From national treasures Tim Toohey and Andrew Boak:
The rising risk of a ratings downgrade
In this report we discuss the risk of a possible downgrade to Australia’s Sovereign rating. Credit rating agency Standard & Poor’s (S&P) current rating is AAA; Stable. We see potential for Australia to be placed on a “negative outlook” over the coming months. This raises the possibility that Australia could see its first outright ratings downgrade since 1989.Low debt levels, but Australia’s poor fiscal performance scores poorly across S&P’s updated ratings methodology Although Australia’s overall public debt burden remains favourable relative to its 11 other AAA-rated peers and contingent liabilities look manageable, significant external vulnerabilities persist and a mix of sharply lower commodity prices, weak growth and political impasse have resulted in an unprecedented degree of fiscal slippage over recent years. Against the backdrop of cumulative negative parameter variations totaling A$283bn in the past 2½ years alone, and our expectation that a further ~A$55bn deterioration may be revealed in the 12 May Budget, we show how S&P’s recently updated ratings methodology suggests a downgrade to Australia’s AAA (stable) status – at a minimum – to a “negative outlook”.
Economic/financial fallout is negative – if difficult to forecast
While the impact of such an event is extremely difficult to forecast, it might reasonably be expected to further undermine consumer/business confidence and strengthen the negative feedback loop which is already hindering a pick-up in spending and borrowing – thereby further diluting the transmission mechanism of monetary policy. In financial markets, there is evidence that a downgrade to “negative outlook” lifts sovereign funding costs by ~10bp (ECB); we anticipate a related downgrade of Australia’s major banks (currently AA-) might raise the cost of term wholesale funding by 5-15bp, potentially adding additional downward pressure (a few percentage points) on the AUD towards our 12-month target of US67c.
It’s always a delight when the sell side out-bears MB. I will add that a pre-emptive downgrade may actually have some positives:
- it would kill the Abbott Government stone dead and force change to someone competent (or less incompetent), and
- elevate Budget discussion to the highest national priority while the global “search for yield” mitigated any dramatic impact on interest rates, raising the prospect of corrective action before we reached the next cycle-ending external shock.
Tough love, as it were.
Having said that, given the caliber of our leadership class, it would more likely send them into total meltdown, shock the Hell out of households, trigger more rate cuts, and leave us even more denuded of counter-cyclical policy ammunition for when the next external shock does come.
