Sigh. They’re onto us all right. From the AFR on Saturday:
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.”
As the only analyst in the country that I know of that has argued that we face this danger from the ratings agencies I draw no satisfaction whatsoever from being right.
This is scary stuff, the stuff of debt-deflations and negative feedback loops that very few Australians will have considered possible in the Lucky Country. Prima facie it may not seems so bad. Investors have largely ignored downgrades in the US and Japan. Why not here too?
Two reasons. First, as I’ve said many times before, we’re not big enough. Australia and its dollar are neither a funding source nor a safe haven. When economic strife is coupled with a downgrade there will be little reason to hold Australian bonds. Second, the Budget backstops the banks. A point the AFR very usefully follows up with this morning:
The federal government’s top infrastructure adviser has urged Canberra to maintain budget discipline amid signs of a global economic slowdown, warning that losing Australia’s AAA sovereign debt rating would threaten the banks’ ability to borrow offshore.
…Infrastructure Australia chairman Rod Eddington urged Canberra yesterday to maintain the discipline of a budget balance through the economic cycle after ratings agency Standard & Poor’s warned in theWeekend AFR that an extended string of deficits could put the nation’s top credit rating at risk.
“Given that we’re big borrowers of wholesale credit globally, I think keeping our AAA credit rating is important,” Sir Rod said. “Japan’s national debt is close to 200 per cent of GDP, but all their debt is domestically held.
“So in a place like Japan it probably doesn’t matter much but in a place like Australia, it is important.”
Losing it is “not a place you want to get to”, he said.
It’s the “discipline that really matters – running a balanced budget through the cycle”, he said.
…Local lenders were underpinned by Commonwealth guarantees after the collapse of US investment bank Lehman Brothers in 2008 and unlike banks overseas, stayed profitable without needing government bailouts.
In short, if the sovereign gets downgraded, so do the banks and their cost of funds rises, either raising the price of credit and/or restricting its distribution. The RBA will aim to offset this with rate cuts but how low can they go? In a global recession scenario, the RBA is probably also constrained by the need to keep some yield spread between our rates and those oversees so that capital doesn’t flee our shores. Potentially then, the resulting hit to asset prices raises unemployment further than otherwise and the automatic stabilisers become more onerous for the Budget requiring more cuts or borrowing or both. Another downgrade might follow, so on and so forth.
I’m not sure how the AFR can add the last paragraph with a straight face. If the guarantees that are the source of this vulnerability aren’t bailouts, inherently distorting the uses of the national Budget, then what on earth are they? But the paper does deserve praise for being the first (outside of MB) to investigate the linkage between the Budget and the banks.
Unfortunately, as so much AFR material seems suddenly want to do, this extraordinarily important issue is being distorted by a political agenda of Labor Party bashing. The problem we face is not one of excessive Labor Party spending. It is of successive governments excessive spending and a national reliance upon a current account deficit model for economic growth that all governments have exacerbated through a failure to address our macroeconomic settings.
In short, the problem is worse than cheap political shots. It is structural. We have simply borrowed too much for too long from the rest of the world, the private sector much more so than the public. We have assumed that current account deficits are benign. They’re not.
So, what is the wash up of the last few days of this debate? The Government’s senior bureaucrats have conceded that there will be no revisiting the 2008/9 stimulus package in the event of a global recession. Only the automatic stabilisers will be allowed to run the Budget into deficit. The principle ratings agency, S&P, has declared that that won’t be enough to prevent a downgrade of the sovereign. So, in the event of a global recession, we have lost both the ability to provide active counter-cyclical fiscal support and the efficacy of monetary policy has been damaged.
That’s not to say we face an imminent crisis. These kinds of structural imbalances work so long as markets are comfortable with them. The tipping points for when markets become uncomfortable are unpredictable and we certainly have a potential long term stabiliser of our external position via the commodities boom.
But the risks are worse than even I have imagined over the past three years.
