Debt analysis agency Standard & Poor’s has officially placed Australia on ‘downgrade watch’, meaning the country’s stellar AAA credit rating could soon be cut.
The agency decided to change Australia’s credit outlook from “stable” to “negative” following the recent election, which raised concerns about the nation’s ability to organise its budget. Now, the likelihood of Standard & Poor’s cutting the rating within the next two years is around one in three depending on whether the agency believes that Australia’s parliament will fail to curb burgeoning debts and deficits by increasing taxes and cutting spending.
Why is the downgrade on the horizon?
Burgeoning offshore debts
Standard & Poor’s believes that Australia’s amount of offshore debt is becoming unacceptably high for a country with a top-quality credit rating. Ultimately, the agency believes that the incoming parliament’s actions will make or break the country’s future fortunes in this regard. The government must pass expenditure and revenue measures through both of the houses of parliament in order to assuage debt levels and, until then, they will be closely monitored by debt analysis agencies scrutinising their every move.
The volatility of elections always brings uncertain financial times with it. The Australian dollar fell as low as USD74.67 on the day of the recent election, so many commentators have noted that being placed on downgrade watch should come as no surprise.
What could the downgrade mean for Australia and its citizens?
If the downgrade goes ahead, it will be the first since the 1980s, and is likely to push borrowing costs up for Australia’s home buyers and banks. Indeed, Australian banks who may not have a leading credit rating could feel the consequences of the downgrade. The AA ratings of some Australian banks, which are used to generate billions of dollars from investors offshore, very much rely on the sovereign AAA rating.
In this way, if global investors charge banks more funding, overall funding costs will be pushed up. As a corollary to this, banks are likely to burden borrowers with higher rates, thereby constricting economic conditions, or to accept lower profits, something that will push share prices and dividend payments down. Ultimately, therefore, the Australian government needs an AAA rating to demonstrate its strength to international investors and, by extension, banks need more capital to show to taxpayers that they are strong and reliable.
Is it worth fighting off the downgrade?
While it is easy for the media to portray the potential downgrade as a harbinger of financial doom and gloom, some believe that fighting to keep Australia’s AAA rating could be more trouble than it is worth.
Ultimately, hanging on to the top grade rating would need to be done by setting out austerity policies to prevent debts from piling up, something that could impact on growth within the country. In this way, the economy could be weakened and the banking sector could be negatively affected.
On top of this, fiscal tightening could force the task of economic rebalancing on to the Reserve Bank of Australia, which could cut rates nearer to zero, impacting savers and worsening inflated asset prices in the process.
So what now?
While the latest downgrade news is undoubtedly a wakeup call for the Australian government, there is no need to panic yet. Past financial crises have led to the establishment of firewalls. Now, government debt put up in Australian dollars and bank debt that is fully hedged are able to reduce the likelihood of other nations losing faith in the country’s economy. Finance markets are not yet worried about losing the AAA status, and the Australian dollar is strong, so there is reason to be optimistic.