S&P:
OVERVIEW
• We expect the general government fiscal position to return to surplus by the early 2020s, as the central government’s continued focus on fiscal prudence turns higher revenue collection into better budget performance. We view the government as having significant revenue flexibility to achieve this based on its track record of raising general government revenue faster than the growth of nominal GDP.
• We are revising our outlook on Australia to stable from negative and affirming our ‘AAA’ long-term and ‘A-1+’ short-term ratings.
• The stable outlook reflects our expectations that the general government fiscal balance will return to surplus by the early 2020s. We expect steady government revenue growth supported by the strong labor market and relatively robust commodity prices, to be accompanied by expenditure restraint. We also expect property prices to continue their orderly unwind, and that this slowdown won’t weigh heavily on consumer spending and the financial system’s asset quality.RATING ACTION
On Sept. 21, 2018, S&P Global Ratings revised its outlook on the long-term ratings on the Commonwealth of Australia to stable from negative. We also affirmed the ‘AAA’ long-term and ‘A-1+’ short-term unsolicited sovereign credit ratings on Australia.OUTLOOK
The stable outlook reflects our expectations that the general government fiscal balance will return to surplus by the early 2020s.
We expect steady government revenue growth supported by the strong labor market and relatively robust commodity prices, to be accompanied by expenditure restraint.
We also expect property prices to continue their orderly unwind, and that this slowdown won’t weigh heavily on consumer spending and the financial system’s asset quality.We could lower our ratings if we consider that it is unlikely for the general government balance to return to surplus over the next five years.
Australia’s weak external position means that its other sovereign credit factors, including the fiscal factors, need to be strong to keep the sovereign rating at the highest level on our scale.
A stronger fiscal position would also be a strong buffer to absorb the consequences of an abrupt weakening of the housing market and the vulnerabilities that event could bring to financial stability.While our base case is for a soft landing, our ratings could come under pressure if house prices fall sharply and increase risks to fiscal accounts, real economic growth, and financial stability.
RATIONALE
We consider it more likely that Australia’s fiscal position will return to surplus in the early 2020s.
The central government currently projects a balanced budget by fiscal 2020 (the year ending June 30, 2020), a year ahead of its earlier expectations.
Nevertheless, we expect large infrastructure spending at the state government level to likely keep the general government balance negative till fiscal 2021.Along with its strong institutions, a credible monetary policy, and floating exchange-rate regime, Australia’s public finances traditionally have been a credit strength for the sovereign rating.
The fiscal position weakened following the global recession of 2008-2009.
The sharp drop in export commodity prices in 2011 sustained downward pressures on public finances,keeping the fiscal balance in deficit.–Flexibility and performance profile: Better labor market conditions and
commodity prices have helped to lift government revenue.• Employment and wage trends over the next few years should continue to support revenue growth.
• External balance sheet is a key credit weakness.Better labor market conditions and commodity prices have helped to lift government revenues.
The resulting boost to income and company taxes have allowed the central government to bring forward its expectations of a budget surplus to 2020 (fiscal year 2019/2020).
However, we expect state government infrastructure spending to keep the general government balance in deficit until 2021.
On the back of our projections for steady economic growth, employment and wage trends over the next few years should continue to support revenue growth.
Although downside revenue risks from commodity prices have receded in the near term, we believe they persist.
Our price assumptions for iron ore are similar to that of the budget assumptions, with average prices falling slightly over the next two years.
(see “Metals Stay Strong: S&P Global Ratings Raises Its Price Assumptions For Metals Again,” published March 9, 2018).We see little change on the policy front affecting the budgetary position.
And the central government’s commitment to a return to fiscal surplus reduces the risks of significant increases in planned spending.
The aim for budget surplus has been consistent across different ruling parties and leaders; so we do not expect the latest political developments to change our fiscal projections.
Even though policies differ, we believe there is strong bipartisan support within parliament to return the budget to surplus.
Consequently, we also consider the Australian government to have more willingness and ability to raise revenue than most other sovereigns.
The government, for instance, has been able to raise its revenue as a share of GDP over the past seven years despite commodity prices remaining well below the peaks in 2011 over this period.Our general government fiscal metrics incorporate the federal, state, and local government levels.
At the state government level, we expect the aggregate fiscal deficit to widen in 2018 compared with 2017, but to narrow thereafter.
This is weighing materially on our forecast of a fiscal deficit in the general government sector.
We expect the state governments’ use of proceeds from past large asset privatizations to temper the government’s debt accumulation.
Several smaller planned asset privatizations could reduce government debt accumulation further.We expect net general government debt to peak at close to 23.3% of GDP in the fiscal year ending June 30, 2020.
This is about three percentage points lower than our forecast early this year, an improvement that is mainly due to our more optimistic view of revenue trends over the next few years.
Because the central government reports its debt stock in terms of market value, historical fluctuations in the debt ratio also partly reflected changes in interest rates during the period.We incorporate some off-budget spending in our fiscal outlook.
Off-budget spending is mainly in the form of loans, though we do not consider these loans to be liquid assets, and consequently, do not subtract them from gross debt.Low interest rates are helping to keep the general government sector’s interest expense burden low, at about 4% of revenues.
House prices have begun to decline recently in an orderly manner, led by the key cities of Sydney and Melbourne.
Market observers attribute the slowdown to tighter lending standards at financial institutions.
In line with this, we expect bank credit to nongovernment residents to average about 170% of GDP, over the period to 2021.
Our forecast includes an increase in the credit-to-GDP ratio in 2019 to 177% due to state-level investment spending growth, but will moderate back toward 170% of GDP by the end of 2021.
At the current high levels, we believe that a sustained acceleration of credit growth could lead to vulnerabilities with regard to financial, fiscal, and economic stability.We consider Australia’s economy, while wealthy, resilient, and performing soundly, to be vulnerable to major shifts in international capital flows.
The economy carries a high level of external debt, exacerbated by typically high current account deficits, volatility in the country’s terms of trade, and a large stock of short-term external debt.
However, in our view, the external debt is mostly generated by the private sector and reflects the productive investment opportunities available in Australia, foreign investor confidence in Australia’s rule of law, and the high creditworthiness of its banking system.
A portion of Australia’s external debt has also funded a surge in household borrowing for housing.Australia’s external debt net of the liquid assets of the public and financial sector (our preferred stock measure) is high, at above 230% of current account receipts in 2018.
Australia’s short-term external debt, which is mostly bank debt, will also remain high, at 135% to 160% of current account receipts during the forecast period.External current account deficits have narrowed over the past two years.
The deficit in fiscal 2018 is likely to be about 2.5% of GDP, down from 4.5% in fiscal 2016.
We believe this stronger performance is likely to be temporary, with current account deficits returning to more than 3% of GDP over the next few years, partly driven by weaker export values as commodity prices reverse some of their recent gains.
We therefore project current account deficits to remain close to or above 10% of current account receipts, which we consider to be high, and the economy’s external debt stock to also remain high.We expect Australia’s external borrowers to maintain easy access to foreign funding.
We note that the Reserve Bank of Australia (RBA, the central bank) has maintained a freely floating exchange-rate regime for more than three decades.
The Australian dollar represents a little over one-and-a-half percent of allocated international reserves as of March 31, 2018, and the currency is represented in a comparable percentage of spot foreign-exchange transactions.Australia’s domestic bond market is deep, and although external borrowing is high, it is mostly denominated in the nation’s own currency or hedged.
We consider Australia’s banking system to be one of the strongest globally.
Along with the resilient and high-income Australian economy, this reflects the low risk appetites of the major banks, which dominate the industry, supported by conservative and proactive regulatory and governance frameworks.
However, risks have increased as a result of a long period of high house price inflation and rising household indebtedness, including debt for unincorporated businesses.We view Australia as possessing a high degree of monetary credibility.
This helps the country to attenuate major economic shocks, which could come, for example, from a slump in Australia’s property market or a sharp downturn in China’s economy.
We believe the RBA’s success in anchoring inflation expectations would allow it to lower policy interest rates from their current level of 1.50% to support growth, even if the currency were to weaken further, given the historical low pass-through to inflation.–Institutional and economic profile: High-income economy and strong institutions are credit strengths
• The Australian economy is high income, diversified, and has shown consistent growth.
• Australian governments have demonstrated a willingness to implement
reforms to sustain economic growth and ensure sustainable public finances.
Australia is a wealthy, diversified, and resilient economy, with GDP per capita of an estimated US$56,500 in fiscal 2019.
We believe the economy’s resilience and flexibility help cushion government finances from economic shocks and are a major support to Australia’s creditworthiness.
Australia’s high level of wealth derives from strong institutional settings and decades of economic reform, which have facilitated the country’s flexible labor and product markets.
Australian governments have demonstrated a willingness to implement reforms to sustain economic growth and ensure sustainable public finances, and have a strong track record from managing past economic and financial crises.
Institutions are stable and provide checks and balances to power, there is strong respect for the rule of law, and a free flow of information and open public debate of policy issues.Economic growth remains sound.
We estimate headline GDP growth to be around 3% in fiscal 2019.
Low nominal interest rates, coupled with pent-up underlying demand, have been encouraging growth in dwelling investment for some time, and the negative effect of the declining mining investment has waned further.Significant currency depreciation up to 2016 spurred services exports, particularly in education and tourism.
And while resources investment continues to be weak, resource export volumes is supported as new capacity is brought on line.
We expect growth to remain firm during our forecast period, and project real per capita GDP growth to average about 1.3% per year during 2019 to 2021.
God bless Chinese stimulus!
No such luck for the banks:
Global Ratings today said that credit pressure remains for Australia’s major banks despite the revision earlier today in our outlook on the Commonwealth of Australia (AAA/Stable/A-1+) to stable from negative.
The sovereign outlook revision reflects reduced likelihood of one of the downgrade scenarios for the four major Australian banks and Cuscal Ltd. (A+/Negative/A-1) that we previously incorporated in our negative outlook on these institutions. Nevertheless, pressure remains on government supportiveness for Australian banks, in our view, and therefore our outlooks on the four major Australian banks– Australiaand New Zealand Banking Group Ltd., Commonwealth Bank of Australia, National Australia Bank Ltd., and Westpac Banking Corp. (all four rated AA-/Negative/A-1+)–as well as Cuscal and Macquarie Bank Ltd. (A/Negative/A-1) remain negative.
We assign each of the four major Australian banks a long-term issuer credit rating that is three notches above their respective stand-alone credit profiles (SACP). The uplift above their SACP reflects our view that the Australian government is likely to provide timely financial support, if needed, to each of these banks. Our long-term issuer credit ratings on Macquarie Bank and Cuscal are two notches above their respective SACPs, reflecting our assessment that these institutions would be potential recipients of timely financial support from the Australian government, if required.
A lowering of our sovereign rating on Australia would have resulted in a downgrade of each of the major Australian banks and Cuscal, reflecting the sovereign’s diminished capacity to support the institutions in that scenario. 0We now consider this to be a low probability scenario, as reflected in the revision in our outlook on the Australian sovereign to stable from negative.
Nevertheless, we consider there remains a one-in-three risk of a downgrade of the four major Australian banks, Macquarie Bank, and Cuscal over the next two years because we may revise our assessment of the government’s tendency to support systemically important private-sector banks in Australia to supportive from highly supportive during this time. This downgrade scenario has already been a part of our negative outlook on the six institutions listed above.
The following are likely triggers for us to review our assessment of government supportiveness:
• Government or regulatory announcements indicating a possible diminution in the government’s appetite to support a failing bank;
• Development of a bank resolution framework that envisages statutory bail-in of senior debt;
• Introduction of a total loss absorbing capacity framework; or
• A further shift in global landscape toward a reduction in government support for banking systems.
