A challenging economic environment – particularly weaker external demand conditions – has affected the fiscal outlook for Australia and New Zealand, resulting in delays to budget consolidation and potentially higher credit risks over the medium term, says Fitch Ratings.
Mid-year budget updates, released yesterday, highlighted the trajectory of a gradual return towards budget surplus remains for both countries, but weaker-than expected economic performance has pushed back consolidation timelines. However, low public indebtedness continues to be a strength, helping to anchor ratings during a period of heightened economic uncertainty.
Slowing external demand has led directly to weaker terms of trade. This has in turn resulted in budget deterioration, owing mainly to weakness on the revenue side, with lower nominal GDP growth likely to weigh on tax receipts. Yet lower inflation should restrain nominal expenditure growth, and currency depreciation has helped to cushion the fall in commodity prices in local-currency terms. The lower currencies of both countries has also boosted export competitiveness, particularly in the services sector which accounts for one-third and one-fifth of New Zealand and Australian exports, respectively.
According to the latest mid-year budget updates between fiscal years 2016-2019, Australia’s underlying cash balance relative to GDP is now expected to be on average 0.4ppt lower each year, while New Zealand’s Operating Balance Excluding Gains and Losses (OBEGAL) is on average 0.3ppt lower.
Australia is now projected to achieve a surplus in FY21, a year later than previously planned. Fiscal balances have started to fall behind many of the 11 other ‘AAA’ rated sovereigns. A failure to rebalance the economy away from mining is a potential risk over the medium term, which could put pressure on public finances and Australia’s credit rating.
However, this risk is only likely to materialise over the long term; rebalancing is only in the early stages, while services exports and residential investment are making bigger contributions to growth. We expect Australia’s gross government debt/GDP ratio to remain firmly below the ‘AAA’ median, and this affords time for a more protracted return to fiscal surplus – in the absence of a severe economic shock.
In New Zealand, the OBEGAL is likely to fall back into deficit in FY16 after unexpectedly reaching a surplus for the first time since 2008 in FY15. Fitch had previously highlighted that a reduction in the general government deficit – leading to a steady reduction in public debt ratios – would be a trigger for positive rating action. But the Treasury now projects Net Core Crown Debt to peak at 27.7% of GDP in FY17, compared with a peak of 26.3% as forecast by the government in May. Nevertheless, New Zealand’s fiscal position still sits comfortably alongside its ‘AA’ peers despite the weaker outlook.
Higher-than-expected net migration inflows have been a boon for New Zealand’s medium-term fiscal outlook, limiting the downward revision to potential growth as a result of lower investment. Growth is now likely to increase from 2.5% to 2.6% in FY16 from a previous 2.8%. Net migration inflows have been due in part to fewer departures of New Zealand citizens to Australia. This has also contributed to a lower estimate of Australia’s medium-term potential growth rate, revised down from 3.5% to 3.0% by the Australian Treasury.
Both the Australian and New Zealand economies share vulnerabilities pertaining to high external indebtedness and commodity dependence, and run large current account deficits. Fiscal projections for both economies are highly sensitive to macroeconomic assumptions, including global demand and commodity prices. This may require the sovereigns to have a slightly larger buffer in public finances than similarly rated peers.
