So, yesterday I caught up with Kyran Curry, the sovereign analyst at Standard and Poors. He was kind enough to grant an interview to help clarify the recent debate around his comments that Australia may be at risk of losing its credit ratings in any downturn. For those that missed it, the AFR gave prominent coverage to the following comments on Monday:
Credit ratings agency Standard & Poor’s has warned it could cut Australia’s coveted AAA rating if the federal government abandons the budget surplus in response to a global recession triggered by the European debt crisis.
…S&P’s director of sovereign ratings, Kyran Curry, said an extended delay in returning the budget to surplus would be inconsistent with Australia’s present rating, which is held by only a handful of the most creditworthy governments.
Australia still has “deep pockets” to respond to another crisis but was “just not quite as strong as it was back in 2008” because of years of budget deficits, he said. “It’s a continuing soft underbelly for the Australian credit story,” he said.
…Mr Curry said he agreed with Treasury secretary Martin Parkinson’s position, expressed to a Senate committee on Thursday, that a second global banking freeze would mean “all bets are off” for Australia, particularly given the heavy dependence of Australian banks on overseas funding.
“We don’t think that’s going to happen any time soon of course . . . but we looked to Spain five years ago, which had a very strong fiscal position, but it got routed by a very weak external position,” he said.
“And we can see Australia, and New Zealand for that matter, following that path if the external environment proves that much less supportive.”
Later that same day, the story was contradicted by Mr Curry on Sky:
AUSTRALIA’S triple-A investment grade rating will remain intact even if the government abandons a pledge to deliver a budget surplus by the end of the next fiscal year to help buffer the economy from a global downturn, Standard & Poor’s sovereign analyst Kyran Curry has said.
“The outlook is stable,” Mr Curry said in an interview. “We think the risks are evenly balanced, I am not concerned about the rating at this point. We’re expecting the government to restore its strong fiscal settings, the delay in returning that surplus by one or two years is not going to bring pressure on the rating,” he said.
For S&P to change its ratings for Australia, the country would have to suffer a sustained period of deficits and offshore bank borrowing would have to balloon from current levels, Mr Curry said.
“We’re not there yet and we don’t expect to get there anytime soon. The balance sheet gives the government some flexibility in delaying that surplus, it’s not as though it’s in Europe,” he said.
Australia is vulnerable to a global slowdown in trade that may come from Europe’s political and economic downturn. The Pacific nation depends on China’s demand for its natural resources and a slowdown in Chinese factory orders could expose its reliance on mining.
Australia’s government has promised to return a budget surplus in the next fiscal year by reversing a 3 per cent of GDP deficit and projects net debt to peak at below 10 per cent of national output.
“It does give the government scope for more additional borrowings to provide support,” Mr Curry said.
So, what happened and where is the rating at?
First, on what happened Mr Curry said “There have been understandable questions raised about the potential ratings implications of a protracted weakening in the government’s finances and the full answer brings in a range of factors that drive the ratings on Australia”. He went on to say that Australia has four strengths that support S&P’s AAA ratings, including its “strong fiscal position, resilient and flexible economy, mature and stable institutional settings, including the RBA and Treasury, as well as the sound credit quality of the banking system, which is important given the banks’ role in funding Australia’s current account deficits”.
I pressed Mr Curry on the scenario in which Australia’s AAA rating may be at risk and he replied that “it would be one in which there was significant weakening in the credit quality of the country’s banking sector involving heightened borrowing costs and or restricted access to offshore funding markets such that government support may be required. Bank liabilities would have to be at risk of migrating across to the sovereign balance sheet.”
I then asked what this meant in terms of practical limitations for the Budget over the cycle. Mr Curry confirmed that to remain consistent with a AAA rating, Australia’s credit metrics would have to feature a return to high fiscal flexibility, underpinned by low public debt and strong fiscal discipline – that is, by returning to surplus as soon as possible and maintaining them over the cycle. He continued, “cyclical deficits will tend not to affect the rating but if a prolonged structural weakening in Australia’s fiscal position were to emerge and surpluses delayed, the rating could be at risk”.
When I asked if this meant that Australia’s rating would likely remain intact if a downturn caused the automatic stabilisers to push the Budget to remain temporarily into deficit he replied “yes”.
Moreover, when I asked if, in the event of a more severe downturn, Australia had some scope to actively stimulate growth via borrow and spend stimulus without jeopardising the rating he again replied “yes”.
He would not be drawn on the limits to this kind of spending, nor whether a repeat of the very large stimulus of 2009/10 would be problematic for the rating if repeated, given what he described as the heightened uncertainly in the global economic outlook and bank funding markets.
So, in sum, S&P’s clarification means Australia’s AAA rating can still support both automatic stabilisers and active stimulus. But I think it is fair to say that a repeat of the large 2009/10 stimulus would risk the rating given the public debt to GDP ratio would rise beyond 50% at a time when bank credit quality was under pressure.
This also clears up three points. The first and most significant is that the Budget has greater scope for stimulus than described by Treasury Secretary Martin Parkinson (A.K.A Parko) in the Senate late last week. We are in a position to borrow and spend beyond the automatic stabilisers if the situation requires it, though the wisdom of doing so is a much finer judgement than it was in 2008/9.
The second point is that Government faces very real ratings pressure to return to surplus. It is not political.
The third point is that this story has gotten legs largely through the AFR quoting Mr Curry out of context. Yesterday the paper continued to run with the angle that Australia could lose its credit rating in a downturn without clarifying what that means.
The reality is that we are back to where I thought we were before the AFR story, with the need to sustain a Budget surplus across the cycle owing to its support of the banking system, which will take the economy down a path of a death of a thousand cuts. For the part I played in amplifying the AFR’s angle, I apologise. At least we now have some greater definition around what sustaining the AAA rating will require of the Government.
