Research Update:

Ratings On Israel Affirmed At 'A+/A-1'; Outlook Stable

Primary Credit Analyst: Elliot Hentov, PhD, London (44) 207-176-7071; elliot.hentov@standardandpoors.com Secondary Contact: Trevor Cullinan, Dubai (971) 4372-7113; trevor.cullinan@standardandpoors.com Analytical Group Contact: SovereignEurope; SovereignEurope@standardandpoors.com

Table Of Contents
Overview Rating Action Rationale Outlook Key Statistics Related Criteria And Research Ratings List

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Research Update:

Ratings On Israel Affirmed At 'A+/A-1'; Outlook Stable

Overview
Fiscal consolidation is taking hold in Israel, following the passage of the 2013-2014 budget and, as a result, we expect a modest decline in the general government debt burden. We are affirming our long- and short-term foreign and local currency sovereign credit ratings on Israel at 'A+/A-1'. The stable outlook reflects our view that the government will continue to consolidate government finances and that the impact of security risks on the Israeli economy will remain contained.

Rating Action
On Sept. 27, 2013, Standard & Poor's Ratings Services affirmed its long- and short-term foreign and local currency sovereign credit ratings on the State of Israel at 'A+/A-1'. The outlook is stable.

Rationale
Our ratings reflect our view of Israel's prosperous and diverse economy, as well as the positive medium-term impact of natural gas production on the external account and the country's considerable monetary flexibility. Geopolitical risks and relatively weak, albeit improving, government finances constitute the major rating constraints. For 2013, we project real GDP per capita growth of 1.2%. This is similar to 2012, but given the contribution of natural gas (about 0.7% of growth in 2013), it implies overall economic activity is weakening. For 2014-2016, we forecast per capita growth to gradually increase again to an average of 1.7% in line with a modest recovery in Israel's key export markets. On Sept. 8, 2013, the Israeli Bureau of Statistics revised its methodology for calculating GDP, leading it to assess 2012 GDP at 6.9% more than previously measured. The main change relates to the inclusion of investment in intellectual property and income from financial brokerage services, together constituting about half of the increase. We are waiting for a more complete dataset before incorporating the revised data in our analysis. We do not expect the revised data to have an impact on Israel's current sovereign ratings, although we note that increased GDP is a positive development. We expect general government debt to rise by 4.4% of 2013 GDP during this

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Research Update: Ratings On Israel Affirmed At 'A+/A-1'; Outlook Stable

year, and by 2.4% in 2016, producing an average increase of 3.3% of GDP in 2013-2016. Nevertheless, we expect Israel's net government debt burden to modestly decline over the forecast horizon--to below 65% of GDP by 2016, from 68% currently. This is due to the increase in nominal general government debt over the period being slightly lower than the increase in nominal GDP. Israel's external fundamentals remain strong. We expect its net asset position to reach 30% of GDP (70% of current account receipts [CARs]) this year. We project external debt will fall below official reserves and financial sector external assets by 42% of CARs in 2016. We base our projection on the current account returning to surplus in 2013 at 1.0% of GDP, and continuing to rise. We estimate that the country's gross external financing needs will continue to decline and stay just below 80% of CARs and usable reserves in 2013. We consider monetary policy flexibility to be a credit strength. The Bank of Israel (BoI or the central bank) has indicated it will relieve upward pressure on the shekel by purchasing foreign exchange in line with its assessment of the effect of natural gas production on the balance of payments. A largely balanced current account and net inward foreign direct investment exceeding 3% of GDP in recent years have pressured the shekel, which has complicated the BoI's task of containing inflation and tempering credit flows to the housing market. We see risks stemming from leadership uncertainty at the BoI, where half the positions on the Monetary Policy Board, including the governor, have no designated successors since resignations were announced in July 2013. In our view, the bank has sufficient institutional depth to manage the situation and we expect selections to be completed soon. We consider Israel's institutions to be generally effective with a satisfactory degree of transparency and accountability. However, the political system is prone to instability and policy predictability is limited. Furthermore, the impact of external security threats exacerbates political uncertainty by inserting another dividing line in the electorate and distorting policy debates. Geopolitical risks are also a rating constraint. Recent skirmishes on the Golan Heights or the November 2012 outbreak of hostilities with Gaza remind us how easily Israel can be drawn into or ignite armed conflict. In this respect, relations with the Palestinians, the war in Syria, and instability in Sinai signal possibilities for deterioration in the medium term. Any significant armed conflict with Israel could have a negative ratings impact if such conflict were to significantly deter investment, weaken the economy's growth potential, or strain external, monetary, or fiscal flexibility.

Outlook
The stable outlook reflects our opinion that the Israeli government's consensus to consolidate its finances will continue to anchor fiscal planning and reduce government debt. We also expect the impact of security risks on the Israeli economy to remain contained.

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Research Update: Ratings On Israel Affirmed At 'A+/A-1'; Outlook Stable

We could consider raising our ratings on Israel if it makes material progress in defusing external security risks. In our view, progress would have positive repercussions for domestic stability, economic growth, and investor confidence. Conversely, we believe that a significant setback in reducing the government's high debt burden, a significant decline in growth prospects, or a substantial deterioration of the security situation in Israel could put downward pressure on the rating.

Key Statistics
Table 1

State of Israel - Selected Indicators

2006 Nominal GDP (bil. US $) GDP per capita (US $) Real GDP (% change) Real GDP per capita (% change) Change in general government debt (% of GDP) General government balance (% of GDP) General government debt/GDP (%) Net general government debt/ GDP (%) General government interest expenditure/revenues (%) Oth dc claims on resident non-govt. sector / GDP (%) CPI growth (%) Gross external financing needs/CAR +use. res (%) Current account balance/GDP (%) Current account balance/CARs (%) Narrow net external debt/CARs (%) Net external liabilities/CARs (%) 145 21,486 5.8 3.4 (2.9) (1.2) 84.3 76.0 12.7 86.7 2.1 99.1 4.8 8.8 24.3 6.0 2007 166 24,037 5.9 3.4 (1.6) (0.6) 78.2 68.3 12.0 97.9 0.5 103.5 3.1 5.8 24.1 7.0 2008 202 28,413 4.1 1.6 3.3 (2.6) 77.2 69.2 11.7 99.9 4.6 108.5 1.4 2.9 13.2 (9.2) 2009 195 26,826 1.1 (1.2) 6.6 (5.6) 79.5 70.9 12.0 93.6 3.3 93.2 4.2 9.8 2.1 (11.2) 2010 218 29,345 5.0 2.8 1.5 (3.7) 76.3 69.6 11.3 95.5 2.7 84.2 3.7 8.4 (10.4) (40.3) 2011 244 32,221 4.6 2.6 2.9 (3.3) 74.1 68.6 10.9 94.8 3.5 84.1 1.4 3.1 (18.7) (52.1) 2012 241 31,282 3.2 1.3 3.5 (4.5) 73.0 67.0 10.7 92.5 1.7 84.5 (0.1) (0.2) (29.5) (67.4) 2013e 266 33,865 3.1 1.2 4.4 (4.4) 73.7 68.1 10.5 92.2 1.9 79.8 1.0 2.4 (36.0) (69.7) 2014f 284 35,530 3.5 1.5 3.4 (3.4) 72.9 67.5 10.3 92.1 2.2 75.4 2.6 5.7 (41.9) (73.7) 2015f 302 37,048 3.5 1.6 2.8 (2.8) 71.3 66.3 10.0 92.6 2.5 73.1 3.1 6.7 (41.9) (77.7) 2016f 324 39,062 3.9 2.0 2.4 (2.4) 69.2 64.5 9.7 92.9 2.6 72.3 3.5 7.3 (42.4) (81.3)

Other depository corporations (dc) are financial corporations (other than the central bank) whose liabilities are included in the national definition of broad money. Gross external financing needs are defined as current account payments plus short-term external debt at the end of the prior year plus nonresident deposits at the end of the prior year plus long-term external debt maturing within the year. Narrow net external debt is defined as the stock of foreign and local currency public- and private- sector borrowings from non-residents minus official reserves minus public-sector liquid assets held by non-residents minus financial sector loans to, deposits with, or investments in non resident entities. A negative number indicates net external lending. CARs--Current account receipts.

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Table 1

State of Israel - Selected Indicators (cont.)

The data and ratios above result from S&Ps own calculations, drawing on national as well as international sources, reflecting S&Ps independent view on the timeliness, coverage, accuracy, credibility, and usability of available information.

Related Criteria And Research

Sovereign Government Rating Methodology And Assumptions, June 24, 2013 Israel (State of), May 30, 2013 Methodology For Linking Short-Term And Long-Term Ratings For Corporate, Insurance, And Sovereign Issuers, May 7, 2013 Sovereign Defaults And Rating Transition Data, 2012 Update, March 29, 2013 Banking Industry Country Risk Assessment: Israel, Dec. 5, 2012 The Syrian Conflict Is Ratcheting Up The Sovereign Rating Risks Of Its Neighbors, Sept. 18, 2012 Criteria For Determining Transfer And Convertibility Assessments, May 18, 2009

In accordance with our relevant policies and procedures, the Rating Committee was composed of analysts that are qualified to vote in the committee, with sufficient experience to convey the appropriate level of knowledge and understanding of the methodology applicable (see 'Related Criteria And Research'). At the onset of the committee, the chair confirmed that the information provided to the Rating Committee by the primary analyst had been distributed in a timely manner and was sufficient for Committee members to make an informed decision. After the primary analyst gave opening remarks and explained the recommendation, the Committee discussed key rating factors and critical issues in accordance with the relevant criteria. Qualitative and quantitative risk factors were considered and discussed, looking at track-record and forecasts. The chair ensured every voting member was given the opportunity to articulate his/her opinion. The chair or designee reviewed the draft report to ensure consistency with the Committee decision. The views and the decision of the rating committee are summarized in the above rationale and outlook.

Ratings List
Ratings Affirmed Israel (State of) Sovereign Credit Rating Transfer & Convertibility Assessment Senior Unsecured

A+/Stable/A-1 AA A+

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