Overview

• The state of Western Australia's budgetary performance is superior to that of most peers, supported by elevated commodity prices, a favorable distribution of federal grants, solid operating expense control, and growing tax receipts from a rebounding economy.
• We expect the state's debt-to-revenue ratio to continue to decline, in contrast to almost all its peers.
• We are raising our long-term ratings on Western Australia to 'AAA' from 'AA+'. The outlook is stable.

Rating Action

On June 27, 2022, S&P Global Ratings raised its long-term issuer credit ratings on Western Australia, an Australian state government, to 'AAA' from 'AA+'. At the same time, we affirmed our 'A-1+' short-term issuer credit ratings on Western Australia. The outlook is stable.

Outlook

The stable outlook reflects our view that the state's fiscal metrics will remain very strong even as commodity prices normalize, aided by a more favorable system of distributing federal grants than in the past.

Downside scenario

We could lower our ratings on Western Australia if its fiscal performance and debt trajectory were to materially underperform our forecasts. This could occur if economic conditions deteriorate--due to a deep downturn among trading partners or accentuated geopolitical tensions, for instance--causing the government to significantly veer from its currently prudent fiscal strategy. A substantial loosening of operating expense restraint might also lead us to reassess our view of the state's financial management.

Given our view that no state or territory in Australia can sustain stronger credit characteristics than the sovereign in a stress scenario, we would also lower our ratings on Western Australia if we were to take similar action on the sovereign.

Rationale

The upgrade reflects Western Australia's continued budgetary outperformance compared with its domestic and global peers. The state is benefiting from elevated royalty revenues–-without the previous downside of lower federal grants, thanks to the 2018 reforms to Australia's horizontal fiscal equalization system-–and growth in tax receipts. We forecast its debt-to-revenue ratio will gradually decline, even as infrastructure investment rises, to levels well below most domestic peers.

Our ratings are supported by Western Australia's track record of robust financial management, a very high-income economy, and exceptional liquidity. These strengths help counterbalance risks associated with dependence on the resources sector. Our ratings are also underpinned by the nation's excellent institutional framework. We have updated our forecasts for Western Australia through fiscal year 2024 (i.e., the year ending June 30, 2024) following the publication of its annual budget in May 2022.

Budgetary and debt metrics materially stronger than those of other states; liquidity coverage remains exceptional

We expect Western Australia to continue to post healthy operating surpluses. The state derives a significant portion of its revenues from mining royalties; in fiscal 2022 royalty income will be about A$11.5 billion, or 36% higher than the figure recorded just two years ago. This is due largely to strong Chinese demand for iron ore, a key steelmaking ingredient. Relative to the state's budget assumptions, we assume the average spot price of iron ore will be higher over the next few years, declining to about US$80 per ton by calendar 2024 (see "Metal Price Assumptions: Shortages Worsen And Prices Spike As Conflict Roils Metals Trading," published March 18, 2022). Volatility in commodity prices and demand remains a moderate risk, both upside and downside, to our forecasts.

A strong economic restart in Western Australia since mid-2020 has propelled broad-based revenue growth, including in transfer duties and payroll taxes. At the same time, the state has kept a relatively tight lid on underlying operating expenses. It had, for instance, maintained a A$1,000 per annum cap on public sector wage increases for four years through 2021.

The government recently relaxed its wages policy to allow a 2.5%-2.75% wage increase for two years. With headline inflation currently tracking at 5.1% nationwide and 7.6% in Perth, the state capital, the government could face pressure to lift wages further. The state's May 2022 budget also introduced several new spending measures across areas such as health and climate change, and a one-off electricity credit for all households.

Importantly, we see downside risks to budgetary performance as being substantially mitigated by reforms legislated in 2018 to Australia's system of horizontal fiscal equalization. The reforms established an effective relativity "floor" for Western Australia (and all other states) of 70%-75% of its population share of the national goods-and-services tax (GST) pool and technical changes to the "equalization benchmark". Consequently, the state is benefiting from top-up grants that it estimates at A$3.7 billion over fiscal years 2021 and 2022. Both major federal political parties remain committed to this new system. The state's relativity had fallen to a historic low of around 30% in fiscal 2016, contributing to a stretch of operating deficits. Without the reforms, the state estimates its relativity could have plunged to 1% by fiscal 2024.

Western Australia's overall fiscal balance is strong. We expect the state to post small after-capital account surpluses, a rare feat given the scale of the COVID-19 shock. This is despite the state again upsizing its budgeted infrastructure program to a record A$33.9 billion over the next four years. Some 50% is allocated to road, rail, and public transport in the next year, including the government's signature Metronet rail extension program. Our analysis is based on Western Australia's nonfinancial public sector (NFPS) accounts, which include the general government sector and nonfinancial government enterprises.

Delivering this enlarged pipeline will be a challenge because governments across Australia are simultaneously endeavoring to ramp up their own infrastructure programs, and there are limits on industry capacity, materials, and skilled migration. Our forecasts for the next three years assume Western Australia will under-deliver on its capital budget. There may be some upside to capital revenues, with the state currently seeking final bids for the sale of TAB, a government-owned wagering agency.

Western Australia is outperforming its domestic peers as well as most comparable German and Canadian peers at the state or provincial level (see "Local Government Debt 2022: Credit Quality Recuperating For Largest Regions In Developed Markets," published April 12, 2022). Several states on the Australian east coast, by comparison, have endured prolonged lockdowns that necessitated extensive fiscal outlays (see "Local Government Debt 2022: Australian State Debt To Breach Half A Trillion Dollars," published March 9, 2022).

We project that the state's tax-supported debt will decline to about 69% of operating revenues by fiscal 2024, from 86% in fiscal 2021. Market yields are rising from historic lows, and we project annual interest expenses at about 1.9% of operating revenues. A recent accounting change--the introduction of Australian Accounting Standards Board 16 Leases--saw Western Australia start to recognize operating lease liabilities as debt from fiscal 2020 onward, in line with changes in reporting by all other states and the private sector.

Western Australia's liquidity is excellent. The state's total free cash--excluding funding contracted since June 30, and after applying our standard haircuts to noncash financial assets--is sufficient to cover about 249% of debt service during the next 12 months. Upcoming debt-servicing needs comprise A$4.8 billion-A$6.8 billion of term debt maturing each fiscal year, about A$3.5 billion in short-term notes and multicurrency euro commercial paper, and around A$1.2 billion in annual interest expenses.

Capital markets in Australia are deep and liquid, and we expect them to remain so. The Reserve Bank of Australia (RBA) backstopped the domestic government bond market through a quantitative easing program that ran from November 2020 to February 2022. It is now allowing its bond holdings to gradually diminish as they mature. We also believe the Australian Commonwealth government would provide support if needed in a severe stress scenario, as it did in 2009-2010, when it offered to provide a guarantee over state and territory government borrowing.

Western Australian Treasury Corp. (WATC) is the state's central borrowing authority. Its debt issuance is primarily in the form of Australian-dollar fixed-rate benchmark bonds, floating-rate notes, and short-term paper. It has a small volume of euro commercial paper borrowing, with all offshore proceeds swapped back into Australian dollars. To reduce refinancing risk, WATC generally tries to ensure that the volume of debt maturing within 12 months is restricted to a maximum of 20% of total debt. Its lending book includes a small volume of loans to universities and local councils outside the NFPS perimeter.

Western Australia's contingent liabilities are small and do not weigh on our credit assessment. Quantifiable contingent liabilities stood at A$990 million as of June 30, 2021. In October 2021, a large lawsuit against the state by private mining companies Mineralogy Pty Ltd. and International Minerals Pty Ltd. was resolved by the High Court, Australia's final court of appeal, in the government's favor.

Economy in solid shape despite omicron variant outbreak; robust management and Australia's excellent institutional settings support the ratings

In March 2022, Western Australia reopened to visitors after ending a "hard border" policy that had lasted almost 700 cumulative days. With the widespread transmission of the omicron variant, COVID-19 cases have been elevated but are currently falling. Over 95% of the state's eligible population (aged 12 and over) is double vaccinated, helping to keep a lid on COVID-related hospitalizations and to keep the number of deaths very low. The state economy had recovered strongly since containing the first coronavirus wave in early 2020.

Western Australia is the main minerals- and petroleum-exporting region of Australia, and the resources industry accounted for about 41% of gross state product (GSP) in fiscal 2021. The state's dominant product is iron ore: Western Australia is the largest producer in the world, accounting for 38% of global supply in 2021, followed by Brazil, at 17%. Future demand for iron ore may be restrained by steel output caps, emissions reduction targets, and a slowing property sector in China, the state's biggest market.

Western Australia's population is about 2.7 million and grew 0.7% through the year to September 2021. Its residents are very wealthy by international standards, with GSP per capita almost 70% higher than the national GDP per capita of about US$63,600. Exposure to the resources sector means economic performance is somewhat volatile. This was particularly apparent in fiscal 2017, when the state economy contracted 1.1% following several years of declining growth. The state estimates that its real GSP grew 3.75% in fiscal 2022. The A$16 billion Scarborough-Pluto liquefied natural gas project and other resource projects could support private business investment over the next few years. The state's unemployment rate sits at 3.1% as of May 2022, below the national average of 3.9%. A rise in inflation has led the RBA to start to normalize monetary policy (see "Economic Outlook Asia-Pacific Q3 2022: Overcoming Obstacles," published June 27, 2022).

We assess Western Australia's financial management to be very strong. The current government has displayed a track record of robust cost control. Supporting the state's management is the institutional framework within which all Australian states and territories operate. We consider this framework to be one of the strongest and most predictable for subsovereign governments globally. It promotes high levels of financial disclosure and transparency. The state government produces annual budgets that include detailed medium-term financial forecasts; it also produces midyear updates, unaudited quarterly interim outcomes, and audited final outcomes within three months of period-end. Accounts are prepared on an accrual basis, with public corporations consolidated in these accounts.

Key Statistics

Table 1

Ratings Score Snapshot

Key Sovereign Statistics

Sovereign Risk Indicators. An interactive version is available at http://www.spratings.com/sri.

Related Criteria

• General Criteria: Environmental, Social, And Governance Principles In Credit Ratings, Oct. 10, 2021
• Criteria | Governments | International Public Finance: Methodology For Rating Local And Regional Governments Outside Of The U.S., July 15, 2019
• General Criteria: Methodology For Linking Long-Term And Short-Term Ratings, April 7, 2017
• Criteria | Governments | International Public Finance: Methodology: Rating Non-U.S. Local And Regional Governments Higher Than The Sovereign, Dec. 15, 2014
• General Criteria: Principles Of Credit Ratings, Feb. 16, 2011

Related Research

• Economic Outlook Asia-Pacific Q3 2022: Overcoming Obstacles, June 27, 2022
• Institutional Framework Assessments For International Local And Regional Governments, June 16, 2022
• Global Ratings List: International Public Finance Entities 2022, June 4, 2022
• Institutional Framework Assessment: Australian States And Territories, May 5, 2022
• Australia's Governments And Banks Remain Resilient To Rising Interest Rates, May 3, 2022
• Local Government Debt 2022: Credit Quality Recuperating For Largest Regions In Developed Markets, April 12, 2022
• Western Australia (State of), March 21, 2022
• Metal Price Assumptions: Shortages Worsen And Prices Spike As Conflict Roils Metals Trading, March 18, 2022
• Local Government Debt 2022: Australian State Debt To Breach Half A Trillion Dollars, March 9, 2022
• Local And Regional Governments Outlook 2022: Long-Term Challenges Resurface As The Pandemic Eases, Feb. 3, 2022
• Australian States Embark On The Recovery Path, Nov. 29, 2021
• Default Transition and Recovery: 2020 Annual International Public Finance Default And Rating Transition Study, Sept. 14, 2021
• Comparative Statistics: Asia-Pacific Local And Regional Government Risk Indicators, Sept. 1, 2021
• Ratings History List: Asia-Pacific Local And Regional Government Ratings Since 1975, May 29, 2020

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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