Iron-Ore State’s Loss of AAA Forces Austerity: Australia CreditBenjamin Purvis and Wes Goodman
Standard & Poor’s decision to strip Western Australia state of its AAA credit rating may act as a warning to Prime Minister Tony Abbott as he assumes stewardship of a national budget that’s been in deficit for five years.
S&P downgraded its assessment of the region that accounts for 48 percent of global iron-ore trade as the state struggles to curb outlays. Western Australia was the biggest beneficiary of the nation’s once-in-a-century resources boom, with spending over recent years including funds allocated for a new football ground whose public cost is comparable to the New York Yankees’ Bronx stadium. As mining investment has crested and the outlook for China weakened, so has the outlook for the state’s revenue.
“Western Australia’s position has deteriorated with big infrastructure spending as the population has grown,” said Gavin Goodhand, who helps manage the equivalent of about $500 million for Altius Asset Management Pty in Sydney. “Revenue has decreased. Their debt levels have increased. They’re trying to rein in expenditures, but obviously not enough.”
The challenges of slowing growth and revenue shortfalls have also hit the federal government and Abbott, sworn in yesterday as the country’s 28th prime minister, is seeking to achieve a budget surplus equal to 1 percent of gross domestic product within a decade. The Aussie dollar dropped this year by the most outside of Japan’s yen among major developed currencies on prospects of weaker demand for the South Pacific nation’s commodity exports.
While Australia’s federal government has an unblemished AAA credit score, New South Wales and Victoria are the only states with top grades from more than one ratings company following Western Australia’s downgrade.
The average yield gap over federal debt for WA notes has risen by one basis point in 2013 even as spreads for every other state have contracted by at least 11 through yesterday, Bank of America Merrill Lynch data show. Western Australia has A$24.8 billion of bonds outstanding, with A$3.7 billion maturing by the end of 2014, data compiled by Bloomberg show.
The yield premium over on WA’s 6 percent note maturing October 2023 today climbed to 85 basis points, the most since May 3, from 79 the day before S&P’s downgrade, data compiled by Bloomberg show.
Ten-year government yields fell 16 basis points today to
3.90 percent as of 9 a.m. in Sydney after the Federal Reserve unexpectedly refrained from dialing back stimulus measures, putting downward pressure on global rates. The move wiped out this month’s earlier increase in yields and the benchmark Aussie bond is currently within half a basis point of where it was at the end of August. The premium to similar-dated U.S. Treasuries was 121 basis points.
The spread between credit-default swaps on Australian government debt and those on U.S. notes narrowed 11 basis points this month to 17 basis points yesterday. That’s headed for the steepest monthly drop since November.
Western Australia’s long-term issuer score was cut to AA+ from AAA by S&P, having been on negative outlook since October. Premier Colin Barnett’s government last month forecast an operating budget deficit of A$147 million in the year to June 30, 2015. Net debt for the total public sector is forecast to increase to A$28.4 billion by June 30, 2017, from an estimated A$18.5 billion at June 30, 2013.
“While Western Australia’s fiscal 2014 budget goes some way to addressing structural fiscal issues, we believe there is likely to be slippage, given the government’s track record on expenditure management and our view of its limited political will,” S&P said yesterday in its statement.
Among projects that the government committed to spending money on are a A$430 million redevelopment of the Perth Museum and a new 60,000 seat Australian Rules football stadium, for which the government has committed to meet about 60 percent of the construction costs. The A$918 million project is equivalent to the $855 million public cost of the New York Yankees stadium completed in 2009 in the south Bronx.
“We have got an issue about managing debt,” Barnett told reporters yesterday in Perth. “We will have to look at our capital works program and we’re going to have to tighten across government. While I’m very disappointed, I must say, as an economist, I agree with Standard & Poor’s analysis. They are right.”
Western Australia’s growth is forecast to slow to 2.5 percent in 2014-15 from an estimated 3.25 percent this fiscal year and 5.75 percent in 2012-13, according to the budget papers.
“The Western Australians will be under more pressure to get their finances in better order,” said John Honan, the Sydney-based chief economist at Ausbil Dexia Ltd., which oversees the equivalent of $8.9 billion. “To lose your rating does come with a cost, in terms of political credibility as well as the cost of funding.”
New South Wales Treasurer Mike Baird, whose state also has a negative outlook at S&P, said his government was taking every possible measure to preserve its top grade.
“No one should underestimate the difficulty of maintaining a triple-A credit rating, when you take into account the massive downgrade in revenues that all states have experienced, and the significant infrastructure backlog we inherited here in NSW,” Baird said in an e-mailed response to queries yesterday.
The federal Treasury said in a pre-election outlook released Aug. 13 that its deficit will widen to A$30.1 billion this fiscal year that ends June 30, 2014, and is no longer projected to return to balance in 2015-16.
That task will be complicated as Abbott’s coalition aims to meet its pledges to abolish Labor’s carbon and mining levies and lower the business-tax rate while funding a A$5.5 billion per year maternity-leave program. To help make savings, the new prime minister also plans to lower subsidies for automakers, cancel handouts to parents of school children and slash foreign aid.
The Australian dollar dropped 8.6 percent this year to
94.96 U.S. cents as of 9 a.m. in Sydney.
The downgrade of Western Australia may also have implications for investors who need to buy AAA rated paper. The pool of Australian provincial bonds with a top credit rating from more than one ranking firm has shrunk by 20 percent following S&P’s move. Along with federal securities and sovereign-backed Kangaroo issuers, state governments are a mainstay of the market for top-quality bonds which are vital to the functioning of bank balance sheets.
“There is a risk that Moody’s would also be looking at some of the long-term fiscal trends and follow this action, though we are yet to be convinced that they will lower their rating on WA,” said Tony Morriss, head of interest-rate research at Australia & New Zealand Banking Group Ltd. in Sydney.