All is well. Fitch have reconfirmed Australia at ‘AAA’; Outlook Stable! This despite the high debt to GDP, and high household debt, and cooling house prices, and the ongoing impact of the Royal Commission.
Fitch forecasts a modest acceleration in GDP growth from 2.3% in 2017 to 2.7% in both 2018 and 2019, above the ‘AAA’ median. Growth will be supported by higher non-mining private investment and public infrastructure investment, particularly as the drag from the substantial multi-year decline in mining investment fades. Exports will be supported by strong global demand and higher liquefied natural gas (LNG) exports as more production capacity comes online. Consumption growth has been steady, but is likely to remain subdued given sluggish wage growth, high household debt, and a savings rate which is already low.
Monetary policy is likely to remain accommodative and supportive of growth over the next two years in the absence of significant wage growth or inflationary pressures. Fitch expects the Reserve Bank of Australia (RBA) to lag the U.S. Federal Reserve in tightening policy rates, only beginning to gradually lift rates with two 25bp hikes in 2019. Australia’s flexible exchange rate provides the RBA with a buffer against tightening global financial conditions. The RBA would be likely to tolerate some depreciation of the Australian dollar, which has been broadly stable against the US dollar to date despite a growing interest-rate differential with the Fed. Macroprudential policies have given the RBA scope to maintain lower rates without substantially contributing to a further build-up in financial-sector risks.
Australia’s net external debt-to-GDP ratio is the highest within the ‘AAA’ category, at 56.1%. The heavy reliance on external funding leaves Australia exposed to sustained shifts in capital flows and higher external financing costs, particularly in the context of tightening global financial conditions which would weigh on growth and financial stability. Most external liabilities are denominated in local currency or hedged to reduce currency and maturity mismatches, helping to mitigate risks. Australia is a net foreign-currency creditor, after adjusting for foreign-currency hedges.
High household debt, at 188.6% of disposable income in 4Q17, poses a potential downside risk for the economic outlook and financial stability. An interest-rate or employment shock could impair households’ ability to service their debt, particularly in the current low-wage-growth environment, thereby pressuring consumption growth. Many households maintain large mortgage offset accounts, which can be drawn down to service debt and smooth consumption, but newer borrowers and more financially weaker households would remain vulnerable.
Housing-price growth has continued to cool on the back of tighter credit standards, prudential regulation, and higher supply. A sharp correction in the housing market could flow through to both consumers and the financial sector. However, a severe downturn is not Fitch’s base case. We expect Australian house prices to remain relatively stable, with modest price rises nationally in 2018.
Australia’s banking system scores ‘aa’ on Fitch’s Banking System Indicator (BSI), the joint highest of any sovereign, and is well positioned to manage potential shocks. Sound prudential regulation has improved the resiliency of bank balance sheets by strengthening underwriting standards and limiting exposure to riskier mortgage products. Recent limits on growth rates for investor and interest-only loans have slowed the growth in these products, which Fitch considers riskier than traditional amortising mortgages. Furthermore, the strong capital position of Australian banks provides substantial loss-absorbing capacity in the event of a shock. The ongoing Royal Banking Commission is likely to have an impact on the public’s confidence in the banking sector, but has not affected the underlying soundness to date
