NO SLIPPAGE: Standard and Poor's warns what could trigger a downgrade to Australia's credit rating

Photo: Mark Kolbe/Getty Images

In July last year, Standard and Poor’s put Australia’s AAA sovereign rating on watch negative, laying the platform for a potential downgrade within two year’s should the federal government not get its fiscal house in order.

Well, the ratings agency is still watching, especially events in Canberra.

In a meeting with the National Australia Bank last week, the group said its main concern towards the rating continues to be Australia’s high level of foreign indebtedness, which represents an inherent vulnerability for debt repayment or market access for borrowers in the event funding markets were to become disrupted.

“Until recently, Australia’s very strong government finances have provided an important and necessary offset to that key concern. However, the continued failure of successive governments to return the budget to balance as forecast, has reduced Australia’s fiscal flexibility,” Ivan Colhoun, the NAB’s chef economist for its markets division, wrote following the meeting. “This led S&P to move the rating to negative outlook in 2016.”

After the meeting, Colhoun said that whether or not a downgrade occurs will likely be determined by the government’s budget forecasts in the period ahead, starting with May’s federal budget.

“Most of the onus seems to rest on the track for the budget and budget forecasts in coming years,” he says. “In this regard, S&P was clear that no further slippage in the forecast return to balance by 2020-21 would be tolerated.”

In other words, the government needs to make good on the current budget forecasts, not allowing for further budget slippage, which has been a feature in the years following the global financial crisis.

Given that less than stellar track record, the group told the NAB that it would be watching the events in Canberra closely in the period ahead.

“(While) it did not seem that S&P was much closer to downgrading the rating, the agency again noted that it would continue to monitor the government’s willingness and ability to pass revenue and expenditure measures through both houses of parliament over the next six to 12 months,” said Colhoun.

S&P provided the NAB with the following scenarios on what could happen next:

  • Downgrade to AA+: That would likely occur if S&P believed the Parliament was unlikely to enact measures to allow the budget to return to a balanced position by the early 2020s (something S&P will continue to monitor over the next 6-12 months). A downgrade would also occur if there was a further weakening of Australia’s external position; and
  • Return to stable outlook: if budget measures were enacted that appear sufficient to reduce fiscal deficits materially over the next few years; or if there was a sharp improvement in Australia’s external position.
  • Based off analysis from the NAB, the budget deficit is tracking a little higher in the first six months of this financial year, but not significantly worse than recent budget forecasts.

    Compared to the same period in 2015, the NAB says outlays have increased by 5.2% in the first half of the year, more than a 3.9% lift in revenues.

    “The Australian budget deficit in the first six months of this financial year is tracking a little higher, but not significantly worse than recent budget forecasts,” says Colhoun. “As such, as yet, it does not seem to be clearly failing to meet S&P’s requirement of a return to balance in the early 2020s.”

    Colhoun suggests the best way to ensure Australia meets S&P’s budget targets, and to keep the AAA rating, would be slower government spending growth in the out-years of the budget forecasts.

    Now all is required is a bit of bipartisanship across the chamber to reach that outcome, something that seems in short supply on many issues at present.

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