Via S&P:
Overview
• We expect the COVID-19 pandemic and associated government response to place significant pressure on the State of Victoria’s fiscal metrics during 2020 and 2021 before they improve in 2022. • We forecast Victoria will incur large operating deficits and higher-than-budgeted after-capital deficits, resulting in a substantial rise in debt levels. • We are affirming our ‘AAA/A-1+’ long- and short-term ratings on Victoria. The negative outlook reflects our view that Victoria’s fiscal repair could be delayed and weaken its financial position compared with our forecasts. Rating Action
On May 25, 2020, S&P Global Ratings affirmed its ‘AAA/A-1+’ ratings on the Australian state of Victoria. The outlook is negative.
Outlook
The negative outlook reflects our view that Victoria’s creditworthiness could deteriorate to a level no longer consistent with a ‘AAA’ rating within the next 12-24 months. The outlook also reflects that on the Australian sovereign rating.
We could lower our rating on Victoria if the COVID-19-related economic disruption is more prolonged than we currently expect or if we believe its financial management is weakening. This would delay Victoria’s fiscal repair and weaken its financial position compared with our forecasts.
We could also lower our rating if we were to take a similar action on the Commonwealth of Australia.
We could revise the outlook to stable if we revised the outlook on our ratings on Australia to stable and, at the same time, if we believe the economic recovery and the state’s financial management capability will support Victoria’s fiscal metrics, notably the state delivering operating surpluses and reducing its debt burden relative to operating revenues.
Rationale
The arrival of COVID-19 pandemic in Australia and the associated government responses are severely disrupting Victoria’s economy and putting significant pressure on the state’s finances. We expect that social distancing will continue to curtail activity across all sectors of Victoria’s economy during calendar 2020, raising the unemployment rate to levels not seen in decades.
We believe the economy remains structurally wealthy and diverse, and Victoria’s very strong financial management is ensuring liquidity coverage is comprehensive during this period of disruption. Underpinning the rating is an extremely supportive and predictable institutional framework.
We expect the state’s budgetary performance and debt burden will weaken during the next few years, before improving in fiscal 2022. The main hit to the state’s finances is primarily revenues, though we expect the state’s expenditure to increase as the economic fallout continues. Victoria is providing significant support to individuals and businesses to minimize the sharpness of the economic contraction, which we believe will result in large operating deficits in fiscal years 2020 and 2021. Combined with the state’s record infrastructure program, this will drive large after-capital account deficits and debt levels to record highs.
Recession and stimulus packages will weigh on Victoria’s fiscal metrics
The COVID-19 pandemic and government response is having a negative effect on Victoria’s operating revenues, especially conveyance duties and payroll tax, as well as goods and services taxes (GST). We also expect operating expenditures will increase relative to the state’s budget earlier this year as the government responds to the pandemic with support for individuals and businesses. We forecast an operating deficit of about 4% of operating revenues in 2020 and 9% of operating revenues in 2021. We expect these metrics to begin recovering in 2022, reflecting improved economic outcomes.
We expect the after-capital account balance to record deficits of about 15% of total revenues in 2020 and 19% of total revenues in 2021. The state is in the middle of a record infrastructure program, including roading, rail crossing removals, and public transport initiatives. The government has announced its intention to further boost infrastructure spending to support the economy.
Reflecting Vitoria’s very weak fiscal outlook and changing accounting standards, we anticipate its debt burden will rise substantially during our forecast periods. We forecast tax-supported debt to reach 117% of operating revenues in 2022, up from 70% in 2018. Victoria’s debt burden is likely to plateau as the budget recovers. Between July 1, 2019, and April 30, 2020, Victoria issued about A$18 billion of bonds to support its liquidity coverage and fund the state’s response to the pandemic as well as its infrastructure expenditure.
Adding to Victoria’s total tax-supported debt is its early adoption of new accounting standards in 2019 and 2020, which record operating leases and service concessions as debt. The recognition of these existing arrangements will have a once-off effect by increasing Victoria’s 2022 debt forecast by about A$17 billion, or 20%.
We have further adjusted Victoria’s nonfinancial public sector borrowing numbers by its estimated Central Banking System figures, which we classify as internal transfers, of around A$6 billion in 2020 to A$6.5 billion in 2022. Victoria’s interest expenses are low, reaching 3.6% of operating revenues between 2019 and 2021 because interest rates are lower than in the past. We also believe Victoria’s contingent liabilities are small compared with its international peers and we believe that only a small portion, if any, is likely to crystallize.
The state’s liquidity coverage is comprehensive, reflecting its internal debt-servicing ratio, access to external liquidity, and potential Commonwealth support. The state’s debt-service coverage ratio is about 227% of its upcoming debt maturities and interest costs. This is higher than what we’ve seen in the past because the state has raised additional debt over the past three months to provide for initiatives to assist businesses and households and the effect of revenue downturns.
We consider the state to have strong access to external liquidity. The Australian states utilize a well-developed capital market for their funding. In March 2020, the Reserve Bank of Australia declared their intention to purchase Australian Government Securities and securities issued by the state and territory central borrowing authorities in the secondary market, targeting yields on three-year government securities of around 0.25%, to help lower funding costs across the economy. Victoria historically has had no difficulty in accessing Australian and international markets, and our expectation is that this will continue. We also expect the Commonwealth to provide support, if needed, as it did during the 2008-2009 financial crisis, when it provided a guarantee of Australian state government debt for a fee, though Victoria didn’t take up this offer.
Wealthy and diverse economy and strong financial management are key credit strengths
We believe Victoria’s economy will contract this year, with the arrival of the pandemic and government-imposed social-distancing rules. This will have a significant economic effect on the state and weaken the state’s fiscal outlook.
Restrictions are starting to ease, and we expect economic activity to resume, albeit slowly. Despite the downturn, we expect Victoria will retain its considerable economic strength, which remains a structural feature. We view the economy as very wealthy in an international context, with a well-diversified economy. A large services sector, high-ranking livability, and a large infrastructure pipeline should support the state’s long-term economic outlook.
Victoria’s financial management practices are very strong in a global context. In response to the current pandemic fallout, the state has set out an A$1.7 billion Economic Survival Package to support businesses and jobs. The state was the first in Australia to update its 2021 funding plan to incorporate assumptions about the crisis at a time of great uncertainty. Victoria continues to display a high level of financial transparency, sophisticated debt and liquidity management, and forward-looking financial planning.
However, the implementation of base expenditure reviews, of which the state was looking to gain efficiencies and target savings to fund expenditure, have been deferred by at least six months. We believe the state’s commitment toward costs savings is important because it should alleviate some pressure on the budget that was building before the COVID-19 pandemic. This was because the government allowed operating expenses–namely employee expenses–to grow relatively fast compared with its peers. We believe these expenditures are inflexible and difficult for governments to reduce.
While Australia’s institutional framework is one of the strongest in the world and underpins our ratings on Victoria, there is a degree of structural imbalance between revenue powers and expenditure responsibilities. The Commonwealth government raises the bulk of revenue, while the states and territories have significant expenditure responsibilities, including in the politically sensitive areas of health and education.
We believe Victoria, along with the other Australian states and territories, does not have substantial budgetary flexibility. This is because under Australia’s institutional framework, the Commonwealth collects about 80% of government revenue and passes on a proportion of these to the states. Current transfers from the Commonwealth represent more than 40% of Victoria’s revenues and are primarily untied GST receipts, which are under pressure for soft consumption expectations.
