Australia’s AAA credit rating at risk: S&P
20 May 2014
A lack of “political will” and failure to rein in spending were key reasons cited by S&P in September when it cut West Australia’s rating. Photo: Bloomberg
Jacob GreberEconomics correspondent
Ratings agency Standard & Poor’s is warning Australia’s prized AAA credit rating could be reviewed unless substantial cuts are made to the budget in coming years.
In an unusually forthright warning, a lead sovereign analyst for S&P, Craig Michaels, said he was counting on the Abbott government to win Senate approval for at least “some” of its $37 billion in planned savings against opposition from Labor, which has pledged to veto about $18 billion in cuts and tax rises.
“We’re looking to see the government improve budget performance over the next few years,” Mr Michaels said in an interview.
If it looked as though “sizeable budget deficits were considered acceptable at the political and the community level then we might reassess, certainly, government commitment and also potentially the trajectory for public sector debt,” he said.
A cut to Australia’s rating would drive up the government’s borrowing costs and be a huge political blow.
S&P’s comments may serve as a wake-up call for opponents of the budget, including Palmer United Party leader Clive Palmer, who argues there is no need for big cuts to the $48 billion deficit because of the AAA rating.
It coincides with a revolt from state premiers enraged by $80 billion in cuts to health and education and a collapse in support for the government after record numbers of voters judged the budget to be unfair and likely to leave them worse off.
However, by emphasising the need for budget repair, S&P has put Australia on notice that its rating is dependent on decisions made today, rather than events of the past. “We’re looking for action,” Mr Michaels said.
A leading credit analyst, Martin Whetton at Nomura, said the S&P comments suggest any back-down by the government on budget repair would be frowned upon by S&P.
“If the government chooses to substantially water down its proposals because of the political cost, that is the sort of thing that would concern rating agencies looking at Australia over the longer term,” he said.
Budget block ‘unhelpful’
Bank of America Merrill Lynch Australia chief economist Saul Eslake said it would be “unhelpful” if the government’s budget measures were blocked.
“I’ve always said just because Canada has debt-to-GDP of 39 per cent doesn’t mean we could run ours up to the same level and keep our rating,” he said.
“Our banks have lots of liabilities which ratings agencies now recognise could become government liabilities in the wrong circumstances.”
A lack of “political will” and failure to rein in spending were key reasons cited by S&P in September when it cut West Australia’s rating.
Mr Michaels said the federal government wasn’t guilty of a lack of political will “at this stage”.
Still, the S&P analyst said he would pay close heed to the upcoming Senate clash over the budget after Labor last week indicated it would oppose cuts to the dole, student loans and family tax payments.
“We won’t really try and second-guess what the outcome will be, but we’ll look at the outcome of the negotiating process through the parliament and have a look at the fiscal outlook on the back of that,” he said.
He said the deficit had widened because of the global financial crisis and that tax revenue is “not as structurally as strong as it appeared before”.
Mr Michaels emphasised Australia was unusual among the 12 nations granted S&P’s gold-plated rating because it relies heavily on foreign investors for capital, including its major banks, Westpac, Commonwealth Bank, National Australia Bank and ANZ Bank.
‘External position is very weak’
“Australia is fairly unique among AAA-rated sovereigns in that its external position is very weak,” he said.
“What that means is that to retain the AAA rating, everything else needs to remain very strong, including public finances.
“So we would be looking for a narrowing of budget deficits as evidence of ongoing commitment to running finances prudently,” he said.
Mr Michaels said the rating was “not on a knife edge” and the government still has “a bit” of wriggle room over the pace of budget repair. But he warned major setbacks would force a rethink by the agency, one of three that rates Australia with the highest possible rating.
Tuesday’s budget showed Australia would accumulate $60 billion in deficits over the next four years, returning to surplus no earlier than 2018-19. In the midyear budget update, the government had forecast $123 billion in shortfalls over that period.
Despite the size and run of deficits, ratings agencies assume Canberra will restore the budget to surplus and pay down debt, expected to peak at 14 per cent of gross domestic product.
While that figures is lower than most other comparable AAA-rated nations – and less than half the net debt of Canada – Australia’s rating carries an implicit assumption the federal government would bail out local banks in a crisis.
Mr Michaels said it would give S&P “some pause for concern” if this week’s budget backlash was a “fundamental shift in the community’s attitude to what they expect from government.
“The risk is that if the electorate becomes much less supportive it becomes much harder for governments to make the hard calls.”
Mr Michaels said chances of Australia being downgraded stood at one in three, “at most.”
“Provided deficits remain relatively small and we see the government committed towards balance over the medium term and debt remains comfortably low, then there’s not immediate pressure on the rating.”
