DBRS Assigns AAA Ratings to Commonwealth of Australia, Stable Trend

DBRS, Inc. (DBRS) has assigned issuer ratings of AAA to the Commonwealth of Australia’s long-term foreign and local currency debt, and issuer ratings of R-1 (high) to its short-term foreign and local currency debt. The trend on all ratings is Stable.

The ratings and Stable trends reflect DBRS’s view that the Australian economic and institutional fundamentals are strong. Australia’s wealthy and resilient economy is supported by low public sector debt, a flexible exchange rate, significant monetary and fiscal flexibility, and effective government institutions. This provides Australia with a high capacity to absorb shocks. Offsetting these strengths are persistent external imbalances, declining terms of trade, and a transition to broader-based economic growth.

The ratings could come under downward pressure if an external shock were to significantly widen external imbalances and feed through to a structural deterioration in economic growth, fiscal outcomes, and public debt. Nonetheless, DBRS considers Australia’s credit fundamentals resilient to foreseeable shocks.

Australia’s growth performance is consistently one of the strongest among advanced countries. From 2003-2013, Australia grew at an average annual 3.0% rate, compared to the 1.7% OECD average. The economy has not contracted since the early 1990s and it managed to avoid a recession during the 2008-09 financial crisis. The combination of competition-enhancing economic reforms, strong demand for raw materials from East Asia, and robust mining investment drove this activity.

Capital formation in mining rose from 1.1% of GDP in 2002 to 6.3% in 2012, while global commodity prices reached record highs. Resource investments accounted for roughly half of the contributions to growth over the same decade. However, the end of the mining investment boom and weaker domestic demand are expected to create a near-term economic drag. The government forecasts growth below trend over the next two years.

The country’s public debt burden is low. At 31.6% of GDP in 2013, gross debt was well below the 65% of GDP average among DBRS’s AAA-rated sovereigns. While debt more than tripled since before the crisis as a result of greater fiscal support and declining revenue, debt-to-GDP ratios seem to have stabilized. The 2014-15 Budget aims to return the fiscal position to surplus by the end of the decade through increased revenues and restraint in operating expenditures. Due to the consolidation effort, DBRS expects gross debt to remain close to 32% of GDP through 2018. The government anticipates net debt to peak at around 15% of GDP in the 2016-17 fiscal year. With a low debt burden, Australia has space to provide fiscal support in the event of a shock.

The banking sector remains resilient and risks to the financial system appears well managed. The major banks are profitable and their capital holdings are above Basel III requirements, providing a buffer to absorb possible asset quality deterioration. Banks’ historic reliance on wholesale funding has diminished since the crisis, as domestic deposits have increased along with the household savings rate. Furthermore, the bank regulator has a strong track record of prudent supervision of the financial system. Regulation requires banks to hold more capital and obtain insurance against riskier borrowers, and the mortgage market cooled in the early 2000s without a disruptive decline in asset prices.

Australia has strong political, civil and social institutions that pursue a credible and transparent macroeconomic policy framework. This structure allows authorities to run strong counter-cyclical policies. Australia’s institutional strength is apparent in its strong legal system, the credibility of fiscal and monetary institutions, and overall public sector transparency. Despite these strengths, Australia faces several challenges.

The end of the mining-investment boom generates some uncertainty surrounding the economic outlook and pressures the economy to rebalance towards broader economic drivers. After supporting growth over the last decade, gross investment has made a negative contribution to growth since mid-2013. Net exports have surprised to the upside in recent quarters to offset the decline in investment. However, the end of the investment boom puts pressure on other sectors to support growth through increased productivity. Since manufacturing has been on a long-term declining trend, the Australian economy attempts to rebalance towards a higher share of service-sector products. During this transition, unemployment could increase as labor migrates away from mining and construction and is absorbed by other sectors.

Moderate concentration in the composition and the destination of exports exposes Australia to sharp movements in its main commodity prices. Non-rural commodities (primarily iron ore, coal, and LNG) now constitute two-thirds of total exports as a result of a decade of strong demand for raw materials from East Asia. China increased its export share last year to 36% of total from 8.4% in 2003. Easing demand from China has caused a decline in global prices for major mineral exports and an accompanying decline in Australia’s terms of trade. A sharp and unexpected fall in commodity prices could pose challenging for domestic resource-sector firms. Nonetheless, the downward adjustment in commodity prices has thus far been manageable and the floating exchange rate has served to absorb large commodity price movements.

Rising property prices and high household debt generate some cause for concern. The household debt to income ratio rose from 47% in 1990, one of the lowest among OECD countries, to 150% in 2013 broadly as a result of rising real housing prices, which have nearly tripled over the last two decades. More recently, interest rate cuts have fed through to the mortgage market and housing prices are up 15.2% since end-2011. Residential mortgages account for roughly half of total lending, thus exposing the financial system to significant deterioration in property prices. However, growth in household debt appears to have stabilized and a sharp increase in household savings since the financial crisis offsets the large debt burden. Moreover, authorities have a number of prudential tools that could limit the effect of a sharp decrease in property prices.

Notes:
All figures are in AUS dollars unless otherwise noted.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website under Methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website under Rating Scales.

The sources of information used for this rating are the Australian Treasury, Australian Bureau of Statistics, Reserve Bank of Australia, International Monetary Fund, World Bank, OECD, Haver Analytics, DBRS. DBRS considers the information available to it for the purposes of providing these ratings was of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

For further information on DBRS’ historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository see http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period while reviews are generally resolved within 90 days. DBRS’s trends and ratings are under constant surveillance.

Lead Analyst: Jason Graffam
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 29 July 2014
Most Recent Rating Update: None

For additional information on this rating, please refer to the linking document under Related Research.