According to Fitch Ratings, Australia’s Commonwealth budget, released on 12 May 2015, highlights the continued weakening of the country’s long-term fiscal consolidation plans, but does not fundamentally alter the core factors supporting Australia’s ‘AAA’ rating. These include low debt-to-GDP versus ratings peers, a stable banking system and a credible fiscal policy framework.
Deterioration in the fiscal outlook since the last budget was widely expected alongside the continued weakening of labour market conditions and a tepid recovery in commodity prices that has not brought prices back to levels seen before the downturn.
The fiscal cash deficit widened and government debt projections increased in the fiscal year ending 30 June 2016 (FY16) budget, reflecting in part the deterioration in economic growth dynamics linked to the fall in commodity prices and slowdown in China. Falling terms of trade have impacted long-term revenue growth projections, which have been revised down to 6.3% annually to 2018 from 6.6% at the last economic and fiscal update. Wage growth and corporate income will continue to be challenged by lower commodity prices, resulting in AUD20bn less in tax revenues over the coming four years compared with the outlook in the 2014 budget.
The deteriorating cash balance also reflects higher spending forecasts compared to the government’s Mid-year Economic and Fiscal Outlook in December.
The government still aims to return to a balanced budget by FY20 – even though fiscal consolidation plans have weakened. It is notable though that with a three-year federal election cycle – the next election is due by January 2017 – there remains significant uncertainty as to whether the political commitment to achieve this target will be sustained. Nonetheless, Australia does benefit from a credible policy framework and Fitch expects Australia to continue to have a significantly lower debt burden than its ‘AAA’-rated peers – general government debt was 31.8% of GDP in 2014 versus the ‘AAA’ median of 41.3%. Notably too, the government forecasts debt-to-GDP to begin falling by FY18 after rising for the next two fiscal years. As such, the budget should not have a significant effect on Australia’s existing strong credit profile.
Fitch believes that the iron ore forecast price in the budget of USD48/tonne seems a reasonable base case, but the budget will remain sensitive to further price falls. Australia’s dependence on commodity exports, especially to China, indicates that the sovereign may need a slightly larger buffer in its public finances than some of its peers at the ‘AAA’ level.
Over the longer term, reducing Australia’s dependence on commodities would mitigate a key vulnerability of the economy and sovereign. The FY16 budget includes some policy measures, including infrastructure investments and targeted SME tax cuts, to raise potential growth and spur service sector exports. As yet, it is uncertain to what extent these sorts of policies will be successful in transitioning growth away from mining.
