GOLDMAN SACHS: Australia's 'AAA' credit rating is under threat

Goldman Sachs thinks Australia’s triple-A credit rating is at risk, and warns the effects would be felt in the wider economy.

The investment bank believes the rating is likely placed on “watch negative” by ratings agency Standard and Poor’s within months, something that would raise the possibility of an eventual ratings downgrade.

In a note to clients, Goldman economists Tim Toohey and Andrew Boak say Australia faces the possibility of being downgraded for the first time in 26 years.

From the report:

“Australia’s poor fiscal performance scores poorly across S&P’s updated ratings methodology. Although Australia’s overall public debt burden remains favourable relative to its 11 other AAA-rated peers and contingent liabilities look manageable, significant external vulnerabilities persist and a mix of sharply lower commodity prices, weak growth and political impasse have resulted in an unprecedented degree of fiscal slippage over recent years”

Toohey and Boak warn, based on changes to S&P’s ratings methodology, that Australia’s AAA rating – at a minimum – could be placed on “negative outlook”.

If that eventuates it suggests a one-in-three chance that the actual credit rating could be cut by S&P at their next ratings review.

Being placed on “watch negative” is akin to a warning shot that a downgrade is coming. Unless actions are taken to address the concerns raised – if that’s indeed a possibility – it’s highly likely that there’ll be a downgrade.

That would have some important ramifications if it were to occur – not only for the government but also Australia’s largest banks along with the household and business sectors.

Toohey and Boak suggest that such a downgrade “would likely result in a similar sized downgrade to the Australian banks” which “might increase the cost of term wholesale funding by 5-15 basis points”.

While only a small a part of most bank’s funding mix – Goldman’s suggests that it’s currently around 13% – that has the potential to see borrowing costs for Australian households and businesses increase as a result.

If that’s not enough to dent the confidence of households and businesses they also believe “such an event would risk strengthening the negative feedback loop which is already hindering a pick-up in spending and borrowing – thereby further diluting the transmission mechanism of monetary policy”.

That is – investor caution will increase – stifling the efforts of the RBA to stimulate non-mining sectors through the use of lower interest rates.

That’s not good news for an economy currently trying to rebalance away from mining investment to increased construction and consumption.

While Toohey and Boak suggest that “it is now possible to create a feasible scenario where Australia forfeits the highest possible sovereign rating for the first time in more than a decade”, the do place one caveat on their analysis: It “excludes the ability of the Government to take corrective action to avert a downgrade.”

That suggests there are still actions available to the government to prevent it from occurring.

The picture will be a whole lot clearer after the federal budget on May 12.

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