Australia's Debt Dilemma Raises Downgrade Fears

  • Moody's has warned debt will grow without revenue measures
  • Number of headline metrics `very similar' to 1986: JPMorgan

1986 may seem like a long time ago, but for Australian Treasurer Scott Morrison some of the parallels with his current budget balancing act are getting too close for comfort.

Back then, Moody’s Investors Service and Standard & Poor’s pulled their AAA ratings as weak commodity prices wrecked government income and external finances. With resources again in a funk and a widening funding gap, National Australia Bank Ltd. and JPMorgan Chase & Co. said last week Morrison needs to undertake repairs in his May 3 budget to safeguard the country’s top rankings. Moody’s warned Thursday that debt will grow without revenue-boosting measures.

“Moody’s are understandably getting impatient,” said Shane Oliver, head of investment strategy at Sydney-based AMP Capital Investors Ltd., which oversees about $122 billion. “We’ve seen each successive budget update push out the return to surplus. This time around -- like back in the middle of the ’80s when we did suffer downgrades -- we again have a twin deficit problem.”

Keating’s Warning

Thirty years ago, then-Treasurer Paul Keating warned the country risked becoming a “banana republic” because of its reliance on resources and it took nearly 17 years to regain the two top credit scores. While Morrison’s language hasn’t been as strident, he has said Australia must live within its means and indicated a focus on reduced spending.

The government expects Australia’s budget position to improve in coming years despite the environment for commodity prices as it controls expenditure growth, Finance Minister Mathias Cormann said Thursday in an e-mailed response to questions. 

“The Government is committed to responsible budget management which protects our AAA credit rating,” he said. “Our public debt remains low internationally and consistent with our plan, the government is committed to stabilizing and reducing our debt over time.”

Australia’s general government net debt is projected to peak at 19.9 percent in 2017, lower than any Group of Seven economy, according to the International Monetary Fund’s fiscal monitor. That number has climbed from minus 0.6 percent in 2009.

“One differentiating feature between Australia and other Aaa rated sovereigns is that, while government debt has increased markedly in Australia, it has been more stable for other Aaa sovereigns,” Marie Diron, a senior vice-president at Moody’s in Singapore, wrote in an e-mailed response to questions. “We expect a further increase in debt and will look at policy measures and the economic environment to review our analysis on this.”

Australian gross debt forecast 20 percentage points higher in 2018 than in 2000; Switzerland seen 11 points lower
Australian gross debt forecast 20 percentage points higher in 2018 than in 2000; Switzerland seen 11 points lower

Lower growth or a financial shock could lead to negative pressure on the ratings, she said. S&P declined to comment in the lead-up to the budget.

A few months after taking over as Treasurer in September, Morrison added A$26.1 billion ($20 billion) to forecast deficits through June 2019 and pushed out an expected return to balance beyond fiscal 2020. Former Treasurer Wayne Swan had promised in 2009 the budget would be back in the black by 2016.

Morrison may have better luck than his predecessors, who saw their plans go awry as a downturn in China drove commodity prices down. Iron ore has climbed more than 50 percent from a December low and the unemployment rate dropped last month to the lowest in 2 1/2 years.

Efforts to increase taxes and reduce spending on welfare programs have stalled amid a voter backlash and stalemate in the upper house of parliament. The government will be keen to avoid unpopular measures ahead of a possible election in July.

“It just feels like this is difficult politically,” said Sally Auld, head of fixed-income and currency strategy for Australia at JPMorgan. “It doesn’t matter who’s in power, they really struggle to get party-room support for meaningful reform one way or another.”

Auld said ratings firms may also grow concerned as private demand for offshore borrowings is starting to rise at a time when the sovereign isn’t as strong as it once was.

Australia’s current account deficit -- a measure of the nation’s indebtedness to the rest of the world -- climbed to 5.2 percent at the end of 2015, matching the widest level since 2010. It averaged about 5 percent in 1986.

“It feels like this is going to be a budget of mild restraint,” Auld said. “Though in the absence of meaningful change on the tax or expenditure front, you have to ask whether that will be enough to keep the rating agencies at bay.”

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