Can Australia hold its AAA credit rating?

Craig Michaels, who assigns credit ratings to Australia for S&P Global Ratings, talks about the AAA credit rating, and why they have doubts about budget forecasts

Introduction – Can Australia hold its AAA credit rating.

Ross Greenwood: Welcome back to money news right around Australia. As you are aware, Australia’s triple AAA credit rating is important. It’s important for the community’s confidence, in the government’s ability to manage the economy. And as you know we are one of the very few nations in the world right now, to enjoy triple-A credit rating from all of the three major credit rating agencies. That being Standard & Poor’s, Moody’s and Fitch.

But for some time Standard & Poor’s has had a negative credit watch on Australia. In other words, it’s watching Australia, it’s watching the government. Now, that the budget’s been handed down and there was a promise in the budget that Australia will return to profit or surplus in 2021, many of the assumptions inside that budget, the spending, the revenue measures all that type of thing being wired up by the credit rating agencies to see whether Australia remains as robust in those promises as it has been in the past.

Let’s go to Standard & Poor’s global. S&P global that has got that negative credit watch on Australia’s AAA credit rating. Craig Michaels is on the line right now. Many thanks for your time Craig.

Interview with Craig Michaels Standard & Poors

Craig: My pleasure Ross.

Ross Greenwood: Just explain to me in regards to the budget and what you have seen how was your assessment of our rating been post that budget in positive numbers you’ve seen.

Craig: Really the budget that was released last week was very similar to what we’ve seen over last 12 months, which is essentially why we have maintained both the rating and the negative outlook. You might remember going back to around 2010 the government was expecting to get to a surplus budget by 2012-13. Since then there has been many years of fiscal slippage on that target. We saw the falls in commodity prices. Now, we’re looking at the surplus of 2021 which is lighter than the original target. Given that a very high level of fiscal slippage and they’re concerned that there could be more, we think any further significant slippage would probably not be consistent with the AAA credit rating.

Ross Greenwood: Okay. Why would you believe there could be some of that fiscal slippage? In other words what you’re saying is that the government wouldn’t fulfill these targets. Why would you imagine from what you’ve seen in the budget, where would the slippage occurred?

Craig: Yes. A best case is that the government will get back to a surplus budget by 2021 but we do say a number of reasons for that might not happen. We’ve talked about these for the last– almost a year now. One is that commodity prices can move around a lot. Since mid-last year when we but the outlook on negative they’re actually paying a lot higher than what we thought. But most of that looks like it’s been a pretty short term, we don’t expect that those strong process we’ve seen recently will be sustained to 2021.

So we don’t think can provide much positive support that could still fall from where they are now, I guess it remains a risk but probably more importantly we’ve seen wage growth remain very low. In fact, we saw that confirmed in the data today. Our concern is that low wage growth could be continuing for a lot longer than what the budget currently seems.

Wage growth rise?

Ross Greenwood: Okay. But the budget assumes by that time when the surplus occurs in 2021, the wages growth will rise where it is around about 2%. In fact, today annually at 1.9%, it would get back even as high as 3-3.5%. Many people have seen that as an erroneous assumption inside the budget because it doesn’t seem as though there is the economic growth or indeed the economic situation that could actually warrant or say wages grow as fast as that over the next four years.

Craig:  Yes. We would agree. This reminds dance or a risk. Absolutely.

Ross Greenwood: In regards to where Australia’s government debt sits and also its external debt because it’s not just, the government debt but also household debt as well, when it stacks up against other nations around the world. Where does this really sit right now?

Craig: Well, if you look at government debt we’re adding up all levels of government federal state and like all. Government debt is still lower. It is creeping up obviously with ongoing fiscal deficits. But it is still a low price compared to most countries that we rate globally. But even among AAA economies.

So why are we so concerned about diversity now? Well, the reason is that while public sector balance sheets are still quite strong, the Australian economy’s balance sheet is very weak. The Australian economy overall owes a lot of money to offshore investors. It’s wholly reliance on foreign investors being willing to continue to roll over what is a very large stock of external debt and to continue to fund structural current account deficit, and if that changed at some point for some reason that capital dried up there could be major impacts on Australia’s economic growth and that would all flow through back to the government.

Given that high vulnerability, we think government balance sheets and budget performance needs to remain very strong to offset that vulnerability.

Ross Greenwood: In fact, in your numbers that came out today, you show that Australia’s external liabilities 246% of current account receipts. The second largest amongst investment grade right and sovereigns just behind the United States. In other words, there’s a whole range of different countries that have lower rating in Australia which also potentially have lower net external liabilities compared with the current account receipts. So that is where that vulnerability really can be seen from Australia’s position that’s obviously borrowed a lot of money to go out and buy expensive housing and the like.

Craig: That’s probably true. Australia has been an attractive destination for foreign investors for decades and decades and most of that has gone into productive stuff, including the resources sector more recently. But you’re right, particularly in the last housing upswing, we saw in the 90s and 2000s households did leverage up a lot and banks increased their offshore exposure a lot to finance that. And that to our mind creates a bigger vulnerability.

We have maintained AAA credit rating for the last 15 odd years despite that. Because a whole bunch of other things that we think are very important for credit us have remained very strong including the strength of governance, High-income Brazilian economy. A credible Reserve Bank which we think Scott Skype to cut right so aggressively if necessary. And a floating exchange rate which has traditionally played a major buffer role since it was founded in the nearly 80’s.

But of course, on top of that, the other key factor is strong public sector balance sheet and strong budgetary formants. That’s the last bit which is starting to look much like you these days.

Ross Greenwood: So Craig, just so the people totally understand this. Just tells them, what Standard and Poor’s right now has a strategy is quit rating range?

Craig:  We are having a AAA which is at the top end of rating range. The negative outlook means that we think is a bad one in three chance that we could downgrade it to the next rating which is double plus sometime in the next two years.

Ross Greenwood: Craig Michaels is the director of a sovereign. Sovereign and public finance rating at S&P global and I got to say, Craig, we appreciate your time here on the program this evening.

Craig: Good to be with you Ross.

S&P cuts ratings for 23 financial institutions

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