Morningstar DBRS Confirms Australia at AAA, Stable Trend

DBRS, Inc. (Morningstar DBRS) confirmed the Commonwealth of Australia's Long-Term Foreign and Local Currency - Issuer Ratings at AAA. At the same time, Morningstar DBRS confirmed the Commonwealth of Australia's Short-Term Foreign and Local Currency - Issuer Ratings at R-1 (high). The trend on all credit ratings is Stable.

KEY CREDIT RATING CONSIDERATIONS

Australia's AAA credit ratings are underpinned by the country's considerable fundamental strengths, including its diversified and highly productive economy, sound macroeconomic policy framework, and highly effective governing institutions. The Stable trend reflects our view that Australia's credit fundamentals remain very strong despite challenges like persistent inflation, modest growth, and a shortage of housing.

The Australian economy has slowed under the pressure of restrictive monetary policy and tighter financial conditions. Despite strong population growth, private consumption weakened over the past year as households endured high interest rates, elevated inflation, and increased tax payments due to bracket creep. Private dwelling investment contracted, partly due to high construction costs. Offsetting this was strong growth in government spending and business investment. The economy is expected to gradually accelerate in 2025, supported by moderating inflation and a resilient labor market. The IMF forecasts GDP growth of 1.2% in 2024 and 2.1% in 2025. The labor market remains strong despite some signs of loosening. Headline inflation has declined in recent months but lingering underlying price pressures could slow the pace of disinflation. The Reserve Bank of Australia (RBA) has held the cash rate steady at 4.35% since November 2023 and will likely maintain its restrictive stance until inflation sits sustainably within its 2-3% target range. We view financial stability risks related to the housing market as contained.

Public finance metrics are in a strong position, as evidenced by the federal government's fiscal surplus position over the last two years. The surpluses were largely driven by higher revenues, supported by a strong labor market and elevated commodity prices. General government debt declined 8 percentage points of GDP from 2020 to 2023. Fiscal deficits are expected to return this year, leading to a modest uptick in the debt ratio through 2025. Nevertheless, the debt trajectory is projected to decline over the next few years.

CREDIT RATING DRIVERS

The Stable trend reflects our view that a downgrade of the credit ratings is unlikely in the near term. Australia has a high capacity to absorb shocks and cope with pending challenges. However, the credit ratings could be downgraded over the medium term if there is a sustained deterioration in fiscal policy discipline.

CREDIT RATING RATIONALE

Fiscal Surplus Is Expected To Shift To A Moderate Deficit

Following two consecutive surpluses, the federal government fiscal balance is expected to move to a modest deficit. The underlying cash surpluses were recorded at $22.1 billion (0.9% of GDP) and $15.8 billion (0.6% of GDP) in FY2022-23 and FY2023-24, respectively. The favorable fiscal results reflect increased tax revenue from bracket creep, elevated commodity prices, and tight spending control. The fiscal balance is forecast to tip back to a moderate deficit this fiscal year, following the implementation of the stage-three tax cuts, moderating commodity prices, and recent cost-of-living relief measures. At the aggregate state level, the fiscal position is projected to weaken given additional cost-of-living support spending and increased infrastructure investment. Over the medium term, additional structural spending pressures could emerge, particularly related to the ageing population, the National Disability Insurance Scheme (NDIS), and the energy transition.

Debt dynamics appear stable due to expectations of moderate economic growth and prudent fiscal policy. Debt-to-GDP for the general government (which includes the Commonwealth, as well as state, territory, and local governments) declined from 57% in 2020 to 49% in 2023. The IMF projects the ratio to modestly rise to 50% in 2025 and then gradually decline over the medium term. Interest costs are expected to rise because of higher borrowing costs but remain, overall, at modest levels. Additionally, the government balance sheet is solid regarding implicit liabilities. The low level of unfunded pension liabilities puts the public sector in a comparatively strong position to manage pension costs over time.

Slow Disinflation Supports The RBA's Restrictive Stance; Housing Price Growth Is Easing

Inflation is moderating but remains elevated due to lingering services inflation. Headline inflation has substantially declined from its peak in late 2022 to 2.8% (y/y) in the third quarter of 2024, partly reflecting the temporary impact of government's electricity rebates. However, core inflation remains high. Core inflation (trimmed mean) was 3.5% in the third quarter. Rising rent, healthcare, education, and insurance prices are key index components driving high inflation. The RBA has held the cash rate at a 13-year high of 4.35% since last November and will likely maintain a contractionary monetary policy stance until underlying inflationary pressures are consistently running within the 2-3% target band.

Following a rapid rise in housing prices over the past two years, home price growth in Australia is easing. Housing prices are generally elevated relative to pre-pandemic levels, reflecting strong demand amid a shortage of housing. Increasing supply has been a challenge due to high construction costs, labor shortages, and zoning restrictions. The rental market is also tight with low vacancies. Rental inflation is moderating, with some regions slowing faster than others, but rents overall are still high relative to pre-pandemic prices. High interest rates and the normalization of net migration levels should help to alleviate demand pressures and support a softening in the housing market.

Financial stability risks appear contained. High levels of household debt and the common variable-rate mortgage in Australia make consumers vulnerable during periods of rising interest rates. Nevertheless, most Australian households have managed the increased cost pressure well, with only a small portion of borrowers experiencing severe financial strain. Australian household balance sheets have been supported by the resilient labor market and the strength of the housing market. Furthermore, a large majority of debtors have accumulated prepayment buffers in the form of offset accounts or redraw facilities, which can help Australian borrowers ease their overall debt burdens. The large Australian banks are well-capitalized with a high level of liquid assets. Strong domestic franchises consistently generate robust profitability. We view the Australian banking system as well-positioned to navigate the current environment. However, we make a one-category adjustment to the `Monetary Policy and Financial Stability' building block assessment to reflect risks that some households and firms could come under financial strain amid high interest rates and adversely impact asset quality on the margin.

Medium-Term Growth Prospects Are Comparatively Strong

The Australian economy has outperformed most of its peers in terms of growth for the last two and a half decades. The drivers of growth have been multifold. Structural reforms in the 1980s and 1990s helped set the stage for a prolonged period of expansion. From the 2000s, Australia benefited from rapid growth in China, which greatly increased demand for Australian goods and services and fostered a decade-long investment boom. Another major contributor was robust population growth, which strongly recovered following the pandemic shock, as temporary workers, tourists, and international students returned to Australia. Net overseas migration accounted for 2.1% of population growth in 2023, with a record net inflow of over 540,000 migrants. The government plans to normalize immigration levels over the next few years, but Australia's medium term growth prospects remain strong.

The main external risk to the economic outlook is a sharp deceleration in Chinese growth. Continued weakness in the Chinese real estate sector and the potential escalation of global trade tensions pose risks to China's outlook. In the unlikely event of a prolonged slowdown in China, Australia would primarily be affected through the terms of trade channel. As Australia's principal trading partner, China accounted for 33% of exports in 2023. Metals, coal, and fuel products account for more than half of Australia's exports. The deterioration of China's property sector could lead to a reduction in demand for Australian commodities like iron ore and coal. In addition, spillovers could extend to Australia's education and tourism service exports, where China is also a leading source of demand. Over the past year, regional tensions between Australia and China appear to be receding. Nearly all of China's restrictions on Australian goods, which were implemented during the pandemic, have been lifted. The final import ban, on Australian lobsters, is expected to be lifted by the end of the year. However, if trade tensions escalate between the two Asia-Pacific countries or between the U.S. and China, the outlook could be negatively impacted.

Australia's external accounts appear broadly in line with economic fundamentals. While Australia has been a perennial net importer of capital for decades, the current account shifted to a surplus from 2019 to 2023. The surplus was principally driven by a large trade surplus, as Australia's terms of trade improved on the back of elevated resource commodity prices and increased commodity production. The surplus has shifted back to a modest deficit of 0.7% of GDP in the first half of 2024 (on a rolling 4 quarter basis), as export commodity prices declined. Morningstar DBRS expects the current account deficit to modestly widen over the next few years. The net foreign liability position remains high (averaging 42% of GDP over the last five years) but has improved, in part due to rising external equity asset values. Risks to balance sheets stemming from currency volatility appear relatively limited and a sizable share of foreign liabilities are in the form of equity.

Australia's Strong Institutional Quality Supports The AAA Credit Rating

Australia's political institutions are a fundamental strength of the sovereign credit profile. Australia is a stable, liberal democracy with effective governing institutions. The political environment is characterized by strong rule of law, a sound regulatory environment, and low levels of corruption. The ruling center-left Labor Party holds a narrow majority in the House of Representative (78 out of 151 seats), but has a minority position in the Senate. As a result, the Labor Party must reach an agreement with the opposition or Independents to pass legislation in the upper chamber. Federal elections are due next year, and the incumbent Labor Party, led by Prime Minister Anthony Albanese, will defend its three-seat majority in the Lower House. The key policies of Australia's Labor Party include investment in housing supply, advancement of renewable energy policies, and improvement to health and well-being services like Medicare and aged care.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

There were no Environmental, Social, or Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (August 13, 2024) https://dbrs.morningstar.com/research/437781.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments. https://www.dbrsmorningstar.com/research/442987.

Notes:
All figures are in Australian dollars unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal methodology is the Global Methodology for Rating Sovereign Governments (July 15, 2024) https://dbrs.morningstar.com/research/436000. In addition Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings https://dbrs.morningstar.com/research/437781 in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' outlooks and credit ratings are monitored.

The primary sources of information used for these credit ratings include the Australian Treasury, Reserve Bank of Australia, IMF, Australian Bureau of Statistics, BIS, World Bank/NRGI/Brookings, Federal Reserve Bank of Dallas, and Macrobond.

Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings was of satisfactory quality.

The credit rating was not initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

Morningstar DBRS did not have access to the accounts, management and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

The last credit rating action on this issuer took place on January 19, 2024.

For more information on this credit or on this industry, visit dbrs.morningstar.com.

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