Rio Tinto’s Brockman 2 mine in WA

Moody’s Investors Service has downgraded Western Australia’s rating to Aa1 from Aaa, reflecting a deteriorating state budget and a reliance on fluctuating mining royalties.

Mining companies in Western Australia have been hit by falling commodity prices, especially iron ore.

And iron ore royalties represent almost 20% of the state government’s revenue and are forecast to bring in $5.6 billion this financial year. The state wins or loses $49 million each time the price of iron ore moves $1 in price.

Moody’s says the state’s assumption on royalties is underpinned by a fairly optimistic forecast for iron ore prices.

It says the challenges related to narrowing the budget gaps include greater volatility in the state’s revenue base, reflecting its increasing reliance on royalty income, expenditure pressures related to the rapid expansion in the economy and population and a weak policy response to the deteriorating financial and debt position.

These trends have led to persistent deficits with the government’s budget gaps averaging 5% of revenues from 2008/09 through 2012/13 and, in 2013/14, the deficit is estimated to be equal to 6.2% of revenues as current spending outpaces revenue.

Moody’s says the state’s fiscal action plan, including an increase in tax rates and a new wage policy which limits salary increases to inflation, is positive but not expected to lead to significant improvements in the near term.

Minimal improvement is expected in the financial performance in 2014/15, with the gap budgeted to be $1.6 billion or equal to 5.7% of revenues, as revenues are forecast to ease in line with slower economic growth.

Net direct and indirect debt rose to a high 96.5% of revenues in 2012/13, from a moderate 44.4% in 2007/08, which Moody’s says is manageable but higher than most other Australian states.

“The state will be hard pressed to meet its very low spending growth targets, unless the government’s fiscal resolve strengthens and new measures are identified,” Moody’s says

Moody’s has downgraded the issuer and debt ratings of the Western Australian Treasury Corporation, backed by the State of Western Australia, to Aa1 from Aaa and changed the outlook to stable from negative.

The ratings agency says the stable outlook is supported by the state’s strong economic prospects and supportive Commonwealth government grants framework.

Western Australia’s economy, while easing as mining investment comes off record highs, is still expected to outpace other Australian states.

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