Fresh from S&P, here is another reason for Aussie weakness today:
OVERVIEW
The sovereign credit ratings on Australia benefit from the country’s strong institutional settings, its wealthy and resilient economy, and significant monetary and fiscal policy flexibility.The country’s high external and household indebtedness, as well as vulnerability to weakening commodity export demand, moderate these strengths.
We have affirmed the ratings on Australia at ‘AAA/A-1+’, and the outlook remains stable.
The stable outlook is based on our assumption that Australia’s continued conservative budgetary policies will result in consistently narrowing deficits over the forecast horizon
RATING ACTION
On July 24, 2015, Standard & Poor’s Ratings Services affirmed its ‘AAA/A-1+’ unsolicited sovereign credit ratings on the Commonwealth of Australia. The outlook remains stable.RATIONALE
The rating affirmation on Australia is based on our view of the country’s strong public policy settings, economic resilience, and significant monetary and fiscal policy flexibility. We believe these factors enable Australia to absorb large economic and financial shocks, as was demonstrated during the global recession in 2009. Australia’s high external imbalances, dependence on commodity exports, and high household debt moderate these strengths.Australia is a wealthy economy, with GDP per capita of an estimated US$60,000 in fiscal 2015. This high level of wealth derives from decades of economic reform and reflects the country’s diverse economic structure and flexible
labor and product markets.Economic growth remains subdued as drivers of growth rotate from mining investment to nonmining sectors and the country’s falling terms of trade dampen income growth. We estimate Australia’s economy expanded by 2.4% in the
year ended June 30, 2015. Mining investment continues to decline from very high levels, weighing on growth. On the other hand, commodity export volumes are rising strongly as mining and energy projects come on line, supporting the country’s economic performance. Dwelling investment, too, is increasing, driven by low interest rates and strong population growth, but other sources of domestic demand remain subdued.We project real per capita GDP growth to average just under 3% over 2015-2018. The completion of some very large liquefied natural gas projects and resulting jump in related exports should spur economic growth in the next couple of years. But we expect domestic demand to remain a little below trend for some time. A key uncertainty for the growth outlook is the outlook for business investment in the nonmining sector.
Moreover, Australia’s growth prospects, prosperity, and credit quality remain exposed to its growing dependence on trade with China. If demand for Australia’s resources were to weaken sharply, a range of disorderly dislocations in the economy could occur, including in its labor and property markets. However, so long as robust demand for its commodities continues, we believe Australia’s economic prospects over the forecast period will remain favorable.
Australia’s public finances remain strong—with low debt, deficits, and debt-servicing costs—although they have weakened as a result of the global recession. Since that time, Australian governments have been striving to return the federal budget to surplus, but the faster-than-expected declines in the nation’s terms of trade have pushed out the timing of achieving this goal by a number of years.
The current Liberal–National Coalition government is seeking to adjust budget policies to improve the structural position of the budget. This includes adjusting the country’s large and growing, but politically sensitive, areas of spending such as pensions, transfers to families, health and education. Such policies have proven contentious and, a little over a year since its fiscal 2014 budget, a number of key policies remain blocked in the Senate. Still, we continue to believe that there is political and community consensus for prudent management of public finances, and we see the current impasse on some budget measures as reflecting disagreement on how this should be achieved. A year ago, we anticipated that compromises would eventually be reached so that budget performance gradually improves; currently some momentum appears to be building on this front, and our rating affirmation is premised on our expectation that further progress will soon be made.
Taking state and local government budget performance into account, we expect the general government sector’s budget balance to post relatively small and declining deficits as a share of GDP over the years to 2018. Under this
base-case scenario, general government net debt is likely to peak at about 21% of GDP in 2017 before gradually declining.While Australia benefits from many fundamental strengths, we view the country’s key credit weakness as being the economy’s high level of external liabilities. The banking system in particular has a high degree of external indebtedness and relies on the ongoing backing of foreign investors. Overall, Australia’s external debt, net of liquid assets held by the government and financial sectors, was nearly 270% of current account receipts (CARs) in the year ended June 30, 2014. Meanwhile, Australia continues to run significant current account deficits—in excess of 10% of CARs. While foreign direct investment into the resources sector has been a major source of external funding in recent years, we expect portfolio flows will continue to re-emerge as the dominant funding source in the period ahead.
In our opinion, however, the risks associated with Australia’s high private-sector external debt are manageable because of several factors. In addition to policies that have engendered a prosperous and flexible economy and that have delivered sound public finances, we find that Australia has a great deal of monetary credibility. The Reserve Bank of Australia’s preferred measure of inflation has generally remained within the central bank’s target of 2%-3% since inflation-targeting began in 1993. Australia has maintained for over three decades a freely floating exchange rate and the Australian dollar is an actively traded currency, ranking fifth on the Bank for International Settlements’ triennual survey of spot foreign exchange turnover. Further, we consider the four major commercial banks are highly creditworthy, notwithstanding their reliance on external funding. We expect the recent announcement by the Australian Prudential Regulation Authority regarding bank capitalization will result in major banks boosting their capitalization levels further over the coming quarters. We believe strengthening bank capital buffers should further enhance the banking system’s resilience to risks posed by high and rising household indebtedness, which now stands at more than 155% of household income.
OUTLOOK
The stable outlook is based on our assumption that Australia’s continued conservative budgetary policies will result in consistently narrowing deficits over the forecast horizon, maintaining the general government debt near or below current levels. We see strong public-sector savings as a necessary countervailing force for private-sector external indebtedness.We could lower the ratings if Australia’s budgetary performance does not improve broadly as we currently expect. Continued parliamentary gridlock on the budget could trigger this scenario, as could an external shock. The latter could come from further deterioration in Australia’s terms of trade, for example, or from a sharp increase in the banking sector’s cost of external funding.
The terms of trade crash only half over the downgrade is inevitable.
