Australia’s prized AAA credit rating is under threat for the first time in nearly three decades following Standard and Poor’s (S&P) decision to place the nation’s sovereign rating on watch negative.
While the agency has not cut Australia’s credit rating, being placed on watch negative implies that there’s a one-in-three chance that a ratings downgrade may occur at some point in the next two years.
It’s a shot across the bows to Australian policymakers, telling them that if action isn’t taken to address its concerns the nation will be stripped of its AAA rating.
To recap what S&P’s concerns are, here a snippet from the statement released today:
The negative outlook on Australia reflects our view that without the implementation of more forceful fiscal policy decisions, material government budget deficits may persist for several years with little improvement. Ongoing budget deficits may become incompatible with Australia’s high level of external indebtedness and therefore inconsistent with a ‘AAA’ rating.
Australia’s budget position, in other words. Seemingly S&P, like others, has grown sceptical over the government’s ability to return the budget to surplus within the projected time frame offered in May’s federal budget.
Crucially S&P said it was “more pessimistic about the central government’s revenue outlook than the government was in its latest budget projections”.
If there’s one thing that many have become accustomed to in recent years, it’s larger than expected deficits and a delay in returning to budget to surplus. It’s been like a broken record, or to borrow one of my favourite phrases, simply “rinse and repeat”.
“It’ll get better next year, promise!,” they say. “Yeah right”, is the collective response in return.
Now Australia faces the very real prospect that it will lose its AAA credit rating, something S&P has retained for the nation since February 2003.
So what to make of the announcement? Is it the end of the world?
Markets certainly don’t think so, at least not yet. One look at reaction to the announcement whiffs of nonchalance. Debt markets are largely unchanged, stocks are higher while the Aussie, after an initial plunge, finished up for the session. Yes, up.
Been there done that, is the general vibe that’s been seen. Not quite couldn’t care less, but close enough to it.
Like Australia’s budget projections missing constantly, markets are well accustomed to sovereign downgrades.
While markets may think that it means nothing, it’s time to see what economists think of S&P’s warning. Here’s just a few of the research notes that have hit out inbox over the course of the afternoon.
Richard Yetsenga, ANZ
Speculation around the credit rating has escalated over recent years, with the lack of significant delivered fiscal reform and an increasingly fractious political environment contributing to a growing sense that movement on the rating was more a question of ‘when’ rather than ‘if’.
The absence of a particularly large direct (market) impact from S&P’s announcement, however, shouldn’t distract from the signal it sends, namely that the policy debate needs to work harder on finding common ground on the fiscal repair task. The reform agenda needs to be emboldened in such a way that it delivers the flexibility that the commercial sector of the economy needs to generate prosperity, while also delivering a sense of fairness and even-handedness which much of the electorate is clearly demanding.
The minor parties share of the vote this election is at record highs in both the House of Representatives (22.7%) and Senate (34.4%). While this complicates the policy environment, and talking about what should happen is easy enough, the reality now is that the room for manoeuvre is diminishing. Today’s announcement from S&P is the first concrete warning signal. It is calling for a shift in approach.
The main effects of today’s announcement are likely to be via monetary policy (suggesting some additional impetus for the RBA to cut in August, even though that has been our call) and some funding costs for those entities linked to the sovereign ceiling.
Shane Oliver, AMP Capital
Being put on negative credit watch by a ratings agency is not surprising. Australia has now seen years of slippage in returning the budget to surplus and the messy election outcome threatens more slippage whichever way it goes.
Of course being put on negative watch is not the same as a downgrade and a country can remain on a negative outlook for up to two years without being formally downgraded. But I suspect its probable that a formal downgrade will follow unless the new government is able to hold the line on the budget deficit projections which will be hard given the likely state of the senate.
Paul Dales, Capital Economics
S&P’s decision to revise Australia’s AAA credit rating from stable to negative is another political blow for the Coalition, but it doesn’t mean much for the financial markets, the states or the banks.
This is not a surprise. The ratings agencies have been worried about the fiscal outlook for some time and the uncertain result of the Federal election has made S&P more convinced that “fiscal consolidation may be further postponed”. S&P said there is a “one-in-three” chance that the credit rating will be lowered from AAA to AA “within the next two years”. We’d be surprised if Australia hangs on that long.
Fears that a downgrade will raise the borrowing costs of the Federal government, the states and the banks are overdone. Nor should it weaken the dollar.
Ivan Colhoun, NAB
The text of today’s statement reveals the agency will “continue to monitor over the next six to 12 months, the success or otherwise of the new government’s ability to pass revenue and expenditure measures through both houses of parliament”. This suggests that if budgetary performance does not continue to track toward current forecasts, or indeed deteriorates, then a downgrade could occur over this time period.
S&P also notes that it may lower the rating should Australia’s external deficit deteriorate further. The agency noted the rating may stabilize (ie revert to stable) if the external accounts improved sharply or “new budget savings or revenue measures were enacted that appeared sufficient to reduce fiscal deficits materially over the next few years”.
There has been virtually no impact on Australian fixed income markets, with Australian government bond yields, state government bond spreads and major bank corporate debt yields all broadly unchanged since the announcement. Even in the event of an eventual downgrade, Australian government borrowers and major banks will remain highly rated on a global basis.
Annette Beacher, TD Securities
We’ve been highlighting our concerns about the rapid deterioration in the debt and deficit metrics for some time. For example, the expected peak in the net debt ratio has exploded from under -10% of GDP in the 2012/13 budget, to nearly double to -19.2% in the May budget
With the (election) failing to identify a clear majority government, the risk of a structural policy reform-free zone for another three years has accelerated, and no wonder S&P has responded accordingly.
Issuing a ‘negative outlook’ today places not only the major political parties on notice that broadening revenues/expenditure restraint needs to feature as key policy measures, the senate crossbenchers need to be more open-minded about policy reform.
Given bond issuance is likely to exceed $A100b this fiscal year, there is a ‘risk’ that offshore investors demand a higher yield to buy Australian debt. However we believe these risks are a fraction of past times, as long as the global search for yield persists, which we expect it to do well into 2017.
In other words, we still question whether the loss of the AAA rating is as much of a concern now as in the past.
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