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Monday, 19 December 2016

Ratings agencies affirm AAA (for now)

AAA confirmed

Firstly, the good news is that all three of the major ratings agencies affirmed Australia's AAA rating.

And, indeed, the Mid-Year Economic and Fiscal Outlook (MYEFO) disclosed a slightly better estimated budget balance (-$36.5 billion) than has been expected in the May budget (-$37.1 billion), in part thanks to commodity prices having been considerably stronger than almost anyone could have expected.

Unfortunately, wages growth has been weaker than expected, and profits have been softer too, so there was a significant deterioration in the cumulative budget deficits totalling $10.3 billion over the next four years. 

Treasury still expects that the budget will be back in surplus by 2020-21, if only just, with government debt peaking at 19 per cent of GDP in 2018-19, though it must be said in recent years the trend has been for expectations to be dashed! 

Sensibly the Treasurer has assumed significant declines in the prices of iron ore and coal over the years ahead rather than using overtly positive estimates. 

Historically, forecasts have been based upon averages of recently prevailing commodity prices, but that wouldn't really be appropriate given the recently experienced price spikes!

The expectations for wages growth on the other hand look very upbeat given how recent numbers have been tracking (although the national accounts partials hinted at an improvement, perhaps). 


Real GDP growth is expected to be a bit slower over the next year before returning to 3 per cent in 2018/19 and 2019/20.

Australia has navigated a tricky period since the financial crisis, with the mining investment boom having ended. The unemployment rate is presently 5.7 per cent, but in all likelihood this needs to fall some way further before decent wages growth returns. 

All the usual analysis of the figures will go on in the media, though it often seems to mirror the political biases of the journalists in question.

One thing that really stood out from the MYEFO figures was the contrasting fortunes between the mining states and the non-mining states, even for non-mining investment.

In the non-mining states, investment has picked up sharply since 2012-13, but in non mining states this has not happened yet. 

The budget papers anticipate that while resources investment will continue to decline over the next year or so, eventually the outlook will improve further, driven by investment in the non-mining sectors. 

The wrap

The good news is that the three major ratings agencies reported that the figures don't warrant a downgrade for the time being. 

However, there are evidently pressures. 

The budget is still projected to return to surplus by June 2021, with the budget's automatic repair mechanism - bracket creep - helping to get us there. 

For this to work on a timely basis, however, the projections assume a sprightly rebound in wages growth, which the latest figures suggest may be at best dubious. 

For this reason, and because commodity prices will probably fall back again at some point, financial markets have likely priced in a fair chance of downgrade from the AAA-rating in due course.