DBRS Confirms the Commonwealth of Australia at AAA, Stable Trend

DBRS, Inc. has 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). The trend on all ratings is Stable.

The confirmation of the AAA ratings reflects Australia’s sound economic fundamentals, prudent policy management, and strong public institutions. The economy continues to grow at a robust pace even amid a large terms of trade shock, and the process of economic rebalancing toward non-mining sectors is advancing. Nevertheless, pockets of weakness persist and other challenges, such as rising home prices, are intensifying.

The ratings are underpinned by Australia’s low public debt and substantial financing flexibility. Gross general government debt reached 41% of GDP in 2016, a level that compares favorably to most other AAA-rated sovereigns. Although public debt has increased since 2008, debt dynamics are expected to stabilize over the next two years as the fiscal adjustment advances. With a strong sovereign balance sheet and historically low interest rates, DBRS believes that Australia has fiscal space to support the economy if needed without putting stress on the AAA rating.

Australia is a highly productive, competitive, and diversified economy. In terms of growth, Australia has outperformed most of its peers for decades. The economy has not suffered a recession since 1991, as sound macroeconomic policy, competition-enhancing reforms in the 1980s and 1990s, and rapid growth in China helped set the stage for a prolonged period of economic expansion.

The economy has also shown remarkable resilience since the end of the mining boom. Currency depreciation has facilitated the economic rebalancing, while monetary accommodation has supported domestic demand. Service exports, in particular, have benefited from the weaker currency and strong demand from trading partners. The unemployment rate has remained relatively low, as strong job growth in the services sector has helped absorb job losses in the mining sector. External conditions have also started to improve. Australia’s terms of trade strengthened in the second half of 2016 and key commodity export prices continued to rise during the first three months of 2017. The IMF expects GDP growth of 2.6% this year and 3.0% in 2018.

While the adjustment has advanced, there are some lingering pockets of weakness. Subdued wage growth and rising levels of underemployment point to slack in the labor market. Furthermore, non-mining capital expenditures have not yet picked up, despite favorable financing conditions.

Australia’s credit profile is supported by a track record of prudent fiscal management. Moderate budget deficits since the global financial crisis have increased the public debt ratio. Nevertheless, the government is implementing a gradual consolidation plan that aims to support the economy as it recovers while providing a medium-term path to balance the budget. DBRS views the commitment to fiscal consolidation positively, but notes that fiscal policy has scope to provide additional support if economic conditions weaken.

In addition, the banking system is well-capitalized with excellent asset quality. The four large Australian banks have increased capital levels in response to regulatory pressure. Strong domestic franchises and efficient cost structures generate consistently robust profitability. Banks have also improved their funding profiles since 2008 by shifting from wholesale to more deposit funding. Lending profiles are generally conservative. Nevertheless, the regulators have introduced additional measures to slow mortgage credit growth, particularly in riskier segments of the market, and bolster bank resilience to shocks.

The main external risk to the outlook is a sharp deceleration in China. As the Chinese economy continues to rebalance process toward more consumption-led growth, risks related to rising corporate debt are rising. A negative growth shock in China would principally affect Australia through the terms of trade channel. Metals, coal, and fuel products account for roughly 60% of Australia’s goods exports, and therefore are exposed to price fluctuations. Spillovers could extend to Australia’s services sector, particularly tourism where China is an increasingly important source of demand.

On the domestic side, expansionary monetary policy has contributed to the buildup of financial imbalances. National housing prices have been rising at a rapid rate since 2012 on the back of supply constraints and low interest rates. Rising home prices in some cities have coincided with rising household debt. The share of household debt to disposable income increased from 129% in December 2000 to a record-high 196% in September 2016. While financial stability risks appear contained, first round effects from an external shock on the Australian economy could be amplified by a correction in the domestic housing market.

RATING DRIVERS
The Stable trend reflects DBRS’s view that Australia has a high capacity to absorb shocks and cope with pending challenges. However, the ratings could experience downward pressure if a large shock or a sharp correction in property prices were to substantially weaken growth prospects and fiscal outcomes, resulting in a sustained deterioration in public debt dynamics.

Notes:
All figures are in A$ 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 at http://www.dbrs.com/about/methodologies.

The sources of information used for this rating include Australian Bureau of Statistics, Reserve Bank of Australia, Australian Office of Financial Management, IMF, UNDP, OECD, and Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating 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 did not have 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: Michael Heydt, Vice President, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer, Global FIG and Sovereign Ratings
Initial Rating Date: July 31, 2014
Last Rating Date: July 29, 2016

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