Fitch, one of the big three credit rating agencies, has affirmed Australia’s solid gold AAA rating overnight. But in the rationale for their decision they highlighted the changing status of the Australian dollar as one of the reasons for the rating.
Fitch said (our emphasis):
Australia’s ‘AAA’ rating is underpinned by the economy’s high income, strong institutions and effective governance. The free-floating exchange rate, credible monetary policy framework, low public debt and growing recognition of the Australian dollar as a reserve currency allow the economy to adjust to changing economic conditions.
If, as Fitch suggest, Australia is growing as a reserve currency, that means it will be taking a small, but central place in the foreign currency investment portfolio of central banks, supranational institutions, and more likely than not an increasing number of private sector investors.
That might help explain why the Aussie has been relatively strong over the past 6 months when pundits were expecting a crash to 65 cents and below. It might also help explain why even with the crashing terms of trade the Australian dollar is hanging relatively tough.
But, while traders and the market have a strong focus on Australia’s China links and the falling terms of trade, Fitch points out a few key metrics which are driving the recognition of the Aussie dollar’s reserve status.
That’s particularly the case when compared with other AAA nations.
“GDP growth of 2.5% in 2015 was marginally slower than a year earlier, but still outpaced the median of 1.8% for ‘AAA’ rated sovereigns,” Fitch said.
They also highlighted that the strong services sector performance and improved consumption would see Australian growth at 2.6% this year and 2.7% in 2017. Not spectacular but stronger than most.
On the debt front again, Fitch highlighted that Australia has better metrics than its AAA peers.
Despite resilient GDP growth, a sharp fall in the terms of trade has weighed on nominal income growth, reducing tax revenues and slowing the expected pace of fiscal consolidation. As such, the government does not expect an underlying cash surplus until the fiscal year ending June 2021 (FY21). Fitch estimates Australia’s gross general government debt (GGD) at 34.5% of GDP in FY15, still 9.1pp below the ‘AAA’ median of 43.6%“.
Fitch also noted the Australian banking system is “is one of the strongest globally on a standalone basis”. That’s before implicit or explicit Australian government support.
There is one “longstanding structural weakness” however that worries Fitch but which, because of the strength of growth, low government liabilities, and a strong banking system is mitigated. That weakness is Australia’s external financing position.
“Net external debt, including derivatives, increased to 61.0% of GDP in 2015 from 54.4% in the previous year. This is higher than the previous 2009 peak,” Fitch said.
This is the risk that, in my years of travelling the globe talking to central banks and global investors, appears to worry them the most about Australia and the economy.
But no doubt the Reserve Bank would counter, as they have many times over the years, that this is both mostly hedged back into Australian dollars and mostly borrowed by the banks on behalf of the economy. As a result this mitigates overall risk to the economy.
But it is still a risk.
“A negative economic shock without offsetting policy actions could lead to further deterioration in public finances,” Fitch said.
But all up Australia’s AAA rating is stable and its outperformance of much of the globe and particularly its AAA peers seems to be driving increasing numbers of global investors into buying the Australian dollar.