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High Noon for Australia’s AAA Rating as Weak Wages Drag Budget

  • Government could be first in 30 years to lose coveted grade
  • Economists expect little change to updated deficit forecast

A worsening of Australia’s deficit in a budget update due at midday could trigger a downgrade of its top credit score. Politicians are worried; economists less so.

While the prospect of being the first government in 30 years to lose the coveted grade alarms lawmakers, some economists think its loss could pave the way for increased spending. Most predict the forecast deficit for the current fiscal year will be little changed from a May projection, and few are panicking about losing the AAA -- whether that happens this week, next year or at all.

The major swing factors for Australia since May have been weaker wages growth and a slower-than-forecast economic expansion; on the plus side, soaring iron ore and coal prices have made budget estimates from seven months ago look outdated. It could be that the good and bad simply cancel each other out, hence the median of 16 economist estimates’ close proximity to the A$37.1 billion ($27.1 billion) deficit forecast in May.

“Much depends on how much of the commodity-price bounce policy makers assume will remain in the forward estimates,” said Paul Bloxham, chief Australia economist at HSBC Holdings Plc. “Although there is a risk of a rating downgrade, we doubt it will arrive today. More progress on fiscal reform is likely to be needed if Australia is to ultimately avoid losing its triple-A rating.”

S&P Global Ratings put Australia on “negative outlook” in July, responding to a knife-edge election that resulted in the government just scraping together a majority in the lower house of parliament. S&P’s take on the outcome was that pressing through fiscal policy decisions would prove even tougher than in the previous term, when opposition parties blocked many proposals.

Two months before that election, Treasurer Scott Morrison projected the books would return to balance by 2021. S&P wants to see evidence that will be achieved, noting the budget has been in deficit since 2009 and a previous Labor government pledged a surplus would be achieved in 2013. That forecast was eventually ditched at the end of 2012.

In parliamentary sessions since the July election, the government has managed to pass some savings, though not without slippage, as it wooed smaller party lawmakers. Given Morrison won’t be announcing new measures with this budget update, the general consensus among economists is that S&P will wait for May 2017 proposals before moving.

Some economists including Westpac Banking Corp.’s Bill Evans have suggested that a rating downgrade would actually be an effective way to break the political gridlock. Losing the AAA could relieve the government of its battle to retain it, and spur much-needed long-term infrastructure spending.

What If S&P Cuts?

In the event S&P bites the bullet this week and opts to downgrade, Peter Jolly, head of market research at National Australia Bank Ltd., sees the following consequences:

  • Downgrade of banks and states, which get an uplift from the sovereign
  • Little reaction in bonds and currencies, as the move has been generally priced in

Jolly’s greater concerns are twofold:

  • Any “spend up” on infrastructure could lead to even more government largess and potentially spur a longer-term slide in the rating
  • The sheer volume of government debt that has been and will be issued may start to “crowd out” the private sector

Another broader issue is Australia needs to attract foreign investment to fund its investment as there’s insufficient domestic savings. As a result, the budget position matters.

“Put another way, a government that can’t balance its day-to-day expenses will not instill foreigners with confidence to invest in Australia,” Jolly said. “Overall, a downgrade will leave Australia with a lesser credit rating and no less urgency for budget repair.”

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