Five reasons why Australia’s AAA rating is in danger

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Australian Economy, Uncategorized

There has been a plenty of speculation about the possibility of Australia losing its AAA rating in the recent time. A rating is normally given to organisations such as governments or companies wishing to borrow money in the markets and provides potential lenders with an easy measure of the likelihood of repayment. The rating is thus used by investors, sovereign wealth funds and pension funds to determine the credit worthiness. These ratings have several grades ranging from the highest AAA to the lowest C being the investment grade paper and anything below BB is regarded as junk. Last year, it was reported that Australia is one of the 12 governments in the world which can proudly flourish a AAA rating. Logically, the highest ratings carry the lowest cost of borrowing and the ratings are assigned by rating agencies such as Standard and Poor and Moody’s. The current danger revolves around:

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For Australia, a credit rating downgrade are associated with consequences because, in theory, lenders would ask for a higher return to compensate for the additional risk. This is not always true as other countries which have been downgraded from AAA, such as Japan and the United States have actually seen a reduction in the cost of borrowing because investors believe that the respective central banks will continue to maintain lower official interest rates. However, the real impact would fall on other borrowers whose health is critically dependent on the condition of the government and this is particularly true for institutions such as state governments and banks. For instance, the banks in Australia would derive the bulk of their funding from international investors could end up paying higher rates, which would then be passed on to the borrowers. According to one estimate, the major banks, could end up paying as much as $ 200 million yearly or more.

Unfortunate election outcome and health of the government: The uncertainty surmounting the election situation in Australia is being tied with the health of the government and so far the same has created some level of turbulence.

Budgetary deficit: This is a significant reason for Australia to fear a downgrade. Standard and Poor has warned that the elections could severely hamper the ability of the government to tackle budgetary deficits. The ability of the new government to enact measures concerning revenue and expenditure will be critical though the strength of the banking system is a positive factor.

Foreign debt: Foreign debt of Australia over $ 1 trillion is being seen as another major concern for rating agencies. The debt is more than twice the foreign income from exports and dividends, which exceeds every other country in the world except for Greece and the USA. Treasurer Scott Morrison has forecasted that net debt will peak at 19.2% of GDP by mid-2018.

Prevailing negative sentiments: Standard & Poor’s (S&P) downgraded Australia’s credit outlook from stable to negative with AAA credit rating unchanged given the current macro challenges and above shortcomings. This primarily comes at the back of the softness expected in the budgetary performance following the recent election outcome.

Exposure to weak commodity export demand: S&P has raised concern about the disparity between its forecast for iron ore prices (close to $US20 per metric ton) and the Government’s budget prediction (forecast $US55 a tonne in most recent budget). In the federal budget, Treasury forecast that a $US10 per tonne drop in iron ore prices can cost $1.4 billion from Commonwealth revenue in FY16 and $3.9 billion in FY17.

Overall, the downgrade is expected to increase government borrowing costs and bank costs while deteriorating the consumer and investor confidence.

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