Overview

• Sound fiscal metrics support our 'AAA' long-term sovereign credit rating on Australia. High commodity prices and inflation, along with strong employment conditions, are narrowing the country's fiscal deficit and slowing borrowing needs.
• We forecast the general government deficit will average about 1.4% of GDP between fiscals 2024 (year ending June 30) and 2026, ensuring net general government debt remains below 30% of GDP.
• Our ratings on Australia benefit from its strong institutional settings, wealthy economy, and monetary policy flexibility. Although external indebtedness is high, we expect the current account to be structurally stronger than in the past.
• We affirmed our 'AAA' long-term and 'A-1+' short-term local and foreign currency sovereign credit ratings on Australia.
• The stable outlook on the long-term rating reflects our expectation that fiscal metrics will remain steady over the next two years.

Rating Action

On Sept. 20, 2023, S&P Global Ratings affirmed its 'AAA' long-term and 'A-1+' short-term unsolicited sovereign credit ratings on Australia. The outlook on the long-term rating is stable.

Outlook

The stable outlook reflects our expectation that the general government deficit and net debt will remain modest over the next two years. Despite the current account balance softening, Australia's external accounts will likely remain stronger than in the past.

Downside scenario

We could lower our ratings if the general government deficit widened materially, causing net debt and interest costs to rise. This could occur if the economic outlook or commodity prices weakened relative to our expectations, causing fiscal outcomes to materially underperform our forecasts.

Rationale

Australia's fiscal accounts continue to improve following the pandemic. Stronger outcomes are driven by robust economic conditions such as low unemployment, elevated commodity prices, and high nominal GDP growth of about 10% per year in fiscal 2022 and 2023. Tailwinds should result in fiscal outcomes in the next year or two being stronger than recent years despite our projection for real GDP growth slowing to 0.6% in fiscal 2024. We anticipate the economy will slow as higher interest rates result in a pullback in consumption growth and soften investment conditions.

We forecast the general government deficit, including the Commonwealth and sub-national governments, will be about 1.4% of GDP between fiscals 2024 and 2026. This should ensure net general government debt remains below 30% of GDP. We estimate the general government deficit to be just 0.4% of GDP in fiscal 2023, down from its peak of about 8.6% at the height of pandemic in fiscal 2021, as economic conditions deliver an unprecedented windfall.

The current account will revert to a small deficit from fiscal 2025, in our assessment. Despite this, external conditions, including the current account, will likely be stronger than in the past two decades, in our view.

Supporting our ratings are Australia's strong institutions, which are conducive to swift and decisive policy making, credible monetary policy, and a floating exchange-rate regime. These strengths ensured Australia's economy, while exposed to commodity demand cycles and vulnerable to international capital flows, remained resilient throughout the pandemic and previous global economic crises.

Institutional and economic profile: A high-income, diversified and resilient economy, and strong institutions, are key credit strengths

• Real GDP growth to slow to 0.6% in fiscal 2024 as monetary tightening kicks in and unemployment rises, albeit from a historically low base.
• Wealthy and high per capita income underpins the sovereign rating.
• Strong political and institutional environment conducive to swift and decisive policy making.

Australia's medium-term economic outlook is sound, even though we estimate real GDP growth will slow to 0.6% in fiscal 2024, its lowest level in decades outside of the pandemic-hit outcome for fiscal 2021. Key reasons for the slower GDP growth are a rapid rise in interest rates and slowing trade partner growth, particularly China (see "Economic Research: Economic Outlook Asia-Pacific Q3 2023: Domestic Demand, Inflation Relief Support Asia's Outlook", published June 26, 2023).

Consumer confidence is well below its long-term average. Australian consumers are particularly sensitive to rising interest rates, given their preference for variable-rate mortgages, and high levels of household debt. Therefore, we anticipate consumption growth will be below trend over the next two to three years, after slowing to 0.1% for the June 2023 quarter. The central bank--the Reserve Bank of Australia (RBA)--increased official interest rates to 4.1% in June 2023 from 0.1% in May 2022, driving mortgage payments substantially higher. The Australian Bureau of Statistics (ABS) estimated mortgage interest payments rose more than 90% for the year to June 2023 for the average employee. This was the largest increase on record. The savings ratio has fallen to its lowest level since 2008.

We expect real GDP growth to settle at 2%-2.5% in fiscals 2025 and 2026. Importantly, nominal GDP growth, which drives taxation revenues, will average about 5% during this period. Australia's historically low unemployment rate of about 3.7% in July 2023 means higher costs and mortgage payments can be absorbed by households, in our view. We expect the slowing economy to lead to a 70 basis point increase in unemployment by June 2024, meaning unemployment will still be low in a historical context. The unemployment rate is about half of its peak during the pandemic, when it hit 7.5% in July 2020.

Real GDP growth was robust at 3.2% in fiscal 2023. Australia was less affected by the global energy crises than many of its peers because it is a large net energy exporter. National accounts such as GDP and the terms of trade benefited from rising energy prices. Nominal GDP growth has averaged about 10% per year in fiscals 2022 and 2023, contributing to strong tax revenue growth.

Net migration has returned strongly after turning negative for the first time since 1946. We forecast population growth at about 2% in fiscal 2023 as net overseas migration increases following the reopening of borders. Travel restrictions limited migration throughout the pandemic with population growth falling to just 0.1% in 2021. Migration contributed about 60% of Australia's 1.6% annual population growth between fiscals 2005 and 2020. Australia's economy remains structurally wealthy and diversified, with a high GDP per capita of about US$64,000 in fiscal 2023.

Australia has a high level of wealth due to its strong institutional settings and policy making as well as decades of economic reform, which have facilitated the country's flexible labor and product markets. Successive Australian governments have demonstrated a willingness to implement reforms to sustain economic growth and public finances, and have a strong track record of managing past economic and financial crises. There has been strong bipartisan agreement in Parliament during previous economic and financial crises. Institutions are stable and provide checks and balances to power, there is strong respect for the rule of law, and a free flow of information and open public debate of policy issues.

Flexibility and performance profile: Elevated commodity prices and high inflation bolstering Australia's public finances

• Sound fiscal metrics with the general government deficit averaging 1.4% in fiscals 2025 and 2026, and net general government debt remaining less than 30% of GDP.
• Monetary policy and a flexible exchange-rate regime remain key strengths.
• Australia's external assessment is weighed down by volatile terms of trade and significant offshore borrowing.

Australia's fiscal accounts are sound. We forecast the general government deficit, including the Commonwealth and subnational governments (i.e., the state and local governments), will average 1.3% of GDP over fiscals 2024-2026. We estimate the deficit narrowed to just 0.4% of GDP in fiscal 2023, aided by a central government surplus of 0.8%. We believe the central government will roughly balance its budget in fiscal 2024, offsetting part of the deficits at the state government level.

Reflecting these deficits, the change in net general government debt will be about 1.4% of GDP between fiscals 2024 and 2026, in our assessment, after accounting for below-the-line spending (such as the establishment of investment funds, infrastructure spending and student loans), and changes in the value of liquid assets. Most of the deficit going forward can be attributed to Australian state governments and their record spending on infrastructure programs. The improvement in fiscal outcomes is a key factor in our 'AAA' ratings because it will reduce the government's annual borrowing needs and provide a buffer to absorb future economic shocks.

Deficits have narrowed substantially since the height of the pandemic, when they peaked at 8.6% of GDP in fiscal 2021. In fiscals 2021 and 2022, multiple outbreaks of COVID-19 and subsequent government-imposed lockdowns hurt Australia's economy and public balance sheets. These lockdowns also allowed the government to control outbreaks quicker than most other countries. This underpinned a stronger economic and fiscal recovery than otherwise would have been the case.

Continued strong demand for key commodity exports--iron ore, coal, and gas--and high inflation are boosting company, personal income, and goods and services taxes. We expect revenues to average about 37% of GDP from fiscals 2024-2026, up from 33.5% for the decade leading into the pandemic. The terms of trade have come down about 12% from record highs, reflecting falling commodity prices (see "S&P Global Ratings' Metal Price Assumptions: Market Conditions Are Broadly Supportive," published July 17, 2023). The RBA's commodity price index has also retreated from a recent high.

Government outflows are also benefiting from strong employment conditions, which are easing pressure on social security payments. Despite this, we expect expenses to average about 38.5% of GDP for fiscals 2024-2026; up from 36% for the decade to 2019. Higher expenses reflect high inflation, rising indexation, infrastructure spending, and additional aged care and the national disability insurance scheme funding. Expenses peaked at about 44% of GDP at the height of the crisis.

Reinforcing our assessment of Australia's fiscal position is our view that it has displayed more willingness than its peers to raise revenues and contain expenditures over the past decade. For example, revenue as a share of GDP has increased since the 2008-2009 financial crisis. Further, expenditures were flat as a share of GDP for the decade leading to the pandemic.

Australia's debt levels are modest in a global context. The improvement in fiscal deficits has slowed the accumulation of net general government debt as a proportion of GDP compared with our previous forecasts. Given the improved fiscal position, net general government debt will be 26.5% of GDP in fiscal 2024; in our assessment, down from our previous forecasts of 31%. Net general government debt was about 12% of GDP in fiscal 2019. We project interest costs at about 3.9% of general government revenues during fiscals 2024-2026.

In our view, Australia's financial system doesn't pose a threat to the sovereign credit rating. The banking system ranks in the top quartile of systems that we assess globally. Along with the high-income Australian economy, this reflects the low risk appetites of the major banks, which dominate the industry, and is supported by conservative and largely effective regulation and supervision.

The Australian banking system remains dependent on offshore funding. In our base case, we expect the share of offshore funding to revert to near-2019 levels over the next two to three years as the RBA's term-funding facility comes to an end. The share of offshore borrowing reduced on the back of strong support by the RBA during the pandemic.

We forecast credit losses will remain low and close to pre-pandemic levels. We also consider that only a small proportion of borrowers will face distress due to rising interest rates and unemployment. That said, high house prices and private-sector debt continue to pose risks to the banking sector.

While house prices in Australia appear to have bottomed out following an orderly correction over the past year, the balance of risks remains tilted to the downside. Our expectations are that house prices start rising again over the next two years amid the strong return of migration, and soft investment conditions. We believe prices are likely to remain high relative to incomes over the medium term.

We expect bank credit to nongovernment residents to remain high at about 160% of GDP, including interbank lending. An abrupt disruption in the property market, which we view as an unlikely event, could lead to vulnerabilities in the financial sector and fiscal and economic stability.

On the external front, Australia remains vulnerable to major shifts in international capital flows. While these vulnerabilities are a structural feature of Australia's economic landscape, they haven't negatively affected the economy or financial system during past crises. We believe this is because of Australia's flexible economy, sound investment prospects, foreign investors' confidence in Australia's rule of law, the high creditworthiness of its banking system, and strong institutional performance in addressing major economic shocks. Australia's external debt is mostly generated by the private sector and reflects the productive investment opportunities available in the country.

External flows are much stronger than in the past, despite our expectations that the current account surplus will narrow this year and revert to a small deficit in fiscal 2025. The current account will weaken as commodity prices normalize and the service account weakens. The current account deficit will average about 2.2% of current account receipts (CARs) in fiscals 2025 and 2026. Australia achieved four consecutive annual current account surpluses during fiscals 2020-2023. Prior to 2020, Australia had run current account deficits since 1974. The current account deficit averaged about 18.5% of CARs for the two decades leading to the pandemic.

Despite stronger flows in recent years, Australia's stock of net external debt, at 200% of CARs from fiscals 2024-2026, and short-term external debt, remains very high on a global scale. The stock of short-term external debt, which is mostly bank debt, has fallen to about 135% of CARs in fiscal 2024 from more than 200% in fiscal 2018. Additionally, net external liabilities have declined substantially in fiscal 2023 to 111% of CARs from 190% in fiscal 2020. Strong commodity prices and export volumes drove CARs more than 25% higher in fiscal 2022, compared with record earnings in 2021.

We expect Australia's external borrowers to maintain easy access to foreign funding. The RBA has maintained a freely floating exchange-rate regime since 1983. The Australian dollar represents about 1.7% of allocated international reserves as of the September 2022 quarter, and the currency represented about 6% of spot foreign-exchange transactions. Australia's domestic bond market is deep and although external borrowing is high, it is mostly denominated in the nation's own currency, or hedged.

Australia has a high degree of monetary credibility via the independent RBA. The implementation of recommendations following a RBA review will strengthen governance and transparency standards, in our opinion. These changes are, in our view, unlikely to result in material differences in monetary policy or economic outcomes.

In the face of elevated inflation, the RBA lifted the cash rate to 4.1% in June 2023 from 0.1% in May 2022. Underlying inflation in July 2023 was 5.6%, down from its December 2022 peak of 7.2%. Inflation remains well above the RBA's target of 2%-3%. We expect inflation will continue to ease over the next year because Australian households are sensitive to rising interest rates, given their high level of household debt, elevated house prices, and the predominance of variable-rate mortgages in Australia. The latter ensures a relatively swift pass-through of monetary policy to households.

The RBA has helped temper major economic shocks such as the pandemic and the 2008-2009 global financial crisis. The central bank responded to the pandemic by:

• Cutting the cash rate to 0.25% in March 2020 and later to 0.1% in November 2020,
• Targeting a three-year Australian Government Securities (AGS) yield of 0.25% in March 2020, which was subsequently lowered to 0.1% in November 2020.
• Introducing the term-funding facility to provide liquidity to the banking system, and
• Purchasing government bonds in the secondary market. Its bond purchasing program ceased in February 2022 after it purchased about A$224 billion of AGS and A$57 billion of state securities. This program helped facilitate the smooth functioning of Australia's bond market during the pandemic.

We expect similar action if required during future crises.

Key Statistics

Ratings Score Snapshot

Related Criteria

• General Criteria: Environmental, Social, And Governance Principles In Credit Ratings, Oct. 10, 2021
• Criteria | Governments | Sovereigns: Sovereign Rating Methodology, Dec. 18, 2017
• General Criteria: Methodology For Linking Long-Term And Short-Term Ratings, April 7, 2017
• General Criteria: Principles Of Credit Ratings, Feb. 16, 2011
• General Criteria: Methodology: Criteria For Determining Transfer And Convertibility Assessments, May 18, 2009

Related Research

• Sovereign Ratings History, Aug. 16, 2023
• Sovereign Ratings Score Snapshot, Aug. 9, 2023
• Sovereign Risk Indicators, July 10, 2023 (An interactive version of the Sovereign Risk Indicators can be found at www.spratings.com/SRI)
• Asia-Pacific Sovereign Rating Trends Midyear 2023: Sturdier Times, July 6, 2023
• Global Sovereign Rating Trends Midyear 2023: Fragile Stability, July 6, 2023
• Economic Outlook Asia-Pacific Q3 2023: Domestic Demand, Inflation Relief Support Asia's Outlook, June 26, 2023
• Banking Industry Country Risk Assessment: Australia, June 2, 2023
• Bulletin: Inflation, Jobs, Spending Restraint Narrow Australia's Deficit, May 9, 2023
• Default, Transition, and Recovery: 2022 Annual Global Sovereign Default And Rating Transition Study, April 29, 2023
• Sovereign Debt 2023: Asia-Pacific Central Government Borrowing To Fall Below US$4 Trillion, March 10, 2023

In accordance with our relevant policies and procedures, the Rating Committee was composed of analysts that are qualified to vote in the committee, with sufficient experience to convey the appropriate level of knowledge and understanding of the methodology applicable (see 'Related Criteria And Research'). At the onset of the committee, the chair confirmed that the information provided to the Rating Committee by the primary analyst had been distributed in a timely manner and was sufficient for Committee members to make an informed decision.

After the primary analyst gave opening remarks and explained the recommendation, the Committee discussed key rating factors and critical issues in accordance with the relevant criteria. Qualitative and quantitative risk factors were considered and discussed, looking at track-record and forecasts.

The committee's assessment of the key rating factors is reflected in the Ratings Score Snapshot above.

The chair ensured every voting member was given the opportunity to articulate his/her opinion. The chair or designee reviewed the draft report to ensure consistency with the Committee decision. The views and the decision of the rating committee are summarized in the above rationale and outlook. The weighting of all rating factors is described in the methodology used in this rating action (see 'Related Criteria And Research').

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