Morningstar DBRS Confirms Australia at AAA, Stable Trend

DBRS, Inc. (Morningstar DBRS) confirmed the Commonwealth of Australia’s Long-Term Foreign and Local Currency – Issuer Ratings at AAA. At the same time, Morningstar DBRS confirmed the Commonwealth of Australia’s Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (high). The trend on all credit ratings is Stable.

KEY CREDIT RATING CONSIDERATIONS

Australia’s AAA credit ratings are underpinned by the country’s considerable fundamental strengths, including its diversified and highly productive economy, sound macroeconomic policy frameworks, and highly effective governing institutions. The Stable trend reflects our view that Australia’s credit fundamentals are unlikely to be affected by near-term challenges, including slowing growth, persistent inflation, and a shortage of housing.

The Australian economy is slowing under the pressure of tighter fiscal and monetary policies. Private consumption was weak through the first three quarters of 2023, despite strong population growth, as households faced elevated inflation, higher interest rates, and increased tax payments. Supply constraints and higher borrowing costs also weighed on residential investment. While these headwinds are expected to continue for the next few quarters, the economy is expected to gradually accelerate next year. The IMF forecasts GDP growth of 1.2% in 2024 and 2.0% in 2025. The labor market remains tight despite some signs of loosening. Employment growth is strong and the participation rate is at a record high. Inflation is elevated but moderating as supply constraints ease and demand softens. The Reserve Bank of Australia (RBA) has raised the policy rate by 425 basis points since 2022. Disinflation is expected to continue, but strong increases in home and rental prices could slow inflation’s return to the RBA’s 2-3% target range. Housing prices are rising again, which will likely intensify concerns over affordability. However, we view financial stability risks related to the housing market as contained.

Public finance metrics have improved as a result of the federal government’s spending restraint and bracket creep. The federal government reported its first fiscal surplus in 15 years in FY2022-23. General government debt has fallen 5 percentage points of GDP from 2020 to 2023, and while expected to rise this year, we view debt sustainability risks as low. Debt servicing costs are expected to remain moderate, notwithstanding the sharp increase in borrowing costs.

CREDIT RATING DRIVERS

The Stable trend reflects our view that a downgrade of the credit ratings is unlikely in the near term. Australia has a high capacity to absorb shocks and cope with pending challenges. However, the credit ratings could be downgraded over the medium term if there is a sustained deterioration in fiscal policy discipline.

CREDIT RATING RATIONALE

The Fiscal Position Is Improving And Helping To Alleviate Inflationary Pressures

Fiscal results have recently improved on the back of disciplined spending control and increased tax revenue associated with bracket creep. The government recorded an underlying cash surplus of $22.1 billion, or 0.9% of GDP in FY2022-23. A roughly balanced fiscal position is forecast for this fiscal year (ends June 30). In addition to delivering better budget results, fiscal policy is working in conjunction with restrictive monetary policy to dampen domestic demand and inflationary pressures. The fiscal deficit is projected to widen modestly in FY2024-25 as the Stage 3 tax cuts are implemented, but the deficit is expected to remain modest. Spending pressures could emerge over the medium term, especially expenditure related to Australia’s ageing population and the energy transition.

Risks related to debt sustainability are low. The IMF projects that debt-to-GDP for the general government (which includes the Commonwealth, as well as state, territory and local governments) declined from 57% in 2020 to 52% in 2023. The ratio is projected to slightly rise to 56% for the next 3 years, and then gradually decline over the medium term. Debt servicing costs are expected to increase moderately due to higher borrowing costs. In addition, the government balance sheet is sound regarding implicit liabilities. The low level of unfunded pension liabilities puts the public sector in a comparatively strong position to manage pension costs over time.

Tight Monetary Policy Is Helping To Curb Inflation; Rapid Migration Flows Further Strain Housing Market

Moderating commodity prices, improving supply chains, and slowing domestic demand have helped ease price pressures. Headline inflation declined from a peak of 8.4% (y/y) in December 2022 to 4.3% in November 2023. However, core inflation is still high and broad based. In response to inflationary pressures, the RBA has increased the policy rate by 425 basis points since May 2022, thereby taking the policy rate to a 12-year high of 4.35%. Given the strength of price pressures, we expect the RBA to maintain a restrictive policy stance through 2024.

Australian housing prices are rising, following a correction in 2022, as the supply of housing has not kept pace with demand. The rental market is also hot, partly driven by strong immigration growth which has added to demand. We anticipate that home and rental prices will continue to rise in the near term, which could intensify affordability concerns and slow inflation’s return to the RBA’s 2-3% target range.

Financial stability risks appear contained. The large Australian banks are well-capitalized with a high level of liquid assets. Strong domestic franchises consistently generate robust profitability. High levels of household debt and the common variable-rate mortgage in Australia make consumers vulnerable to rising interest rates. However, Australian households have weathered the increased cost pressure relatively well so far, given Australia’s resilient labor market and households’ strong balance sheets. Furthermore, a large majority of borrowers have accumulated prepayment buffers in the form of offset accounts or redraw facilities. We view the Australian banking system as well-positioned to navigate the current environment. However, we make a one-category adjustment to the ‘Monetary Policy and Financial Stability’ building block assessment to reflect risks related to the ongoing adjustments in property prices.

Strong Immigration Helps Sustain Growth In Near Term, Growth Prospects Are Comparatively Strong Over Medium Term

The Australian economy has outperformed most of its peers in terms of growth for the last two and a half decades. The drivers of growth have been multifold. Structural reforms in the 1980s and 1990s helped set the stage for a prolonged period of expansion. From the 2000s, Australia benefited from rapid growth in China, which greatly increased demand for Australian goods and services and fostered a decade-long investment boom. Another major contributor was strong population growth, which averaged 1.6% per year over the 15 years preceding the COVID-19 shock. The post-pandemic recovery in net migration has been very strong and accompanied by the rapid return of tourism and international students. Net overseas migration reached a record high of about 518,000 for FY2022-23. The population boost has helped sustain growth over the last year, and while the government plans to normalize immigration levels over the next few years, Australia’s medium term growth prospects remain strong. The IMF estimates Australia’s potential GDP growth at about 2.3%, which is high among peer advanced economies.

The main external risk to the economic outlook is a sharp deceleration in Chinese growth. The pandemic setbacks combined with the economic fallout of a slowing real estate sector and the potential escalation of global trade tensions pose risks to China’s outlook. In the event of a more prolonged slowdown in China, Australia would principally be affected through the terms of trade channel. Metals, coal, and fuel products account for more than half of Australia’s exports, and therefore are exposed to price fluctuations. Spillovers could extend to education and tourism service exports. Regional tensions over the last year between Australia and China appear to be stabilizing. China has lifted some restrictions on Australian goods and is expected to continue to do so over the next year. However, the outlook could be negatively impacted if trade tensions escalate between the two Asia-Pacific nations. The one category adjustment to the ‘Economic Structure and Performance’ building block assessment reflects the risks from potential regional volatility or escalating geopolitical tensions.

Australia’s external accounts appear broadly in line with economic fundamentals. Australia has been a perennial net importer of capital for decades, but the current account shifted to a small surplus in 2019. The surplus increased in 2020 and 2021 as Australia’s terms of trade improved, primary income payments declined, and service imports fell. The surplus narrowed in 2022 and 2023 due to easing commodity prices, strong import demand, and large primary income payments abroad. Morningstar DBRS expects the current account to return to a modest deficit over the medium term. The net foreign liability position has slightly improved but remains high (averaging 42% of GDP over the last five years); however, risks to balance sheets stemming from currency volatility appear relatively limited and a sizable share of foreign liabilities are in the form of equity.

Australia’s Strong Institutional Quality Supports The AAA Credit Rating

Australia’s political institutions are a fundamental strength of the sovereign credit profile. Australia is a stable liberal democracy with effective governing institutions. The political environment is characterized by strong rule of law, a sound regulatory environment, and low levels of corruption. In the May 2022 federal elections, the Labor Party, led by Anthony Albanese, defeated the incumbent Liberal-National coalition. The Labor government’s policy key priorities include investment in housing supply, advancement of green energy climate policies, and improvement to healthcare and well-being services like Medicare and aged care.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

There were no Environmental, Social, or Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (04 July 2023) https://dbrs.morningstar.com/research/416784/dbrs-morningstar-criteria:-approach-to-environmental,-social,-and-governance-risk-factors-in-credit-ratings.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments at: https://dbrs.morningstar.com/research/426951.

Notes:
All figures are in Australian dollars unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal methodology is the Global Methodology for Rating Sovereign Governments (06 October 2023) https://dbrs.morningstar.com/research/421590/global-methodology-for-rating-sovereign-governments . In addition Morningstar DBRS uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (04 July 2023) https://dbrs.morningstar.com/research/416784/dbrs-morningstar-criteria:-approach-to-environmental,-social,-and-governance-risk-factors-in-credit-ratings in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS’s outlooks and credit ratings are monitored.

The primary sources of information used for these credit ratings include the Australian Treasury, Reserve Bank of Australia, IMF, Australian Bureau of Statistics, BIS, World Bank/NRGI/Brookings, Federal Reserve Bank of Dallas, and Haver Analytics. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings was of satisfactory quality.

The credit rating was not initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

Morningstar DBRS did not have access to the accounts, management and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

The last credit rating action on this issuer took place on January 20, 2023 .

For more information on this credit or on this industry, visit dbrs.morningstar.com.

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