Ratings On Australia Affirmed At 'AAA/A-1+' On Monetary And Fiscal Flexibility

WE Online, Australia - Standard & Poor's Ratings  Services said today it has affirmed its 'AAA/A-1+' unsolicited sovereign  credit ratings on the Commonwealth of Australia. The outlook remains stable.

"The unsolicited ratings on the Commonwealth of Australia benefit from the  country's strong public policy settings, economic resilience, and significant fiscal and monetary policy flexibility," said credit analyst Craig Michaels. "We believe these factors provide Australia with a strong ability to absorb  large economic and financial shocks, as was demonstrated during the global recession in 2009. Australia's high external imbalances, dependence on commodity exports, and high household debt moderate these strengths."

Australia is a wealthy economy, with GDP per capita of about US$67,500 in 2013. Australia's economic resilience reflects decades of economic reform, its diverse economic structure, and flexible labor and product markets. Growth of the Australian economy is expected to have remained below trend at 2.9% in the year ended June 30, 2014, as mining investment continued to decline from very high levels and weigh on growth. Partly offsetting this will have been further strong growth in commodity exports as mining and energy projects are progressively completed and commence production.

We anticipate further gradual strengthening in nonmining sectors of the economy, but for growth to remain a little below trend for some time. This partly relates to the soft outlook for national income growth, which we expect will continue to affect real activity. We anticipate income growth will remain relatively weak in the medium term as Australia's terms of trade are likely to continue to decline--with prices for the country's key commodity exports continue to weaken, in large part due to rising Australian and global production. Our current projection is for real per capita GDP growth to average 2.9% over 2014-2017, somewhat below our expectations a year earlier.

Moreover, risks remain for Australia's growth prospects, prosperity, and credit quality. These stem largely from the country's growing dependence on trade with China. If demand for Australia's resources were to weaken sharply, there could be a range of disorderly dislocations in the economy, including in its labor and property markets. However, while robust demand for its commodities continues, we believe Australia's economic prospects over the forecast period will remain favorable.

Australia's public finances remain strong--with low debt, deficits and debt-servicing costs--although they have weakened as a result of the global recession. The current Liberal-National Coalition government is continuing the previous Labor government's efforts to adjust expenditure in light of ongoing revenue shortfalls, and seeking to achieve budget surpluses in the medium term. This gradual budget adjustment is supported, in our view, by the government's high degree of flexibility for adjusting revenue and spending, as well as strong bipartisan and community support for prudent management of public finances. (At the time of writing, most of the government's 2015 budget measures were yet to pass the Senate. But we expect that compromises will eventually be reached so that budget performance gradually improves.) Taking state and local government budget performance into account, we expect the general government sector's budget balance to post relatively small and declining deficits as a share of GDP over the years to 2017, but for deficits to narrow more slowly than we expected a year ago. Under this base-case scenario, general government net debt is expected to peak at about 21% of GDP (slightly higher than we previously anticipated)in 2015 before gradually declining.

In our opinion, while Australia benefits from many fundamental strengths, its key credit weakness is the economy's high level of external liabilities. The banking system in particular has a high degree of external indebtedness and remains highly reliant on the ongoing backing of foreign investors. Overall, Australia's external debt, net of liquid assets, was more than 230% of current account receipts (CARs) in fiscal 2013, although this was a little lower than we previously expected. Meanwhile, Australia continues to run significant current account deficits--in excess of 10% of CARs. While foreign direct investment into the resources sector has been a major source of external funding in recent years, we expect portfolio flows will continue to re-emerge as the dominant funding source in the period ahead.

In our opinion, however, the risks associated with Australia's high private-sector external debt are manageable because of the strength of the country's financial system, the high degree of foreign currency debt hedging, and an actively traded currency that historically has allowed external imbalances to adjust. Additionally, Australia's highly credible monetary policy framework remains able to help counter the impact of any economic shocks.

"The stable outlook is based on our assumption that Australia's historically conservative budgetary policies will remain in place such that fiscal deficits continue to narrow, and that the general government debt burden will remain low," said Mr. Michaels.

"We could lower the ratings if external imbalances were to grow significantly more than we currently expect, either because the terms of trade deteriorates quickly and markedly, or the banking sector's cost of external funding increases sharply. Such an external shock could lead to a protracted deterioration in the fiscal balance and the public debt burden. It could also lead us to reassess Australia's contingent fiscal risks from its financial sector. We could also lower the ratings if significantly weaker than expected budget performance leads to net general government debt rising above 30% of GDP."