On July 27, the Israeli prime minister dismissed as “silly” a series of negative credit-rating agency reports. They criticized the amendment passed on July 24 that stops the Supreme Court from striking down unreasonable governmental decisions.
This raises two serious questions for businesspeople: What is the name of the game? What is the endgame?
Political wild card: The ruling coalition has a 64-56 majority in the Knesset, but this is partly because in the 2022 election, two parties (Meretz and Balad) gained just under the Knesset threshold of 3.25%, meaning around 6% of Israeli votes (289,410 in number) counted for nothing. Note that 6% of 120 Knesset seats equates to around seven seats.
Name of the game?
Politics aside, what is the problem in economic and investment terms? In a nutshell, the name of the game is RISK control.
Anyone who has read Rich Dad Poor Dad by Robert T. Kiyosaki understands that employees carry out instructions and receive a fixed salary.
But investors and entrepreneurs take risks and try to make profits above salary levels. Those risks include estimating demand, marshaling resources, and scaling up by hiring employees. Risks such as poor demand, asset theft (see below), and exchange-rate fluctuations are unwanted.
What the credit-rating agencies said: Nobody knows the future, but risk control involves reviewing available information, such as reports issued by credit-rating agencies.
The Moody’s report on July 25 says: “The wide-ranging nature of the government’s proposals could materially weaken the judiciary’s independence and disrupt effective checks and balances between the various branches of government, which are important aspects of strong institutions. Israel has no written constitution and its institutional set-up relies to an important extent on judicial oversight and review. In addition, the executive and legislative institutions have become less predictable and more willing to create significant risks to economic and social stability.”
Also on July 25, Morgan Stanley lowered Israel sovereign credit to a “dislike stance” because: “We see increased uncertainty about the economic outlook in the coming months and risks becoming skewed to our adverse scenario.”
Two days later, S&P quantified the risk: “In the short term, we expect that persisting political uncertainty will combine with weaker economic performance in Israel’s key trading partners in Europe and the US as well as tighter monetary policy, causing Israeli economic growth to slow to 1.5% in 2023 from 6.5% in 2022.”
Why risk matters – OECD: The OECD transfer-pricing guidelines are used by tax authorities and taxpayers to check whether intercompany transactions in multinational groups are reasonable. The three main considerations are: functions, assets, and risks. Why risks?
According to the OECD, “Funding and risk-taking are integrally related in the sense that funding often coincides with the taking of certain risks (e.g., the funding party contractually assuming the risk of loss of its funds)… The risk will, for example, be lower when the party to which the funding is provided has a high creditworthiness, or when assets are pledged, or when the investment funded is low risk, compared with the risk where the creditworthiness is lower, or the funding is unsecured, or the investment being funded is high risk.”
More simply, investors putting up funds want a decent profit reflecting the risk they take.
What is the endgame?
As the Israeli government pointed out, Israel is economically strong at present. This is mainly because investors backed the Start-Up Nation over the years. But if the business climate worsens, that’s a risk.
If the court system is no longer considered independent and impartial, justice may seem less likely, especially protection against intellectual-property (IP) theft. That’s a big risk investors detest.
Consequently, it seems around 80% of Israeli start-ups routinely incorporate and register their IP in the US. So, risk control means the all-important hi-tech sector is hollowing out. This will have a knock-on effect on the rest of the Israeli economy.
Sooner or later, the Israeli government will need to take non-silly risk-reduction measures. Based on the experience of other countries that gained independence from Britain, including the US, Canada, and Australia, a written constitution is needed. This should reduce uncertainty and risk by prescribing checks and balances. That way, neither ministers nor judges can run wild with unchecked power. Big companies have internal checks; democratic governments need them too.
Conclusion: A happy ending to the present crisis means de-risking Israel. An appropriate written constitution covering everyone would show Israel means business.
As always, consult experienced professional advisers in each country at an early stage in specific cases. leon@hcat.co
The writer is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.
