This report does not constitute a rating action.
New Zealand's councils will continue to experience credit strain. The local government sector is heavily indebted due to strong population growth and pressing needs for infrastructure including renewals in response to past underinvestment and new quality standards. Further, the policy environment is less predictable than in the past.
On Feb. 24, 2025, S&P Global Ratings lowered its institutional framework assessment to very predictable and well balanced. This is second highest on our six-point scale, down from highest, extremely predictable and supportive. We believe the sector's revenue and expenditure balance and predictability of policy have weakened (see "Institutional Framework Assessment: New Zealand Local Governments Face Rising Fiscal Imbalances And Less Certain Policy Settings," published on RatingsDirect March 17, 2025 for further details).
In response to this change, we today lowered our long-term ratings on 18 New Zealand local councils and three council-controlled organizations by one notch (see "Various Rating Actions Taken On New Zealand Councils On Lower Institutional Framework Assessment," March 18, 2025).
Frequently Asked Questions
Why did S&P Global Ratings take these actions and what's changed this year?
Rising operating expenses, infrastructure budgets, and responsibilities are exerting pressure on the finances of New Zealand's local governments. Revenues and central government (Crown) grants are not increasing enough to cover this additional spending. This is leading to widening revenue and expenditure mismatches, as seen in larger deficits and higher debt.
We also view predictability of policy settings, and the financial impact of water reforms, to be less certain than in jurisdictions that carry the strongest institutional framework assessment. The impact on local government finances as a result of the reforms remains uncertain after more than six years.
How do revenue and expenditure mismatches feed into the institutional framework assessment?
We expect debt growth to increase as councils spend more due to higher government standards for areas like water quality and earthquake strengthening, to cater for strong population growth, and a growing recognition that they have historically underinvested in underground infrastructure. We forecast deficits after capital accounts of about 20% of total revenues, on average across the sector, over the next three years. The deficit in fiscal 2024 was almost double our previous expectation of 11%, which was based on council annual plans and ten-year long-term plans.
Furthermore, councils have limited revenue tools to fund this spending, as Crown capital grants have generally become scarcer, and because of political pushback against large increases in property rates. In addition, recent Crown rhetoric calls for councils to take on even more debt rather than "rate-fund" infrastructure.
Because of weaker fiscal outcomes, we project sector-wide debt to rise to levels that are much higher than in other jurisdictions that carry the strongest institutional framework assessment. Local government debt rose to 197% of operating revenues in fiscal 2024 from about 150% prior to the pandemic. Based on council budgets, we had previously forecast debt to reduce to 176% of operating revenues in fiscal 2024. This did not materialize.
To accommodate this growth in debt, councils and the New Zealand Local Government Funding Agency Ltd. (LGFA) are lifting self-imposed borrowing limits. Raising debt limits is generally negative for credit quality across the sector.
How does the Crown's 'Local Water Done Well' initiative change the picture?
Policy changes and uncertainty surrounding water reforms were a key driver of our decision to lower the institutional framework assessment. Frequent and material changes to policies mean it is difficult for councils to produce accurate budgets, and for us to incorporate sound assumptions into our forecasts and credit ratings.
Under the Local Government (Water Services Preliminary Arrangements) Act 2024, councils have several options to implement water reforms by July 1, 2028. These options include keeping water-service delivery in house; establishing water organizations that are council-controlled (either individually or jointly); or establishing mixed consumer-trust/council-controlled water organizations.
Some options could help alleviate financial pressure on individual councils, while others won't. In some cases, we expect these reforms will hurt credit quality, especially if wholly owned council-controlled water organizations become highly leveraged.
Depending on their structure, we could view a council-controlled organization as part of its parent council's tax-supported debt or at least a contingent liability of the council (see "New Zealand Local Government Outlook 2024: Bridge Over Troubled Waters," Nov. 19, 2023). Regardless of the options implemented, we don't believe water reforms, by themselves, will improve the large revenue and expenditure imbalance inherent in the system. It remains unclear how the local government sector will address its widening structural financial imbalance, in our view.
Were all local council ratings affected by the change in the institutional framework assessment?
No. We rate 25 councils; today we lowered the ratings on 18 councils by one notch. These 18 councils previously carried negative outlooks, which means we had already signaled that they would likely be downgraded if we were to lower the institutional framework assessment.
Why did we take rating actions on some councils but not others?
We determined that seven councils maintain sufficient headroom within their current ratings to accommodate a lower institutional framework assessment. This was generally for one or both of the following reasons:
- If the councils' individual credit profiles are at the stronger end of the current rating categories.
- If there are countervailing factors that potentially offset the lower institutional framework, such as improving economic prospects and diversification, or improving fiscal outcomes with smaller deficits and declining debt and interest costs.
That said, our lower institutional framework assessment may erode the headroom at the current rating levels for these seven councils.
How do the deficits of New Zealand local councils compare with other jurisdictions globally?
New Zealand's councils run much larger cash deficits when considering infrastructure spending. Prior to the pandemic, these councils generally incurred, on average, deficits after capital accounts of about 10% of total revenues. This widened aggressively to about 21% of total revenues in fiscal 2024 (ended June 30, 2024; see chart 1).
In comparison, subnational governments in many developed countries around the world run small deficits after capital accounts of less than 5% of total revenues. One exception are Australian states, which have struggled to return their budgets back to pre-pandemic levels. Nonetheless, their deficits after capital accounts are still narrower than that of New Zealand councils.
Chart 1
What about debt versus global peers?
New Zealand local councils are highly indebted relative to many other developed countries. This reflects their much larger cash deficits. The local council sector's debt reached 197% of operating revenues in fiscal 2024; other municipal systems with the highest institutional framework assessment have debt of about 100% of operating revenues or less.
Meanwhile, debt levels of Australian states (which have the highest institutional settings) have spiked since the pandemic, yet the sector's debt levels are still about 30 percentage points lower than New Zealand local councils were prior to the pandemic. The policy settings that Australian states operate in are more predictable than New Zealand local councils' thanks, in part, to their constitutional protection.
Chart 2
Why do sector-wide credit metrics matter for individual council credit ratings?
We believe the strength of a system's institutional arrangements is positively related to creditworthiness. Strong institutional settings promote accountability and transparency, long-term fiscal sustainability, and predictable local government policy. Our local government credit ratings consider both the relevant institutional framework and the local government's individual credit profile.
We recognize that not all councils reflect sector-wide trends. For these councils, stronger individual credit profiles or unique circumstances can offset weaker institutional settings. For example, if a council has a stronger financial position with lower deficits and a declining debt trajectory, there may be sufficient headroom within its rating to accommodate a lower institutional framework assessment.
Will councils pay higher interest costs because of these rating actions?
Some councils that borrow through capital markets or banks may pay marginally higher interest costs. Credit ratings are one factor that investors consider when viewing credit risk. The LGFA also generally charges higher margins for borrowers with lower credit ratings. However, its lending terms are discretionary and we cannot predict LGFA pricing decisions.
Does this mean the ratings on New Zealand's local councils are much weaker than that of global peers?
New Zealand's local councils remain highly rated in a global context at between the 'AA' and 'A' categories. We assess the institutional framework as being very predictable and well-balanced, the second highest assessment on our six-point scale. This is in line with that of municipal systems in Germany, Japan, and the U.K.
What is the effect of today's actions on the rating on the LGFA?
We affirmed our 'AA+' foreign-currency and 'AAA' local-currency ratings on the LGFA on March 18, 2025 (see New Zealand Local Government Funding Agency Ltd. Ratings Affirmed; Outlook Stable, March 17, 2025).
At the same time, we lowered the sector risk profile component of LGFA's stand-alone credit profile. However, there was enough headroom under the current rating to accommodate this change, particularly with its improving capital adequacy. Councils still have very strong capacities to service their debt obligations to LGFA, in our view.
What is the effect of these council downgrades on the sovereign rating on New Zealand?
There is no direct bearing on the rating.
Our assessment of the sovereign's fiscal performance and debt burden looks at the "general government" sector: i.e., it consolidates the central and local governments. In theory, widening of local government deficits and debt could weigh on this assessment.
However, the local government sector in New Zealand is a small component of the general government. It accounts for just 11% of gross general government debt on our measures. As such, activity at the central government level will continue to drive sovereign fiscal metrics.
Related Research
- Various Rating Actions Taken On New Zealand Councils On Lower Institutional Framework Assessment, March 18, 2025
- New Zealand Local Government Funding Agency Ltd. Ratings Affirmed; Outlook Stable, March 17, 2025
- Institutional Framework Assessment: New Zealand Local Governments Face Rising Fiscal Imbalances And Less Certain Policy Settings, March 17, 2025
- Bulletin: New Zealand Councils' Institutional Framework Lowered On Rising Debt, Feb. 24, 2025
- New Zealand Local Government Outlook 2024: Bridge Over Troubled Waters, Nov. 19, 2023
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| Primary Credit Analysts: | Anthony Walker, Melbourne + 61 3 9631 2019; anthony.walker@spglobal.com |
| Martin J Foo, Melbourne + 61 3 9631 2016; martin.foo@spglobal.com | |
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