DBRS Confirms AAA Ratings to Australia, Stable Trend

DBRS, Inc. has confirmed the 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 reflect DBRS’s view that the Australian economic and institutional fundamentals are strong. Moderate public sector debt, a flexible exchange rate, significant monetary and fiscal flexibility, and effective government institutions support the wealthy and resilient economy. This provides Australia with a high capacity to absorb shocks. Offsetting these strengths are an uncertain transition to broader non-mining drivers of growth and high household debt from the persistently rising price of real estate.

The ratings could come under downward pressure if an external shock or a sharp deterioration in property prices – from a precipitous slowdown of China’s economy – were to weaken domestic demand and financial sector stability, and feed through to a sustained deterioration in economic growth, fiscal outcomes, and public debt.

Australia’s growth performance is consistently one of the strongest among advanced economies. The economy has not contracted since the early 1990s, demonstrating resilience to shocks. The combination of competition-enhancing economic reforms, strong demand for raw materials from East Asia, and robust mining investment has driven economic activity. Despite declining mining investment and slower real income growth since the terms of trade peak in 2011, DBRS expects output growth from rising resource exports and a recovery in the non-mining business sector to return real GDP to its 3% long-run average.

The country’s public debt burden has increased sharply since 2007 but remains manageable. Consensus estimates show general government debt reached 34.3% of GDP in 2014, below the 67.2% of GDP average among DBRS AAA-rated sovereigns. The fiscal consolidation process has been slower than directed by the 2014-15 budget due to commodity revenue underperformance and rising public expenditures. The underlying cash deficit ended the calendar year at 3.1% of GDP. Yet, the Treasury forecasts the deficit to narrow to 1.5% by fiscal year 2016-17 and DBRS expects net debt to remain stable around 20% of GDP over the medium-term, allowing space to provide fiscal support in the event of a shock.

The banking sector remains resilient and regulators appear to be managing risks to the financial system. The major banks are profitable and non-performing loans are low. Despite recent stress test results that indicate capital positions of the four major banks would fall to low levels under a severe adverse scenario, capital ratios remain above Basel III requirements. This provides a buffer to absorb possible asset quality deterioration. Improvement in capital ratios since the global financial crisis partly reflects a shift in banking activity towards mortgages and lower risk weights, rather than an ample increase in capital. As of July 2016, regulation will require the largest banks to adjust mortgage risk weighting to 25%, from 16%, increasing minimum capital requirements. Furthermore, the recent increase in domestic deposits reduces bank reliance on wholesale funding.

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 driving growth over the last decade, gross investment has made a negative contribution to annualized 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 authorities are attempting to rebalance the economy towards a higher share of service-sector products. During this transition, unemployment could remain high as labor migrates away from mining and is absorbed by sectors servicing the domestic economy as well as the rapidly growing Asian markets.

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 63.6 total exports from a decade of strong East Asian demand for raw materials. China increased its share of Australia’s total goods exports last year to 33.6%, up from 9.6% in 2004. 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 deterioration in the Chinese growth outlook would likely further pressure commodity prices and could pose challenging for domestic resource-sector firms. Nonetheless, the flexible exchange rate has served to absorb large downward adjustments in 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 to 154% in 2014, due to rising real housing prices that increased 203%over the same period. More recently, interest rate cuts have fed through to the mortgage market and housing prices are up 16.9% from 2012 to 2014. Mortgages account for 61% of total lending, thus exposing the financial system to deterioration in property prices. However, high household debt is offset by household net savings, which increased as a percent of disposable income from 1.4% to 9.3% from 2006-2014. 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.

DBRS does not typically accept editorial changes other than to correct for factual, accuracy and/or to remove confidential, material non-public, or sensitive information that might otherwise be inadvertently disclosed.

Lead Analyst: Jason Graffam
Rating Committee Chair: Roger Lister
Initial Rating Date: 31 July 2014
Most Recent Rating Update: 31 July 2014

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