Queensland's treasurer declared in June 2020 that "no government in Australia can think of delivering a surplus." We agree. Most Australian states and territories (hereafter "states") have almost eliminated community transmission of COVID-19, allowing their economies to reopen earlier than anticipated. But while the worst-case threat to public health may have passed, risks of further outbreaks loom large and the full fiscal shock is yet to transpire.

State governments ordinarily release their annual budgets around the second quarter (Q2) of each calendar year. This year, they've taken the extraordinary collective step of postponing budgets to Q4 at the earliest, resulting in a paucity of data. If states extend the delays well into calendar 2021, it could signal a shift in their commitment to fiscal transparency. We expect that when budgets are eventually released, many states will forecast historically large cash deficits and substantially higher borrowing needs.

The states have reportedly committed to around A$48 billion of health and economic support measures so far. Most of the support will be delivered during fiscal years 2019-2020 (i.e., the year ended June 30, 2020) and 2020-2021. We think the A$48 billion estimate is inflated because many announcements appear to simply fast-track or rebadge measures that were already budgeted.

However, upcoming budgets will almost certainly contain new stimulus measures. States are under pressure from federal policymakers and the governor of the Reserve Bank of Australia (RBA) to spend more, particularly through infrastructure investment. It may be difficult for states to add new projects to their large forward pipelines. New investment will help to create jobs, but workers aren't readily fungible across industries such as hospitality and retail that have been hit hardest by the pandemic. While more stimulus ordinarily implies greater borrowing, some states could "recycle" existing assets to finance new infrastructure.

These decisions are for governments and parliaments to make. S&P Global Ratings does not set limits on the amounts that states can spend or borrow. Our credit ratings speak to an entity's capacity and willingness to repay debt obligations. But the direction of fiscal policy can of course, among other economic and financial factors, contribute to rating changes.

This report is the first in a series that updates the market on key issues affecting the credit quality of the states. Downward risks to state credit ratings are rising, and are most elevated for Victoria, now battling a second wave of infections (see "Australian State Of Victoria 'AAA' Rating Placed On CreditWatch Negative On Pandemic Lockdown Uncertainty," published Aug. 5, 2020). In forthcoming articles, we assess in more detail the states' economic profiles, revenue streams, debt burdens, access to capital markets, and other factors.

Annual Budgets Have Been Delayed …

To date, five of the eight state governments have confirmed a date for their next budget (chart 1). Queensland and Australian Capital Territory will hold elections in October 2020; their budget dates will be left for the incoming government to decide. Several states have published interim fiscal updates covering only the 2020-2021 fiscal year and mostly excluding government-owned businesses. Australian Capital Territory on Aug. 27 released the most comprehensive update so far.

The states postponed their usual Q2 budgets following the decision of the Commonwealth (i.e., the Australian sovereign government) to defer its own until Oct. 6, 2020. This means they've now entered the 2020-2021 fiscal year without a formal budget. Budgets are sometimes rescheduled to accommodate elections, but the coordinated postponement this year is highly unusual. Annual reports for fiscal 2019-2020 are usually due around September or October but there could be delays this year. Some states have published preliminary, unaudited outcomes.

Chart 1

… And This Calls Into Question Some States' Commitment To Transparency

Budgeting in the midst of a crisis is tough. Official forecasts are often rendered obsolete within weeks or days of their release. Case in point: The strict "stage four" lockdown of Melbourne, Victoria's capital city, was announced just 10 days after the Commonwealth and Victoria released economic and fiscal updates. This substantially changed the assumptions underpinning both updates.

Nevertheless, if budgets continue to be delayed well into calendar 2021, we may reconsider our longstanding views on the commitment of policymakers to fiscal transparency. This is a key component of our financial management assessments on individual states and our institutional framework assessment that underpins all state ratings. The COVID-19 crisis has seen ministers granted exceptional powers with much less oversight than usual. Some state parliaments temporarily suspended or reduced their sitting days, too.

Transparency lags other countries. In the U.S., just 12 states--excluding Michigan, which has a fiscal yearend date of Sept. 30--had failed to enact a 2020-2021 budget before June 30 (see "As COVID-19 Grips U.S. State Finances, Some Budget Debates Will Continue Well Beyond The Deadline," published June 30, 2020). With only a handful of exceptions, New Zealand's 78 councils stuck to their June 30 statutory deadline for adopting annual plans. (In New Zealand, councils form the second tier of government and operate on a June 30 fiscal year, though their annual budgets cover just one year.)

Budgets are important for parliamentary scrutiny and public accountability. They offer detailed projections for revenues, expenses, assets, and liabilities for the upcoming fiscal year and three more years of "forward estimates." In addition, a state's budget is usually followed by an update from its central borrowing authority (i.e., its debt management office), laying out borrowing requirements for the upcoming year.

To keep the lights on, states have passed interim supply bills. In the past, supply mechanisms generally have only been used when fixed election dates cause delays to budgets or when there's a delay between budget day and the passage of accompanying appropriation bills.

Legislation passed in New South Wales allows the government to spend up to 75% of the prior year's appropriation, adjusted for inflation. This should keep public services running for about three-quarters of the 2020-2021 fiscal year or until the next budget, whichever occurs first.

Existing New South Wales laws give the state treasurer power to spend money in a crisis to meet "exigencies of government." In other states, parliaments have approved raising the limit of their "treasurer's advance," "treasurer's reserve," or "governor's appropriation fund" by a few percentage points to allow for unforeseen emergency spending (table 1). Amounts spent via these emergency powers are reported to and retrospectively approved by a later parliament.

Table 1

The legislation in Victoria provides interim spending authority of A$35.9 billion, equal to 50% of the prior year's appropriation (adjusted for inflation), to fund the government until its November budget. It also upsized the treasurer's advance limit to A$10 billion for the first six months and A$14.5 billion for the last six months of calendar 2020. An update in August 2020 estimated that A$2.6 billion had been drawn against the first A$10 billion tranche.

In Western Australia, Tasmania, and Northern Territory, supply of about 50% of the prior year's appropriation will allow their governments to operate until around Christmas. The figure is roughly 100% in South Australia and Australian Capital Territory. In Queensland, supply for the first half of fiscal 2020-2021 was in place from earlier legislation, and in April 2020 a supplementary A$1.6 billion was authorized.

Caution should be exercised in interpreting these numbers. The A$24.5 billion advance in Victoria is not a debt facility, as is sometimes reported in the media, though extra spending will usually imply more borrowing. And depending on the precise timing of budgets, the supply allocations of 50%-100% are such that states can generally spend money at a faster clip than last year. But the large sums in Victoria are noteworthy, especially as advances are typically reserved for operating rather than capital expenditure. We expect a substantial drawdown against the second, A$14.5 billion, tranche, given the need to provide economic support during Melbourne's stage four lockdown, and in response to the longer-lasting damage that the lockdown will inflict.

States Are Rolling Out Health And Economic Support Measures

The states have committed to approximately A$48 billion of emergency economic assistance, equal to 2.5% of GDP, according to Commonwealth estimates. It's difficult to quantify the real stimulus on offer, but we think the aggregate impact on state finances will be less than A$48 billion. Several announcements appear to simply fast-track or rebadge existing expense measures. A common approach, for example, is for governments to "guarantee" a future infrastructure pipeline that was already funded in a prior budget.

Table 2 is our compilation of major announcements. Reporting across jurisdictions is inconsistent and some states exclude new capital works from their tallies, so the table should be taken as indicative only. Most of the fiscal impulse will be felt in fiscal 2020-2021.

Tasmania announced a A$3.1 billion "construction blitz" (excluded from table 2) that includes A$1.8 billion already budgeted; the total construction value of private housing enabled by various state subsidies, rather than spent by the state; and A$200 million of assets reallocated in the state's pension fund. Some states have promised to speed up payments to suppliers, which helps to support supplier cash flow but is not new money. The take-up of some demand-driven relief programs appears to be running behind expectations, perhaps reflecting the faster-than-expected reopening of state economies.

Some initiatives, such as the provision of concessional loans to local councils or loan guarantees to universities, won't affect the nonfinancial public sector cash accounts that form the basis of our credit rating assessments. They could, if very large, change our assessment of a state's contingent liabilities. Where tax deferrals are offered to the private sector, government revenues are reprofiled rather than foregone, and so we would expect revenues to recover in future years.

The main categories of health or stimulus expenditures include grants to small businesses and JobSeeker recipients; various support packages for struggling industries, such as tourism and the arts; home building grants; boosts to health system capacity, including spending on beds, clinics, medical supplies, and mental health services; worker retraining funds; and new or accelerated infrastructure spending. On the revenue side, they include temporary tax concessions, deferrals, or rebates (for taxes on land, payroll, gaming etc.); license fee waivers; rebates on household fees, such as energy bills; and deferral of rent for tenants in government-owned properties.

Table 2

Momentum is building for further stimulus. The prime minister has called on states to spend big in areas like social housing and infrastructure, contending that the Commonwealth "cannot do all the fiscal heavy lifting on its own." (We think it's unsurprising that the lion's share of stimulus has so far fallen on the Commonwealth. After all, it controls most of the levers for funneling cash quickly to households and firms through the tax-and-transfer system.) Similarly, the RBA governor has said that state balance sheets should be utilized to create jobs and reportedly appealed for another A$40 billion of infrastructure investment over the next two years.

Stimulus Spending Will Weaken Budgetary Performance …

More capital spending will add to the strain on state credit profiles, especially if it is in the order of A$40 billion. Infrastructure investment isn't counted in the headline net operating balance--the balance of recurrent revenues and recurrent expenses--that state politicians focus on, but it is counted in the cash surplus/deficit and our measure of the after-capital-account balance. We look at both operating and after-capital-account balances in our credit rating assessments.

Both balances will take a battering in fiscal 2020-2021 across all of the states. The Commonwealth government has committed several billion dollars to state infrastructure grants for certain priority projects, which will only slightly offset the new spending.

In addition, our fiscal metrics take into account capital spending by government-owned enterprises such as public transport operators, electricity and water utilities, and ports. Our preferred perimeter of government is the nonfinancial public sector, which consolidates the general government sector--not to be confused with the concept of general government under our sovereign rating methodology--with public nonfinancial corporations.

… But The Forward Infrastructure Pipeline Is Already Brimming

By fast-tracking and announcing new infrastructure projects, states are borrowing from the post-financial crisis playbook of a decade ago. Back then, they ramped up capital investment by over 40% between fiscal years 2007-2008 and 2009-2010 (chart 2). The Commonwealth channeled large, specific-purpose grants to the states to upgrade schools, roads, and social housing. "Shovel-ready" was Macquarie Dictionary's word of the year in 2009.

Chart 2

Public investment may raise the productive potential of Australia's economy. It will also contribute to short-run growth at a time when domestic consumption and private investment are weak. In New South Wales, for instance, the government expects its near-A$100 billion four-year infrastructure pipeline to add about half a percentage point to state economic growth over the next two years. The construction industry is labor-intensive, accounting for 9% of all employment in Australia. Falling government borrowing costs will reduce the hurdle rates on some investments.

But new capital works could stretch the capacity of industry and government. This is because even before the pandemic, the states were already gearing up for an infrastructure boom. A large volume of road and rail projects is entering delivery phase, particularly along the eastern seaboard.

Skills and labor shortages continue to be a concern. Despite the rising unemployment rate, workers displaced from industries such as hospitality and retail are usually ill-suited for construction work. Decelerating population growth could alter the cost-benefit calculus or reduce the urgency of some projects. And politicians might be less inclined to worry about transport congestion if the pandemic leads to greater acceptance of working from home.

Despite these hitches, we anticipate that states will continue to see infrastructure as an obvious vector for stimulus. They will add to the pipeline of capital works beyond fiscal 2020-2021 so that the tapering at the end of chart 2 won't eventuate. So-called shovel-ready projects still take time to plan and execute--there's a natural tension between the desire to move money quickly and the practicalities of procurement--and so projects will likely end up spread across the forward estimates.

This will be good for the economy if the post-pandemic recovery is shallow or protracted. However, if spending is elevated over several years, such that a state's large after-capital-account deficits become entrenched rather than temporary, downside risks to credit ratings will grow.

Industry experts suggest that governments will need to concentrate on smaller-scale projects and maintenance. Shifting the focus to, say, social housing construction and school upgrades could see faster rollouts than new public transport initiatives, especially given the bleak outlook for workers in residential housing construction. The Commonwealth is also working on reducing environmental regulation approval times.

Some existing projects are experiencing delays. This is despite the designation of construction by most states as an "essential" industry during earlier lockdowns. Contractors have been affected by supply chain disruptions and restrictions on movement.

Tasmania underspent its capital budget, at general government level, by 27% in fiscal 2019-2020, according to its preliminary, unaudited accounts. It expects to play catch-up on infrastructure in fiscal 2020-2021. In Australian Capital Territory, the underspending was about 34% at total territory level. During the past few years states have often underdelivered relative to their capital budgets, and so, in the past, we have regularly assumed in our own budgetary forecasts an execution rate of 80%-90%. Crucially, this means debt tends to rise at a slower pace than is projected in state budget papers.

Asset Transactions May Be A Point Of Differentiation

We see upside to some states' fiscal metrics from the potential monetization of brownfield assets, whether by lease, concession, privatization, or similar arrangement. Over the past decade the states have raised billions of dollars for new infrastructure by "recycling" existing assets. These include ports, desalination plants, electricity networks, land title offices, public housing, commercial property, wagering operators, and insurance businesses.

Such transactions have helped several states, most notably New South Wales, deliver new infrastructure while maintaining debt at lower levels than would otherwise be the case. In some cases, debt that is held against a project is deconsolidated upon its sale. States will want to ensure that proceeds are used productively because giving up assets means losing a long-term revenue stream.

Western Australia is seeking bidders for its TAB wagering operator. South Australia is selling the franchise rights for Adelaide Metro tram and train services. New South Wales is scoping a potential divestment of its remaining 49% stake in WestConnex, a large motorway scheme. Commentators have identified tens of billions of dollars' worth of other potentially sellable state assets, such as energy companies. It's possible that transactions will be deferred if governments decide they cannot achieve a fair selling price during a pandemic.

Some state governments have forcefully campaigned against or were elected on the promise of no asset sales. We don't believe, for instance, that there is appetite for asset sales in Queensland. We also think that water assets, which comprise a large proportion of the public nonfinancial corporations sector, are likely to remain off the privatization agenda.

Deficits Rising, Credit Quality Under Strain

State credit quality is weakening. We have negative outlooks on our 'AAA' ratings on New South Wales and Australian Capital Territory, reflecting that on the Australian sovereign. Our rating on Victoria is on CreditWatch with negative implications.

Governments are intervening in unprecedented ways to simultaneously curb the movement of people and commerce, expand healthcare capacity, and keep firms and households afloat. In most states, early and forceful action helped to avert a public health disaster, though at enormous economic cost. The cash impact on state finances of stimulus decisions so far is likely to be hefty, but short of A$48 billion. However, we expect upcoming annual budgets to announce much more.

In addition, while the measures described in this report are discretionary in nature, upcoming budgets will disclose large nondiscretionary declines in state revenue from taxes, fees, and goods-and-services tax (GST) grants. Together, the extra spending and plummeting revenues will drive deficits much higher. We assess these effects in more detail in forthcoming reports.

Our Coronavirus Assumptions

S&P Global Ratings acknowledges a high degree of uncertainty about the evolution of the coronavirus pandemic. The consensus among health experts is that the pandemic may now be at, or near, its peak in some regions but will remain a threat until a vaccine or effective treatment is widely available, which may not occur until the second half of 2021. We are using this assumption in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

Related Research

• Local Government Sector COVID-19 Financial Implications, Report 3 – Comparison Of 2020 Annual Plan Budgets Against Long-Term Plans, New Zealand Department Of Internal Affairs, Aug. 21, 2020
• Australian Treasury Corp. Of Victoria 'AAA' Rating Placed On CreditWatch Negative After Similar Action On State, Aug. 5, 2020
• Australian State Of Victoria 'AAA' Rating Placed On CreditWatch Negative On Pandemic Lockdown Uncertainty, Aug. 5, 2020
• Bulletin: Lockdown Will Delay Victoria's Economic Recovery, July 8, 2020
• As COVID-19 Grips U.S. State Finances, Some Budget Debates Will Continue Well Beyond The Deadline, June 30, 2020
• Australian Capital Territory Outlook Revised To Negative After Similar Action On The Sovereign; Ratings Affirmed, April 8, 2020
• New South Wales Treasury Corp. Outlook Revised To Negative After Similar Action On State; 'AAA/A-1+' Ratings Affirmed, April 8, 2020
• New South Wales Outlook Revised To Negative After Similar Action On The Sovereign; Ratings Affirmed, April 8, 2020
• Australian State Ratings Depend On Fiscal Discipline And Quick Economic Rebound, April 1, 2020
• Public Finance System Overview: Australian States and Territories' Institutional Framework One Of The Strongest In The World, Nov. 11, 2018
• Budget Operations Framework, Victorian Department of Treasury and Finance, Feb. 2017