A government proposal to cap foreign enrolments could hit Australian universities hard. This is because the country's university sector is among the most dependent in the world on international student revenue (see chart 1).

The Australian government says the cap is needed to help tackle a domestic housing crisis and deliver more sustainable growth. If implemented in its proposed form, the plan would crimp universities' financial performance and autonomy, in our view. Lower fee revenue could mean less internal funding for research, halting Australian universities' recent ascent up the global rankings. And weaker financial profiles could translate into lower credit ratings.

Chart 1

Draft Legislation Threatens To Unravel A Thriving Industry

We have long commented that heavy reliance on international fees could expose universities to risks that include shifting geopolitical rivalries, currency fluctuations, or foreign interference. But an abrupt and homegrown threat to the sector's lucrative business model has caught most observers by surprise.

The Education Services for Overseas Students Amendment (Quality and Integrity) Bill 2024, introduced into parliament in May 2024, would give the federal minister for education wide-reaching and unprecedented powers to cap new international enrolments at Australian universities from 2025. Limits could be set by institution, course, or location. The minister may grant higher allowances to institutions that invest in new student accommodation to help address a housing shortage.

Australian universities have strong incentivizes to pursue foreign students, given their willingness to fork out course fees that are often triple the government-controlled tuition fees paid by domestic students. The number of foreign students in the tertiary sector consequently ballooned by 90% in the decade to 2023 as vice-chancellors embraced vociferous demand, particularly from Asia (see chart 2).

Chart 2

Small Deficits Are Possible

If international enrolments are severely curtailed, we estimate that Australia's top-tier institutions will quickly see their operating margins compress or flip into small deficits. For comparison, net adjusted operating surpluses (by our measures) averaged a robust 8.5% at the Australian National University and 7.6% at the University of Melbourne over 2018-2022.

Australia's standing in global rankings could be impaired since revenue earned from foreign students cross-subsidizes research activity. This, in turn, will dull Australia's allure as a study destination. Ranking providers score universities on metrics like research citations and even international student ratios.

Australia already punches far above its weight, with nine institutions in the world's top 100 according to the QS World University Rankings and six according to Times Higher Education. Rankings are relative, so future performance would also hinge on the policies enacted by competitor countries.

Unis Have Financial Flexibility To Cope

The forcefulness of managerial response would be key to protecting strong credit ratings. We currently rate five Australian universities, all between 'AA+' and 'AA-'. The experience of the COVID-19 pandemic--when Australia closed its borders over 2020 and 2021--suggests that they have flexibility to tighten their belts in any future downturn.

Universities could trim headcount, scale back capital expenditure, or draw on healthy liquidity buffers. In addition, universities with strong brand recognition might be tempted to ratchet their foreign tuition fees even higher, to earn more from a smaller pool of deep-pocketed students.

In contrast, recent social pressure on the sector to "decasualize" its workforce and give staff greater job security might constrain this flexibility.

Interventionist Approach Could Curtail Universities' Autonomy

Australia's competitors are turning inward, too. Canada, for instance, is reducing international study permits (which will be allocated on a province-by-province basis) and holding a nationwide cap steady for two years; the U.K. is restricting the ability of foreign students to bring family members. Across Australia, Canada, and the U.K., issuance of international student visas plunged 21%-28% in the first three months of 2024 relative to the same period in 2023.

The Australian plan, however, appears far more interventionist in proposing powers to set limits at individual course and institution level. Such micromanagement could complicate universities' strategic planning, which we presently view as a credit strength.

It's not yet clear if some institutions will be shielded from the caps more than others. The government's Draft International Education and Skills Strategic Framework, also released in May 2024, identifies over-reliance on foreign students at both a provider level and from a single country as unacceptable risks. Inner-city universities in Sydney, Melbourne, and Brisbane, that enroll the largest shares of foreign students and the highest concentrations of Chinese nationals, would seemingly have the most to lose.

However, the Australian government will have limited success, in our view, in diverting international students away from crowded eastern-state capitals and toward regional campuses. This is because most foreign students prefer metropolitan living. Regional universities have also been disproportionately bruised by earlier government efforts to tighten visa processing.

Domestic Education Will Be The Priority

The proposed caps are part of a broader suite of measures that could rebalance the tertiary sector. For instance, the Australian Universities Accord in 2023 recommended the creation of a new Higher Education Future Fund, which could redistribute own-source revenues (read: mostly foreign tuition fees) from wealthier to less affluent universities.

The government also wants to increase the tertiary attainment rate of Australia's working-age population to 80%, by 2050, from 60% at present. This would imply a large nationwide increase in Commonwealth-supported places. Australia's already mega-sized institutions could thus become larger, less commercially oriented, and more homogenous.

Immigration Is A Hot-Button Election Issue

The proposed legislation has bipartisan support and seems likely to pass this year. The government is under pressure to rein in immigration before a likely federal election in 2025.

Australia's annual population growth hit 2.5% in the September 2023 quarter (see chart 3), the highest rate since 1952. Foreign students account for about one third of inbound migrants. The recent aberrant surge reflects pent-up demand following the pandemic, coupled with a January 2023 edict from the Chinese government saying it would no longer accredit online studies at overseas universities.

Chart 3

The federal opposition has sought to link foreign arrivals with a perceived housing crisis. In his response to the May 2024 budget, Australia's opposition leader Mr. Peter Dutton joined the call for caps on foreign student numbers. Annual rent inflation has surged to 8.5% in capital cities and the national residential vacancy rate stands at just 1.1%.

We think it's unlikely that universities can meaningfully boost supply of student accommodation. The domestic construction industry is overstretched, and onerous local council planning rules are a major impediment. There are just 79,000 purpose-built student accommodation (PBSA) beds in Australia, according to Savills. This means most international students are forced to rent in the private market.

Unis May Be Able To Twist The Government's Arm

The government has offered no firm clues on how it will calculate numerical enrolment limits for each course or institution. The range of possible downside scenarios is therefore exceedingly wide. One report cited in the Australian Financial Review estimated international enrolment cuts as large as 60%-95%, based on analysis of government and opposition statements.

We think universities might yet be able to persuade the government to water down its proposals. They may gain support from business groups who see the value of foreign students in filling labor shortages and advancing so-called soft power diplomacy. Foreign students are widely employed in the hospitality industry and so their absence could contribute slightly to wage inflation.

Some universities could accelerate 2025 offers to international applicants before the caps are set, on the basis that any attempts to later undo these offers could render the government liable for compensation.

Or, if caps are instituted on a "first come, first served" basis, there could be a flood of applications for the first semester (February intake) of 2025. This means the true financial impact won't become obvious until later. The litmus test will therefore be 2026.

Editor: Lex Hall

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