12 April 2016
by Jacob Greber

Federal debt load 'pushing against' AAA boundary, warns NAB

Two of the nation's big four banks have warned the federal government risks losing the patience of credit agencies, whose AAA rating for Australia has helped underwrite some of the lowest household mortgage rates on record.

With politicians likely to be tempted into new and underfunded spending promises in the looming federal election, National Australia Bank's global head of policy research, Peter Jolly said Commonwealth debt was now "pushing against ratings agencies' AAA boundary".

Mr Jolly's remarks were echoed by Michael Blythe, chief economist at Commonwealth Bank of Australia, who said while the ratings agencies "have been very patient with us; there's a limit to their patience".

"The reality is that we've seen this continued pushing-back of the return to surplus, and even if we manage to get there on the current timetable, it will be the most drawn-out return we've seen," Mr Blythe said.

So far both sides of politics are emphasising the need for fiscal restraint, with Treasurer Scott Morrison maintaining the budget will ensure the government lives "within its means".
"It means you don't make promises for which there is no money," he said on Monday. "It means that you keep your expenditure control tight."

Opposition treasury spokesman Chris Bowen said the government has failed to deliver on its promise to fix the budget ahead of the last election, which was based on a "magic pudding" of lower tax, lower spending, lower debt and surpluses. "What we got was the exact opposite," he said.

"Under any factual assessment the government has simply failed to deliver on its own promises, doubling the deficit between their first budget and their second budget, with net debt blowing out too."

Central to election
Concerns about the rating will be at the heart of the next election, with the prospect of the first downgrade since the late 1980s likely to damage confidence and undermine the credibility of Canberra's political classes.

Another concern is that while a downgrade may not drive up borrowing costs for the government itself, given its debt is issued in Australian dollars and which it can theoretically print at will, many finance experts believe it would almost certainly squeeze the banks, which rely on offshore funding to run their mortgage books.

That's because Australia's lenders enjoy a de facto AAA credit rating on the assumption that the federal government would bail them them out in a crisis. Once downgraded in the event of a Commonwealth rating cut, they may not be able to continue supplying households and businesses with as much credit and at current low prices.

At this stage the federal budget appears to be tracking roughly in line with what Mr Morrison outlined in the mid-year update just before Christmas, when fresh revenue write-downs forced him to increase the forecast deficit to $37.4 billion for 2015-16 from $35.1 billion in last year's budget.

The forecast deficit for 2016-17 was increased to $33.7 billion from $25.8 billion, with no return to surplus before 2021-22.

Three weeks out from the budget there have been only a few new spending promises by the Turnbull government, including almost $3 billion in funding to the states for health, and $500 million for Western Australia.

Analysts expect the headline deficit numbers to remain relatively stable when the budget is published, given commodity prices have rebounded sharply since the start of the year. Partial monthly finance department data to the end of March also show the deficit for this financial year is tracking a few billion dollars less than what was forecast in the mid-year economic and fiscal outlook.

Concern over repair
However, NAB's Mr Jolly expressed unease that the looming federal election and next month's budget may see both sides of politics ease up on budget repair efforts to maximise votes.

He also pointed out that debt levels are well above the average of the past 36 years, hitting 15 per cent of GDP last year and on the way to 18 per cent over the next two years. That's about three times greater than the last time S&P cut the credit rating to AA in 1989.

Mr Jolly said that keeping the ratings agencies happy would require demonstrating "ongoing restraint", thereby continuing the likely drag on economic growth of recent years.

"With a general election at some point over the next six months, where the government and opposition will be releasing policy initiatives and making promises, a question for investors is whether fiscal restraint will continue."

In January, S&P warned that Australia's AAA rating was based on an expectation of ongoing budget restraint that would result in "consistently narrowing deficits over the forecast horizon, maintaining the general government debt near or below current levels".

The agency cautioned that there was a need for "strong" government savings to offset the exposure caused the offshore borrowings of Australia's banks.

Andrew Hanlan, a senior economist at Westpac, said the rating would be revisited after the next federal election, but he expressed hope that the fall in the terms of trade, which has bedevilled budgeting since late 2011, may have stabilised.

"If we're at that point, fiscal policy can start to make some progress," Mr Hanlan said. "Going forward, it comes down to policy choices; and fiscal policy is a social document between the government and the electorate. But if we get income growth back towards trend, we can maybe get the deficit to narrow.