thin end of the wedge — changes in the judiciary could trigger further institutional reforms that could send Israel permanently down a low-growth path,” said Nicholas Farr, an emerging market economist at Capital Economics.

Analysts say there may be a short-term hit to the economy — especially if the country’s main union threatens a public-sector strike — but growth will suffer more in the long run due to lower investment and a brain drain.

inflammation

Netanyahu’s office did not respond to a request for comment on the possible fallout of his government’s judicial policy.

His November. 1 Ahead of his election victory, the veteran right-wing leader and free marketeer focused his campaign on rising living costs.

Netanyahu has stamped his economic credentials, offering financial relief to families struggling with inflation.

Israel has maintained a current account surplus in its balance of payments due to large foreign investments in technology companies and propping up the shekel.

But the central bank has warned for months that the shekel faces damage from the government’s judicial overhaul. Bank Governor Amir Yaron said on July 10 that the shekel’s „excessive depreciation” had contributed up to 1.5 percentage points to inflation.

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The central bank has raised interest rates higher than expected as Israel’s high risk premium weakens the shekel, meaning more pain for mortgage holders and other borrowers.

Monday’s vote could pose a major long-term political risk for Netanyahu.

By voting, Netanyahu sided with more hard-line and far-right elements in his coalition government than with moderates, some of whom are vying to succeed him, political analyst Amots Asa-El said.

That creates a potential rift in his coalition government that could worsen if Netanyahu pulls too far on either side. And, despite commanding a loyal voter base, Netanyahu may have lost his Likud party’s moderate supporters for good.

„A large part of right-wing Israel is completely opposed to what he did,” said Asa-El, a research fellow at the Shalom Hartman Research Institute. „It’s not a matter of right and left, it’s a matter of right and wrong.”

Written by Mayan Lubel; Editing: William McLean

Our Standards: Thomson Reuters Trust Principles.

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