S&P Global Ratings assigns credit ratings to local and regional governments (LRGs) based on its qualitative and quantitative analysis of a range of financial, economic, managerial, and institutional factors. Our analytical framework for rating LRGs is now articulated around six major components, resulting from our methodology: institutional framework; economy; financial management; budgetary performance; liquidity; and debt burden.

Our assessment of the institutional framework is an important component of the rating. The institutional and legislative environment in which an LRG operates provides an important context in which to evaluate the LRG's individual credit profile. Therefore, we combine our assessment of the institutional framework and the five other factors listed above to determine an indicative credit level for an individual LRG. We then adjust this level for certain overriding factors to provide the final rating for the respective LRG (see "Methodology For Rating Local And Regional Governments Outside Of The U.S." published on July 15, 2019).

LRG Characteristics By Rating Category

The rating bias of LRGs in Asia-Pacific has tilted negative, predominantly because the number of negative outlooks has increased in New Zealand. This follows our revision of the trend of the New Zealand local council sector's institutional framework to weakening from stable and the large increase in spending at individual councils. The institutional framework assessment remains extremely predictable and supportive.

Elevated inflation and the economic recovery have helped boost operating revenues in recent years. But they were accompanied by higher operating spending in the form of wage adjustments and capital spending and borrowings becoming more costly. Capital expenditure continues to be elevated for many LRGs, as it became necessary to address infrastructure development needs following the normalization of migration.

This trend is most striking in Australia and New Zealand with higher inward migration rates compared with other countries in Asia-Pacific. LRGs in New Zealand also face the additional burden because of weaker operating accounts and substantial increases in capital expenditure, including national water reforms and disaster-related reconstruction efforts. This infrastructure push is resulting in higher debt levels and interest costs, which is weighing on the liquidity coverages of several LRGs.

We expect many Asia-Pacific LRGs to remain relatively resilient to periods of stress, given their high credit quality. Nevertheless, our five-year forecasts for 'AA' category rated LRGs' balance after capital accounts as a percentage of total revenue has deteriorated in recent years. This reflects loose fiscal policy in Australian LRGs, and substantial increases in New Zealand LRG's capital expenditure. Mirroring this, tax-supported debt as a percentage of consolidated revenue has also trended upwards in both the 'AA' and 'A' categories.

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'AAA'

The State of Western Australia is the only rated LRG in the 'AAA' rating category. Australian states operate in an extremely predictable and supportive institutional framework. Their financial management practices are very good, as demonstrated by their detailed long-term planning and good internal and external risk management, particularly in their treasury functions.

Western Australia has a strong economy, with very high GDP per capita in a global context. However, Western Australia's economy is less diversified than the national average because of its exposure to mining and related construction. We estimate its GDP per capita reached US$98,100 in 2023, compared with US$64,700 at the national level. The state generally posts sound operating surpluses. We project its operating balance to average 9.7% of operating revenue over 2023-2027 while the balance after capital accounts will revert into a small deficit of about 1.3% during that period. Debt levels are moderate, with an average tax-supported debt of 64.6% over 2023-2027. Elevated commodity prices have resulted in unusually strong outcomes for Western Australia over the past few years, which we expect to have moderated more recently.

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'AA'

LRGs in the 'AA' rating category form the biggest group in Asia-Pacific, comprising 21 councils in New Zealand, six Australian states and territories, and the Seoul Metropolitan Government (SMG) of Korea. The Australian states and New Zealand LRGs operate in an extremely predictable and supportive institutional framework that underpin their strong financial management.

We view Korea's intergovernmental system as very predictable and well-balanced. The institutional setup in Korea anchors Korean local governments' generally better budgetary outcomes compared with many international peers. As the economic center of Korea, SMG has stronger economic and financial profiles than its peers in the same rating category.

In general, LRGs in this rating category have weaker credit profiles than 'AAA'-rated peers because of wider or more-volatile budget deficits or higher debt burdens (except for SMG).

Key economic and financial risk indicators that we observe for 'AA'-category rated LRGs are:

• High national GDP per capita, with a median level of about US$49,700. Some economies in this category demonstrate a weaker socioeconomic profile compared with higher rated LRGs, especially in New Zealand.
• Moderate budgetary performance with strong operating margins but wider deficits after capital accounts, which vary in line with investment appetite of the LRGs. We usually see larger deficits at New Zealand councils than at SMG as the former have many infrastructure responsibilities, as a proportion of their balance sheets, among global peers. Meanwhile, deficits after capital accounts at Australian LRGs are elevated because their operating balances are weaker while conducting very large road construction and public transport initiatives. The median deficit after capital accounts is about 13.8% on average over 2023-2027, which is high compared with all other rating categories.
• High and increasing debt burden. We forecast that median tax-supported debt as a percentage of consolidated operating revenue will average 166.8% in 2023-2027. We also project the median interest payment as a percentage of operating revenue will remain elevated and should average roughly 6.0% in 2023-2027, as debt and interest costs increase.
• SMG is an exceptional LRG in this context. Despite its lower national GDP per capita (US$35,560 in 2023), we expect its strong revenue and prudent budgeting principles and process to keep anchoring its strong fiscal performance. We also expect it to record marginal surpluses after capital accounts over 2022-2026. Its tax-supported debt is among the lowest of all rated LRGs in Asia-Pacific at 41.5% of operating revenue in 2023, albeit increasing moderately. Similarly, interest expense is among the lowest, standing at 0.5% of total revenue on average in 2022-2026.

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'A'

The LRGs in the 'A' rating category are in New Zealand, Japan, and Malaysia. The institutional frameworks of these LRGs vary, and while they are more indebted than LRGs in higher rating categories on average, it is difficult to derive common characteristics between these LRGs by looking at the medians. An increasing number of LRGs in New Zealand are rated in the 'A' category. This could increase further if the institutional framework assessment is lowered.

'A'-rated LRGs in their country of domicile exhibit the following characteristics:

• The 'A' ratings on four New Zealand councils reflect their weaker economic profiles, wider budget deficits, weaker liquidity assessments than 'AA'-category domestic peers, and idiosyncratic governance deficiencies, even though they benefit from an extremely predictable and supportive institutional framework. Weaker financial metrics stem from their proportionally higher capital spending, resulting in both widening deficits after capital accounts and high debt. We expect median tax-supported debt to average 268.4% of consolidated operating revenue in 2023-2027, based on higher spending pressures. On top of that, these entities have significantly higher interest charges, with a median of 9.2% of total revenue over 2023-2027.
• Japanese LRGs in this rating category are economic centers and thus GDP per capita in these regions exceeds the national average. Fiscal consolidation efforts and high revenue collection supported by moderate but persistent economic growth will leave their operating margins high throughout the forecast horizon. We expect median operating margins will reach 15.6% of operating revenue on average in 2022-2026. At the same time, we project balances after capital accounts to show a slight surplus, on average, helping outstanding debt balances to decline and offset the rise in funding costs. Nevertheless, the ratings on these LRGs are constrained by the sovereign rating on Japan. We anticipate that their financial profiles and debt servicing capacities would come under extreme pressure in the event of a sovereign default.
• The rating on Sarawak reflects a blend of stronger and weaker scores compared with peers. Although Sarawak's GDP per capita is higher than domestic peers', the state also faces concentration risk in the oil and gas sector. These weaknesses are more than offset by the state's large operating surpluses, which we expect will average 57.8% of operating revenues in 2022-2026. Sarawak achieves these surpluses by being one of the few LRGs in Asia-Pacific where high commodity prices and depreciation of the domestic currency both support its revenue. Thus, despite ongoing investments in infrastructure, we anticipate Sarawak will post solid surpluses after capital accounts of 17.7% over the same period and decreasing debt burden.

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'BBB' and lower

We currently do not rate publicly any LRG in those categories in Asia-Pacific.

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