DBRS Confirms Australia at AAA and R-1 (high), Stable Trend

DBRS, Inc. has today confirmed the Commonwealth of Australia’s long-term foreign and local currency issuer ratings at AAA and its short-term foreign and local currency issuer ratings at R-1 (high). All ratings have a Stable trend.

The confirmation of the AAA ratings reflect DBRS’s view that the Australian economic and institutional fundamentals are strong, despite the July 2, 2016 election that narrowed the Coalition government’s ruling majority and weakened its political mandate. Moderate public sector debt, a flexible exchange rate, sufficient monetary and fiscal flexibility, and effective government institutions support the wealthy and resilient Australian economy. The outcome of the election has raised questions around the fiscal consolidation strategy and occurred at a time when the economy faces heightened challenges. These include the uncertain economic transition to broader drivers of growth outside the mining sector and the high household debt from the persistently rising price of real estate. Nevertheless, Australia has a high capacity to absorb shocks and cope with these challenges.

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 drove activity for most of the last two decades. Despite declining mining investment and slower real income growth since the terms of trade peak in 2011, DBRS expects growth to remain healthy.

The country’s public debt burden has increased sharply since 2007 but remains manageable. General government debt reached 37% of GDP in 2015, according to the IMF, well below the 67% of GDP average among DBRS AAA-rated sovereigns. The consolidation process has been slower than directed by previous budgets due to commodity revenue underperformance, weaker income growth, and rising public expenditures. Notwithstanding the weakened Coalition government, the Treasury forecasts the deficit to narrow to 1.4% by fiscal year 2017-18, from 2.4% in 2014-15. DBRS’s baseline scenario is for the government to achieve a primary surplus by 2018 and stabilize net debt below 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 at 1.0%. Efforts have been made by the Australian Prudential Regulatory Authority (APRA) to set capital ratios such that Australian banks are “unquestionably strong” in order to reduce long-standing bank vulnerabilities such as exposure to residential mortgages. The ratio of regulatory tier 1 capital to risk weighted assets increased on an international basis to 13.8% as of 1Q16. APRA also required the largest banks to increase risk weighting on mortgages over the last year. Furthermore, bank reliance on offshore wholesale funding has diminished due to improved deposit 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. After driving growth over the last decade, gross investment has made a negative contribution to annualized growth since mid-2013. Thus far, non-mining investment has not offset the significant decline in mining investment. Output potential has declined to 2.6%, according to the IMF, below the 3.2% historical growth average. Household consumption has been the primary growth driver since mining investment peaked, as expansionary policies, currency depreciation, and lower oil prices support domestic consumption. The decline in the unemployment rate, to 5.8% in June 2016 from 6.3% in June 2015, illustrates labor market flexibility.

Rising property prices and high household debt generate some cause for concern. The household debt to disposable income ratio reached an all-time high of 134% in 2015, up from 70% in 2000. The increase in household debt is due to the dramatic rise in real housing prices, up 144% over the same period. Property price growth was initially due to effective financial sector reforms, and an increase in housing demand and household net wealth. More recently, interest rate cuts have fed through to the mortgage market and housing prices are up 25% from 2012 to 2015. Mortgages account for two thirds of total lending, thus exposing the financial system to deterioration in property prices. However, financial stability risks appear contained. High lending standards, net household savings, and capital buffers could limit the effect of a sharp decrease in property prices.

As a small open economy with high external debt and moderate concentration in the composition and the destination of exports, Australia is exposed to external price movements. Gross external liabilities increased to 118% of GDP in 2015, primarily by private sector external debt of 100% of GDP. Furthermore, key commodities make up two thirds of total exports, one third of which is directed to China. Easing Chinese demand has caused a decline in global prices for major mineral exports and an accompanying decline in Australia’s terms of trade. A sharper deterioration in the Chinese growth outlook would likely further pressure commodity prices and could pose challenging for domestic resource-sector firms. Nonetheless, private sector external debt is hedged against currency mismatches and rollover risk is mitigated by extended maturities. The flexible exchange rate has also served to absorb large downward adjustments in commodity price movements.

RATING DRIVERS

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

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. These can be found on www.dbrs.com at:
http://www.dbrs.com/about/methodologies

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 was not initiated at the request of the rated entity.

The rated entity or its related entities did participate in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.

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: Roger Lister
Initial Rating Date: 31 July 2014
Most Recent Rating Update: 29 July 2016

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