S&P gets positive on Australia

There is no reference here to declining deposit rates or the need to borrow more offshore when the “traditional sectors” of the economy start to fire. In fact, much of the note is dedicated to finding strengths in our savings rate:

And the resilience of foreign investor appetite for Australian assets:

The rise in mining and energy investment has likewise seen a shift in net capital inflows toward foreign direct investment (FDI) in recent years (see chart 6). These FDI flows are likely to be less susceptible to sudden shifts in investor sentiment than portfolio flows. Mining and liquefied natural gas (LNG) projects are underpinned by medium-to-long term payoffs, so these investors will probably focus more on longer-term demand fundamentals than short-term volatility. The very large LNG projects that are under construction also have long-term contracts with customers in place.

Along with FDI, foreign investment flows into government bonds have been strong in recent years, with the share of foreign ownership rising to more than 70%. This capital is probably more vulnerable to a sharp withdrawal than FDI. But we note that, anecdotally, foreign central banks have been among the main buyers of this debt; these investors are unlikely to quickly alter their portfolios in response to swings in broader investor sentiment. In any event, the government will become much less exposed to capital markets should the budget balance shift to surplus in the next year or so as we expect.

The note concludes:

In summary, Australia remains on a sound path in our base-case scenario, with a number of key strengths supporting the ‘AAA’ rating. Yet there are risks, albeit low-probability ones, that could cause the sovereign credit rating to fall. Australia is not immune to a number of downside scenarios which, if they eventuate, would likely cause higher public debt levels and put downward pressure on the rating. Further, we could lower the ratings if external imbalances were to grow more than we currently expect, either because the exchange rate no longer adjusts to terms of trade movements, the terms of trade deteriorate quickly and markedly, or the banking sector’s cost of external funding increases sharply.

That said, a number of mitigating factors would assist the Australian economy to withstand such potential shocks and limit the sovereign’s financial exposure. Australia’s strong fundamentals also make steep falls in the sovereign credit rating highly unlikely, barring major policy errors.

This more positive tone coincides with sovereign analyst Kyran Curry moving from Australia to Europe. The two new analysts, Craig Michaels and KimEng Tan, are clearly more favorably disposed towards Australia. If you think that’s weird in something so important as a sovereign rating then guess again. A rating is only an opinion.

I will close by saying that as much as I would like to embrace this change of tone, I reckon it’s a mistake. While there is no doubt that Australia is enjoying fantastic cyclical strengths that should be reflected in ratings analysis, its structural position is more imbalanced than ever. Modest improvements in household debt and external borrowing ratios have been achieved via massive increases in reliance upon a very narrow basket of commodities.

S&P also this week put out a note on the impacts for commodities in the event of a structural shift in China to lower growth. It estimated that the falls in commodity prices would be in the range of 5-12%, including for iron ore in downside scenario. Here is the chart from that note:

This is so laughably optimistic that I didn’t bother reporting it. If that is now informing their sovereign analysis then S&P is wrong on Australian risk.