By Steven Scheer and Maayan Lubell
JERUSALEM (Reuters) – A day after Prime Minister Benjamin Netanyahu pressed ahead with contentious changes to the judiciary, an ad covered the front page of all Israel’s leading newspapers in black, reading at the bottom: “a black day for Israel’s democracy.”
It was a paid ad by a group of high-tech companies protesting against Netanyahu’s judicial policies, which analysts say have unleashed a slew of risks, both for Israel’s economy and for his own political future.
On Monday, Netanyahu’s nationalist-religious coalition granted parliamentary approval to new legislation that will limit some of the Supreme Court’s powers, despite mass street protests and fierce objection from the opposition.
Israel’s shekel moved on every twist and turn in parliament as efforts to reach a judicial compromise intensified and finally crashed.
But the volatility of the shekel, which has weakened about 10% versus the dollar since Netanyahu’s government announced judicial plans in January due to foreign investor unease, is just one of the economic downsides so far.
For now, Israel’s economy is relatively robust, with growth forecast at 3% this year and unemployment at a 3.5% rate. The high-tech sector is an important growth engine that accounts for 14% of jobs and almost a fifth of GDP.
All that will likely suffer if Netanyahu’s government pursues more changes that would be perceived as compromising what is still seen abroad as a strong and independent judiciary.
Already on Tuesday, Morgan Stanley cut Israel’s sovereign credit to a “dislike stance.”
“The recent events point to continued uncertainty and thus the potential for an increased risk premium that would lead to weakening FX and higher borrowing costs,” Morgan Stanley said.
“Such economic shocks tend to 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’s passage signalled political tensions will continue and will likely have negative consequences for Israel’s economy and security situation.
Before the report’s publication Netanyahu appeared to try and offset the damage, issuing a statement that said: “This is just a momentary reaction, when the dust settles it will become clear that Israel’s economy is very strong.”
‘OFF A CLIFF’
“The future of the Israeli economy does not look very bright at this moment,” said economist Itzchak Raz, an economist with the Hebrew University in Jerusalem.
Economists and serving officials have urged Netanyahu’s coalition not to pursue judicial reforms without broad agreement.
“They’re still ignoring the huge warning signs and they’re driving us over the cliff,” said Raz.
Even if Netanyahu chooses to scrap plans for further judicial changes, damage will be hard to fix.
The high-tech sector, which is usually mute on political debate, has been a driving force in the protests against the government’s moves. Israel’s nearly $500 billion economy is fuelled by its tech sector, which accounts for more than half the country’s exports and one-quarter of tax income.
A number of tech firms have reported moving funds out of Israel, while foreign inflows have slowed sharply. New startups are increasingly domiciling abroad.
A survey by the Israel Innovation Authority found that by May, 80% of startups established so far this year were opened outside Israel and that companies also intend to register their future intellectual property overseas.
“Trends like registering a company abroad or launching new start-ups outside Israel will be hard to reverse,” said Start-Up Nation Central CEO Avi Hasson.
The tech sector has a lot to lose if more controversial judicial changes come because firms need a trusted legal system to protect their intellectual property.
“The biggest worry is that these reforms are just the thin end of the wedge – the changes to the judicial system may result in further institutional reforms which could put Israel on a permanently lower growth trajectory,” said Nicholas Farr, an emerging markets economist at Capital Economics.
Analysts say that while there may be a short-term hit to the economy — especially if there is a public sector strike as the country’s main labour union has threatened — growth will suffer most over the longer term through decreased investment and a so-called Brain Drain.
INFLATION
Netanyahu’s office did not respond to a request for comment on the possible fallout of his government’s judicial policy.
In the run-up to his Nov. 1 election win, the veteran right-wing leader and free market champion focused his campaign on soaring living costs.
Brandishing his economic credentials, Netanyahu promised financial relief to households buckling under inflation.
Israel has maintained a current account surplus in its balance of payments, owing to massive foreign investment into tech firms and propping up the shekel.
But the central bank has warned for months that the shekel was taking a hit from the government’s judicial overhaul. Bank Governor Amir Yaron said on July 10 that an “excess depreciation” of the shekel had contributed up to 1.5 percentage points to inflation.
With Israel’s higher risk premium helping weaken the shekel, the central bank has raised interest rates more than it hoped for, meaning more pain for mortgage holders and other borrowers.
Monday’s vote could also pose a big political risk for Netanyahu in the longer term.
By pushing the vote through, Netanyahu sided with the more hard-line and far-right elements in his coalition government rather than with moderates, some of whom are vying to succeed him, said political analyst Amotz Asa-El.
This creates a potential crack in his coalition government that could worsen if Netanyahu pulls too far toward either side. Moreover, despite commanding a loyal voter base, Netanyahu may have lost moderate supporters of his Likud party for good.
“There are huge parts of right-wing Israel who are totally opposed to what he has done,” said Asa-El, research fellow at the Shalom Hartman research institute. “This is not at all a matter of right and left, it’s a matter of right and wrong.”
(Writing by Maayan Lubell; Editing by William Maclean)
