Overview

• We expect Queensland's operating margins to weaken and the after-capital account to revert into a large deficit as the state ramps up its capital expenditure program to address the energy transition.
• Queensland has temporarily benefitted from elevated commodity prices, which resulted in exceptional outcomes in 2022 and 2023.
• Queensland's exceptional liquidity position as well as its wealthy economy and management support our ratings.
• We affirmed our 'AA+' long-term and 'A-1+' short-term issuer credit ratings on Queensland. The outlook is stable.

Rating Action

On Sept. 21, 2023, S&P Global Ratings affirmed its 'AA+/A-1+' issuer credit ratings on the Australian state of Queensland. The outlook on the long-term rating is stable.

Outlook

The stable outlook reflects our expectation that Queensland's operating margins will narrow and its after-capital account will revert to large deficits. This will see debt rise to levels comparable with 'AA+' rated peers.

Downside scenario

We could lower our long-term ratings on Queensland if we believe management is weakening. An indication of this could be operating margins going into deficit, or after-capital account deficits underperforming our forecasts.

Upside scenario

Upside rating pressure could occur if we believe Queensland's financial management is improving, as demonstrated by consistently stronger after-capital account balances and structurally lower debt levels.

Rationale

We expect the State of Queensland's (Queensland) fiscal position to weaken as mining royalties fall from unprecedented levels, and infrastructure spending rises. We expect Queensland's operating surplus to fall to 1% of operating revenues in fiscal 2024 (ending June 30, 2024), from 17.3% in fiscal 2023, as mining royalties recede.

Queensland's after-capital account balance will revert to large deficits of about 10% of total revenues as the state increases its infrastructure program and as revenue windfalls taper. Queensland is increasing its infrastructure pipeline to fund its energy transition as it owns several large energy generators. In September 2022, the state committed to a target of 70% renewable energy by 2032. We have updated our forecasts for Queensland through to fiscal 2026 following the publication of the state's 2023-2024 budget.

Queensland's debt levels will rise across our forecasts as the after-capital accounts move back into deficit. Debt levels have moderated in recent years because of unexpected revenue windfalls. We believe the state will maintain its exceptional liquidity.

Our ratings on Queensland are supported by the general strength and wealth of the state's economy. Queensland contained the spread of COVID-19, allowing its economy to outperform peers over the past three years. The state also benefits from an extremely strong institutional framework and strong financial management.

Local economy sound; experienced financial management and Australia's institutional settings support creditworthiness. The government expects gross state product (GSP) to grow 2%-3% a year over the next three years. We project state final demand will rise by 2.0%-3.5% annually over the same period. We see downside risks to these forecasts because headwinds are rising. These include the effects of rapidly rising interest rates domestically and abroad.

Queensland's economy has outpaced the national average over the past few years. Household consumption has generated the greatest momentum, underpinned by a strong labor market. Unemployment is about 4%, near to the lowest levels in decades.

The national economy is slowing. We forecast Australia's real GDP will grow 1.4% in calendar year 2023, before rising to over 2% in 2025. Continuous rises in inflation and steady domestic demand have pushed the Reserve Bank of Australia to raise policy rates rapidly (see "Economic Outlook Asia-Pacific Q3 2023: Domestic Demand, Inflation Relief Support Asia's Outlook," published June 26, 2023).

Queensland has a comparatively diverse economy. However, it is also one of the world's largest coal and liquified natural gas (LNG) exporters. This implies changes in commodity prices and demand; and international energy policies can affect the state's future economic and revenue growth. Post the recent coal price surge--that was due to geopolitical tensions--we expect prices will recede over the next two to three years. Revenue from royalties should remain nearly twice as high as 2019 levels in our base case, aided by changes to the royalty regime in 2022.

The easing of trade restrictions in February 2023 by China should support Queensland's coal exports. An unofficial ban on the import of coal commenced in late 2020 due to geopolitical tensions between the Australian and Chinese central governments. Following the restrictions, Queensland exporters redirected about 90% of the coal previously exported to China to India, Japan, and Korea.

Queensland's longer-term growth should derive support from the Brisbane 2032 Olympic and Paralympic Games. The government expects these events to generate a 10-year pipeline of construction jobs, and trade and investment opportunities.

Supporting our strong financial management assessment is Queensland's fiscal strategy in adherence to a Charter of Fiscal Responsibility. The charter guides medium-term focus toward steady improvements in fiscal goals, including debt stabilization and the delivery of sustainable operating surpluses.

Queensland has a prudent approach to long-term planning and transparency. The state also has exceptional debt and liquidity management through Queensland Treasury Corp. Queensland is the only Australian state to fully fund its pension obligations. The state responded to the pandemic by introducing a Savings and Debt Plan to achieve efficiencies of about A$3 billion over four years. This target was fully met.

The institutional framework within which all Australian states and territories operate supports Queensland's strong financial management. We consider this framework to be one of the strongest and most predictable for subnational governments globally. It promotes a robust management culture and high levels of disclosure and transparency.

Energy transition to weaken budgetary metrics and increase debt; liquidity remains exceptional. We forecast Queensland's operating margins will narrow materially from 2024. We expect operating surpluses to average 2.7% of operating revenues between 2024 and 2026. Our revenue outlook on the state is softer in the near term because we expect economic conditions to tighten and coal prices to retreat. Further, expenses will likely be much higher in 2024, reflecting a large cost of living package, social housing spending, and rising wages.

The Queensland economy has benefitted from strong growth in mining royalties, which have supported budgetary metrics. Operating revenue grew by 12% in 2023, primarily from elevated coal prices, but also growth in payroll tax receipts from the tight labor market. We forecast Queensland's operating balance will average about 7.5% of operating revenues in 2022-2026, peaking at 17% in 2023.

Surging commodity prices underpinned Queensland's strong operating position in 2022 and 2023. Mining royalties in 2022 and 2023 were A$9 billion and A$18 billion respectively, compared with an average of A$4.2 billion in the five years prior. New progressive coal royalty rates introduced in July 2022 allowed the state to capitalize on elevated coal prices and accounted for about one third of mining royalties in 2023. We expect metallurgical coal prices to decline to about US$160 per tonne by calendar 2025 (see "S&P Global Ratings' Metal Price Assumptions: Market Conditions Are Broadly Supportive," published July 17, 2023).

Mining royalties, solid economic performance, and a tight labor market have propelled Queensland's operating revenue. Some of the upside has been channeled into new spending, such as cost-of-living relief, social and affordable housing, and domestic energy transition initiatives. The government's wages policy is implemented through public sector agreements covering wages and conditions for employees. The policy caps pay increases at 4% a year for the first two years of the agreement, and 3% in the final year. The agreement also provides for an annual one-off payment, capped at 3%, where headline inflation exceeds wage growth.

The state increased its capital pipeline substantially in the 2023-2024 budget. Queensland's large infrastructure program focuses on transportation-related projects, social housing supply, and the domestic renewable energy transition, along with developing health and education infrastructure. The state expects to spend about A$19 billion on energy transition over the next four years. The total Energy and Jobs plan is currently budgeted at A$62 billion and covers projects such as hydro plants, wind and solar farms, and battery storage.

Queensland delivered A$13.6 billion in capital expenditure in 2023 and we expect this to increase progressively to about A$18 billion in 2026. Our assessment assumes the state will deliver about 90% of its capital budget between 2024 and 2026. Although capital delivery is improving, record levels of infrastructure across Australia resulting in capacity constraints and skilled labor shortages mean Queensland may struggle to fully deliver on its budget capital spending.

The state's large capital plan will keep its after-capital account in large deficit. We forecast the after-capital account deficit will average about 4.3% of total revenues between 2022 and 2026. Large after-capital account surpluses in 2022 and 2023, buoyed by elevated commodity prices, distort the five-year average. As the capital program ramps up and commodity prices retreat from elevated levels, we anticipate budgetary metrics will be structurally weaker. We expect the after-capital account deficit to average about 10% of total revenue over the next three years.

Queensland's rising debt burden is also the result of its large capital expenditure pipeline. We forecast total tax-supported debt will reach 139% of operating revenue by fiscal 2026. Like its fiscal outcomes, the state's total tax-supported debt as a proportion of operating revenues benefited from surging coal royalties in fiscal 2023. Such was the rise in operating revenue in 2023, the ratio of total tax-supported debt to operating revenues fell from 133% in 2022 to 100% in 2023. We expect interest costs to average 3.7% of operating revenues between 2023 and 2025.

On June 30, 2021, Queensland established the Queensland Future (Debt Retirement) Fund (DRF) for future debt repayments. The government initially seeded the fund with about A$8 billion of assets. Assets within the DRF will only be used to reduce debt and pay associated administration expenses. The Queensland Future Fund Act 2020 provides the legislative framework for establishing and using the fund. We deduct a haircut amount of the DRF assets from our measure of tax-supported debt. We apply haircuts to DRF's non-cash asset holdings. This reflects our view of credit and liquidity risks associated with these types of assets. We could reverse our analytical approach if we observe any weakening in the government's commitment to the stringent rules that govern the fund.

Queensland has comprehensive liquidity coverage. This reflects the state's substantive holdings of liquid assets, strong access to external liquidity, and potential federal support, if required. Queensland's debt-service coverage ratio is about 212% of upcoming debt maturities, interest costs, and budget requirements. It has about A$17 billion of debt maturing over the next 12 months, including short-term notes.

The state's liquid assets include its superannuation assets used to offset upcoming superannuation liabilities. This is because, unlike other states that use trust accounts, Queensland directly manages these assets and can use them for liquidity purposes, if required. Furthermore, we expect the state to continue to fully fund its superannuation liabilities, unlike its domestic peers.

We believe Queensland has strong access to external liquidity. Capital markets In Australia are deep and liquid, and we expect them to remain so. The Reserve Bank of Australia backstopped the domestic government bond market through a quantitative easing program that ran from November 2020 to February 2022. It is now allowing its bond holdings to gradually diminish as they mature. We also believe the Australian central government would provide support if needed in a severe stress scenario, as it did in 2009-2010, when it offered to provide a guarantee over state and territory government borrowing.

Queensland has limited exposure to contingent liabilities, and these do not weigh on our assessment of its credit metrics. The state is prone to natural disasters such as cyclones, floods, fires, and drought. These events pose risks to its economy and budget. A significant proportion of costs to deal with such events are met by Commonwealth Disaster Recovery Funding Arrangements and insurance. Therefore, we do not expect any single such event to significantly weaken Queensland's credit profile.

Key Statistics

Ratings Score Snapshot

Related Criteria

• General Criteria: Environmental, Social, And Governance Principles In Credit Ratings, Oct. 10, 2021
• Criteria | Governments | International Public Finance: Methodology For Rating Local And Regional Governments Outside Of The U.S., July 15, 2019
• General Criteria: Methodology For Linking Long-Term And Short-Term Ratings, April 7, 2017
• General Criteria: Principles Of Credit Ratings, Feb. 16, 2011

Related Research

• S&P Global Ratings' Metal Price Assumptions: Market Conditions Are Broadly Supportive, July 17, 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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