Overview

• The government has announced several large stimulus packages to support the economy in response to the COVID-19 shock. We expect the government debt burden to weaken materially as a result.
• We have revised our outlook on Australia to negative from stable to reflect a substantial deterioration of its fiscal headroom at the 'AAA' rating level. At the same time, we are affirming our 'AAA/A-1+' long- and short-term local and foreign currency ratings.
• Our ratings on Australia benefit from the country's strong institutional settings, its wealthy economy, and monetary policy flexibility. The country's high external and household indebtedness as well as its vulnerability to weak commodity export demand moderate these strengths.

Rating Action

On April 8, 2020, S&P Global Ratings revised the outlook on its long-term ratings on Australia to negative from stable. At the same time, we affirmed our 'AAA' long-term and 'A-1+' short-term unsolicited sovereign credit ratings on Australia.

Outlook

The negative outlook reflects our view that Australia faces fiscal and economic risks that are tilted toward the downside.

Downside scenario

We could lower our rating within the next two years if the COVID-19 outbreak causes economic damage that is more severe or prolonged than what we currently expect. With household indebtedness at elevated levels, this could delay the process of repairing the government balance sheet beyond what we expect currently. Government indebtedness and interest costs will remain at elevated levels.

Upside scenario

The outlook could revert to stable if the general government fiscal balance improves in line with our expectations as the economy recovers or if Australia's external position improves. Stronger fiscal and external positions would provide the sovereign with a buffer to absorb another potential economic or financial shock.

Rationale

The COVID-19 outbreak has dealt Australia a severe economic and fiscal shock. We expect the Australian economy to plunge into recession for the first time in almost 30 years, causing a substantial deterioration of the government's fiscal headroom at the 'AAA' rating level. The large budget deficits that we project in fiscal years 2020 and 2021 are likely temporary and do not represent a structural weakening of fiscal performance. Net government debt and relative interest cost nevertheless are likely to remain at elevated levels for a number of years.

Along with its strong institutions, a credible monetary policy, and floating exchange-rate regime, Australia's typically strong fiscal performance remains a credit strength for the rating. Australia meanwhile remains susceptible to vulnerabilities associated with its high external and household indebtedness.

Environmental, Social, and Governance (ESG) Credit Factors for this Credit Rating change:

• Health and Safety Factors

Flexibility and performance profile: Recession and fiscal stimulus to weigh on Australia strong public finances

• Large COVID-19-related budget deficits do not represent a structural weakening of fiscal performance. Net government debt and interest cost nevertheless are likely to remain elevated.
• Monetary policy and a flexible exchange-rate regime remain key strengths as the central bank commences purchasing government bonds.
• A high level of external and household indebtedness remains a key vulnerability to the economy and rating.

Australia's general government budget, including the Commonwealth and subnational governments, will deteriorate sharply in fiscal years 2020 and 2021 as the economy moves into a COVID-19-induced recession and governments across the country implement large stimulus packages. We believe the budget will begin improving in fiscal 2022, after the economy begins to recover.

We expected the general government deficit to average about 7.5% of GDP between fiscal years 2020 and 2021 before narrowing sharply. We believe the change in net debt would return to its structural level of 0% to 3% of GDP per year after the effects of COVID-19 pass through the Australian system. Revenue headwinds, including company and personal income taxes, consumption taxes, and property conveyance duties, and rising social welfare payments and health costs will drag on Australia's general government balance during the next few years, even as the government's large stimulus packages cease. The Commonwealth and, to a lesser extent, state governments have launched large fiscal stimulus packages worth about 3.8% of GDP in fiscal 2020 and 7.2% of GDP in fiscal 2021. These are designed to be temporary, and are targeted at supporting the economy and workers during the next six months. While fiscal stimulus measures will soften the blow presented by the COVID-19 outbreak and weigh heavily on public finances in the immediate future, they won't structurally weaken Australia's fiscal position. This expected improvement is a key supporting factor of our 'AAA' rating.

Although we expect fiscal outcomes to improve in fiscal 2022, risks are firmly pointed toward the downside. We believe there could be more fiscal stimulus packages to come and that economic conditions could further deteriorate, pushing the expected recovery beyond our current expectation of late 2020.

There is strong bipartisan support within parliament to achieve sound fiscal outcomes during the economic cycle. This was evident with Australia's budget improving in recent years on the back of tight fiscal discipline, strong labor market conditions, and high commodity prices. Australia was on track to achieve a surplus in fiscal 2021 before the COVID-19 outbreak, and achieved a deficit of just 0.5% of GDP in fiscal 2019. We believe Australia is more willing than its peers to raise revenue to achieve budget outcomes. The general government has been able to raise its revenue as a share of GDP during the past seven years, for example, despite commodity prices remaining well below the peaks in 2011 during this period.

With the widening of fiscal deficits during the next few years, we expect the change in net government debt to average about 8% per year in fiscal years 2020 and 2021, resulting in net general government debt almost doubling to 32% of GDP in fiscal 2021. Interest costs will rise to more than 5% of government revenues between fiscal years 2020 and 2023.

The government has also announced a 50% guarantee of small and medium-size enterprise loans entered into before Sept. 30, 2020. This has added about A$20 billion--roughly 1% of GDP--to its contingent liabilities, which remain limited. Among these are risks associated with the country's financial sector, including the property market.

The property outlook is uncertain; open houses and auctions have been restricted and a wide range of businesses closed as the government tries to limit the spread of COVID-19. We expect a decline in transaction volumes rather than a sharp fall in prices during this period, with prices aided by record low interest rates. House prices, which remain high relative to incomes, picked up strongly in the first half of fiscal 2020 following an orderly unwind between 2017 and 2019. We expect bank credit to nongovernment residents to fall in the current environment, while remaining very high at about 165%-170% of GDP, including interbank lending. An abrupt disruption in the property market, which is not our expectation, could lead to vulnerabilities in the financial sector and fiscal and economic stability.

We consider Australia's banking system to be one of the strongest globally (see "Banking Industry Country Risk Assessment: Australia," published on Oct. 24, 2019). Along with the high-income Australian economy, this reflects the low risk appetites of the major banks, which dominate the industry, and is supported by conservative and largely effective regulation. However, risks remain elevated as a result of a long period of high house price inflation and rising household indebtedness, including debt for unincorporated businesses.

We consider Australia's economy to be vulnerable to major shifts in international capital flows. Even though the current account deficit narrowed in recent years, we believe the economy carries a high level of net external debt, at 250% of current account receipts (CAR), volatility in the country's terms of trade, and a large stock of short-term external debt. Australia's short-term external debt, which is mostly bank debt, will also remain high, at more than 150% of CARs. Its high level of external debt has been exacerbated by historically high current account deficits of more than 10% of CARs. Current account deficits have narrowed to an estimated 1.5% of CARs between fiscal years 2020 and 2022, and the volatility in the country's terms of trade is beginning to decrease.

Australia's external debt is mostly generated by the private sector and reflects the productive investment opportunities available in Australia, foreign investor confidence in Australia's rule of law, and the high creditworthiness of its banking system. A portion of Australia's external debt has also funded a surge in household borrowing for housing in the past decade.

We expect Australia's external borrowers to maintain easy access to foreign funding. The Reserve Bank of Australia (RBA, the central bank) has maintained a freely floating exchange-rate regime for more than three decades. The Australian dollar represents a little more than 1.5% of allocated international reserves as of Sept. 30, 2019, and the currency is represented in a comparable percentage of spot foreign-exchange transactions. Australia's domestic bond market is deep, and although external borrowing is high, it is mostly denominated in the nation's own currency or hedged.

Australia has a high degree of monetary credibility via the independent RBA. This should help the country to temper major economic shocks such as the current COVID-19 outbreak, as it did during the 2008-2009 global financial crisis. We believe the RBA has successfully anchored inflation expectations over many years; however, it has struggled to achieve its inflation target in recent years as unemployment and underemployment remain stubbornly high. The RBA has responded to the current shock by cutting the overnight cash rate to 0.25%. It has also begun undertaking controlling the yield curve of three-year Australian Government Securities and state government securities by purchasing bonds in the secondary market. Its aim is to keep the yield around 0.25%, which should flow through to the economy, and help facilitate the smooth functioning of Australia's bond market.

Institutional and economic profile: High-income economy in recession and strong institutions are key credit strengths

• The Australian economy is high income and diversified, which support the rating, even though it is in recession.
• Australian governments have demonstrated a willingness and ability to implement reforms to sustain economic growth and ensure sustainable public finances.

While we believe the Australian economy is in recession, like most of its peers after the global outbreak of COVID-19, it remains wealthy and diversified, with a high GDP per capita of an estimated US$51,400 in fiscal 2020. Our expectations are for the economy to substantially weaken before recovering toward the end of calendar 2020. The government's large fiscal stimulus is aimed at supporting the economy during this period, particularly vulnerable workers and industries. These measures should somewhat soften the blow presented by COVID-19 and support the recovery efforts when they occur. Major weather-related events such as bushfires and storms also hindered economic activity in the most recent summer.

We estimate annual economic growth to fall to 1.3% in fiscal 2020, propped up by the first half of the year before bushfires and COVID-19, and strong population growth. However, Australia will record its first negative per capita growth since the 2008-2009 global financial crisis. We currently expect growth to pick up to 2.0% in fiscal 2021 and about 4% in fiscal 2022. On a per capita basis, growth will remain 0.9% per year on average.

While there continues to be a high degree of uncertainty about the rate of spread and timing of the peak of the coronavirus outbreak, some government authorities are estimating late second to mid-third quarter 2020, which we've used in assessing economic and credit implications (see "COVID-19 Macroeconomic Update: The Global Recession Is Here And Now" and "COVID-19 Credit Update: The Sudden Economic Stop Will Bring Intense Credit Pressure," published March 17, 2020).

S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak about midyear, and we are using this assumption in assessing the economic and credit implications. We believe the measures adopted to contain COVID-19 have pushed the global economy into recession (see our macroeconomic and credit updates here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

Australia's economy is well-placed to recover after the COVID-19 outbreak is contained, thanks to its pent-up demand, low nominal interest rates, large infrastructure pipeline, strong population growth, and the waning negative effects of declining mining investment. A large amount of the government's stimulus packages are designed to aid businesses through this event and ensure the economy recovers faster than it would otherwise. Further, currency depreciation should support exports, particularly in education and tourism once travel restrictions are lifted.

Australia's high level of wealth derives from strong institutional settings and decades of economic reform, which have facilitated the country's flexible labor and product markets. Australian governments have demonstrated a willingness to implement reforms to sustain economic growth and ensure sustainable public finances, and have a strong track record from managing past economic and financial crises. Importantly, there is strong bipartisan support in parliament during economic and financial crises. Institutions are stable and provide checks and balances to power, there is strong respect for the rule of law, and a free flow of information and open public debate of policy issues.

Key Statistics

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Ratings Score Snapshot

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Related Criteria

• Criteria | Governments | Sovereigns: Sovereign Rating Methodology, Dec. 18, 2017
• General Criteria: Methodology For Linking Long-Term And Short-Term Ratings, April 7, 2017
• General Criteria: Use Of CreditWatch And Outlooks, Sept. 14, 2009
• General Criteria: Methodology: Criteria For Determining Transfer And Convertibility Assessments, May 18, 2009

Related Research

• Sovereign Ratings History, March 13, 2020
• Sovereign Ratings List, March 13, 2020
• Sovereign Ratings Score Snapshot, March 3, 2020
• Sovereign Debt 2020: Asia-Pacific Central Governments To Borrow Nearly US$3 Trillion, Feb. 21, 2020
• Sovereign Debt 2020: Global Borrowing To Increase To $8.1 Trillion Amid Favorable Financing Conditions, Feb. 20, 2020
• Global Sovereign Rating Trends 2020: Sovereign Debt Buildup Continues, Jan. 29, 2020
• Sovereign Risk Indicators, Dec. 12, 2019. An interactive version is also available at http://www.spratings.com/sri
• Banking Industry Country Risk Assessment: Australia, released Oct 24, 2019
• Global Sovereign Rating Trends: Midyear 2019, July 25, 2019
• Default, Transition, and Recovery: 2018 Annual Sovereign Default And Rating Transition Study, March 15, 2019

In accordance with our relevant policies and procedures, the Rating Committee was composed of analysts that are qualified to vote in the committee, with sufficient experience to convey the appropriate level of knowledge and understanding of the methodology applicable (see 'Related Criteria And Research'). At the onset of the committee, the chair confirmed that the information provided to the Rating Committee by the primary analyst had been distributed in a timely manner and was sufficient for Committee members to make an informed decision.

After the primary analyst gave opening remarks and explained the recommendation, the Committee discussed key rating factors and critical issues in accordance with the relevant criteria. Qualitative and quantitative risk factors were considered and discussed, looking at track-record and forecasts.

The committee's assessment of the key rating factors is reflected in the Ratings Score Snapshot above.

The chair ensured every voting member was given the opportunity to articulate his/her opinion. The chair or designee reviewed the draft report to ensure consistency with the Committee decision. The views and the decision of the rating committee are summarized in the above rationale and outlook. The weighting of all rating factors is described in the methodology used in this rating action (see 'Related Criteria and Research').

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