Worrying About Aussie AAA Is So 1980s as Economy Craves Stimulusby
Markets yawn as S&P fires warning shot on top credit rating
Politicians shudder at prospect of losing ‘badge of honor’
The silence was deafening.
When S&P Global Ratings fired a warning shot on Australia’s AAA sovereign grade -- cutting the outlook to negative from stable -- the announcement was met with a metaphorical yawn on the currency, equity and bond markets. While local lawmakers scurried to microphones to reassure the electorate, traders instead focused on a global bond rally that’s left little role for ratings among developed nations.
For S&P, the inconclusive July 2 national election raised question marks about the prospects of implementing fiscal tightening in coming years, worries that the politicians sought to soothe. Yet for economists considering the drag from the end of Australia’s mining-investment boom, and large infrastructure needs to provide for an expanding population, an obsession over the rating is a misplaced concern.
“In the current global macro environment, where low inflation and weak growth are sending many sovereign yields negative, and major central banks are about to deliver further monetary policy easing, there may be less cost or impact from a ratings downgrade,” said James McIntyre, head of economic research at Macquarie Bank Ltd. “AAA ratings are now very scarce.”
The AAA score Australia holds with just 11 others is more a badge of honor for the country’s political class -- and has become increasingly so in recent years as their record of reform has diminished. A downgrade would tarnish any sitting treasurer’s tenure, after repeated elections in which both main political parties at least paid lip service to fiscal discipline.
Treasurer Scott Morrison held a press briefing to address S&P’s statement less than an hour after it hit the wires. Now, the perceived albatross of a potential downgrade may spur Aussie politicians to find common ground in tackling the budget deficit -- leaving less fiscal support for an economy with weak wage growth.
The Liberal-National coalition -- tipped to form government with a slender majority -- has the view that Australia has a spending, not revenue, problem and opposes increasing taxes. The main opposition Labor party is prepared to hike taxes, but wants to spend the proceeds, especially on healthcare and education. The stalemate has plagued fiscal policy for the past three years, and put the country on track for a dozen years of deficits.
The ruling coalition said in this year’s budget that the gap would be closed by 2021. Such promises have been made before. S&P flagged on Thursday that the previous Labor administration pledged in 2009 it would return the books to the black by 2013.
Today’s deficits are a legacy of tax cuts executed during the height of Australia’s mining boom in the last decade, when then-Treasurer Peter Costello deployed the windfall cash from surging exports to China. The move, popular at the time, left fiscal revenue structurally weaker once record commodity prices reversed.
In an era when Japan has the world’s most-indebted government yet also has negative yields even on bonds that mature more than a decade from now, ratings are decreasingly relevant. When the U.S. and U.K. were stripped of their top grades, it proved no deterrent to their debt yields falling.
Indeed, the Aussie failed to move Monday when Moody’s Investors Service warned the nation’s credit profile depended on effective implementation of the government’s fiscal objectives.
Circumstances are much different from the 1980s, when Moody’s downgraded Australia at a time when the country was in the grip of weak commodity prices and collapsing exports, and few international investors sought Aussie assets as a diversification strategy. Then-Treasurer Paul Keating warned that the nation risked becoming a "banana republic" if it failed to change.
"If this government cannot get the adjustment, get manufacturing going again, and keep moderate wage outcomes and a sensible economic policy, then Australia is basically done for,” Keating said in an interview in 1986, after the nation recorded what was then its biggest current-account deficit. "We will end up being a third-rate economy.”
Keating came out with a tough fiscal plan in August that year that pledged cuts in real spending and administered another dose of austerity in May 1987. The downgrade served to galvanize political action.
It took 16 years for Moody’s to restore the AAA grade. In between came the country’s worst recession since the 1930s and relentless implementation of politically difficult economic change that included tariff cuts, competition reform, Costello’s 1996 budget cuts and the introduction of a goods and services tax in 2000.
While industries and their workers saw a painful adjustment, wages and incomes advanced, leaving it now one of the world’s wealthiest nations, with a targeted welfare state. As population gains strain the country’s infrastructure, McIntyre at Macquarie is among those calling for the government to counterbalance the drag from falling mining investment.
For now, there’s little sign of either political party endorsing either an immediate return to fiscal discipline, coupled with regulatory reforms to spur growth, or an ambitious national infrastructure initiative.
Amid the drift, S&P holds its finger on the downgrade trigger.