I’ve doubted the resilience of the Queensland economy for some time now. Back in April I asked if Queensland was headed for recession on the back of the failing real estate market. Today I note that Fitch has joined me in those doubts.
Fitch Ratings-Sydney/Barcelona-26 July 2011: Fitch Ratings has revised the State of Queensland’s (QLD) and Queensland Treasury Corporation’s (QTC) Outlooks to Negative from Stable. Both their Long and Short-Term Foreign and Local Currency ratings have been affirmed at ‘AA+’ and ‘F1+’, respectively.
The Negative Outlooks reflect the slow pace of QLD’s budgetary recovery in an operating environment that largely remains challenging. A downgrade of the Long-Term Foreign and Local Currency ratings is likely if QLD is unable to recover to sufficiently positive operating margins and limit the growth of its debt over the next 24 months.
QLD’s ratings take into consideration the strong institutional framework in Australia – as reflected in support from Australia’s federal government (Commonwealth) from tied and untied grants, and fully funded superannuation liabilities. The ratings also reflect QLD’s concentrated export industry; rapid growth of debt on the back of a weaker operating budgetary performance and a significant need for capex; and the considerable contingent liabilities of QTC. These weaknesses are partly mitigated by QTC’s conservative funding approach and significant assets.
QLD’s economy has benefited from the strong performing mining industry which provided QLD with a robust level of royalties and has proved to be fairly resilient to the impact of the natural disasters and the strong Australian dollar exchange rate. However, other parts of the economy which are less related to the mining industry have performed fairly moderately. This divergence mainly relates to cautious consumer spending, uncertainty about further interest rate increases, the strong Australian dollar and the withdrawal of the Commonwealth’s stimulus package. As a result QLD’s gross state product (GSP) is expected to be flat in FY11 but QLD forecasts this to increase significantly in FY12, mainly driven by the recovery of export volumes and private business investments. The rebuilding work of the flood and cyclone damage should also support GSP growth. However, in Fitch’s view there are downside risks to this forecast.
“Fitch believes that QLD has limited financial flexibility to counter potential future shocks,” said Andrea Jaehne, Director of Fitch’s International Public Finance team. Fitch’s view reflects QLD’s high operating cost base and the prospects of a sluggish economic recovery which could constrain revenue generation. The agency also notes QLD’s high reliance on its major export partners to underpin recovery. Performance to date also reflects the impact of a series of natural disasters in FY11 and QLD’s budgetary performance is estimated to have deteriorated with operating expenditure exceeding revenue growth leading to an estimated negative operating margin of 4.56%. Out of the total rebuilding costs following the severe damage of the floods and cyclone, 75% will be absorbed by the Commonwealth.
QTC’s ratings are based on the statutory guarantee of QLD and its 100% state ownership. QTC has been classified as a dependent public sector entity of the state as per Fitch’s criteria, ‘Ratings of Public Sector Entities Outside the United States’. This is in view of its strong control by the state, and strategic importance to QLD’s local government sector. QTC acts as the central funding vehicle for QLD, the state’s local councils and state-owned companies, and holds the superannuation scheme for employees of QLD and its agencies.
QTC has a strong reliance on wholesale funding markets and investor sentiment. However, Fitch takes comfort from the Commonwealth’s track record to support the financial funding vehicles of the states by guaranteeing newly issued debt. At FYE10, QTC had financial liabilities outstanding of AUD73.8bn of which around 42% still carry a guarantee by the Commonwealth. The remainder was guaranteed by QLD. Of QTC’s debt, AUD16bn was used by QLD itself – an increase of 49% within the last 12 months. However, AUD21bn of QTC’s debt refers to self-supported state-owned entities. Maturities are well-spread, reducing refinancing risk.
QLD is one of six Australian states, with a population of 4.5 million at end-December 2010. The state is responsible for the delivery of services such as healthcare, education and transportation. The main revenue source is grants from the Commonwealth.
It seems to me that Fitch has just called out Queensland for Dutch disease. The old economy of real estate has slowed significantly and doesn’t look to be returning any time soon. The economy is now completely dependent on resource exports. That lack of risk spread means that the economy now has a single point of failure. The kicker in the statement is the line “Fitch believes that QLD has limited financial flexibility to counter potential future shocks”.
I completely agree, and the issue is that there are a lot of potential shocks on the horizon including a continuation of the downturn in the Queensland real estate market.