07/07/2016 - 20:01

Ratings action not inconsequential

07/07/2016 - 20:01

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There’s a one in three chance the Commonwealth government’s credit rating could be downgraded within the next two years, according to Standard & Poor’s, a move which would be expensive for taxpayers and may have flow on effects for other borrowers.

The change in outlook is a headache for Treasurer Scott Morrison (photo: Attila Csaszar).

There’s a one in three chance the Commonwealth government’s credit rating could be downgraded within the next two years, according to Standard & Poor’s, a move which would be expensive for taxpayers and may have flow on effects for other borrowers.

On Thursday, S&P moved Australian sovereigns to negative outlook, although the agency maintained the AAA/A-1+ rating for now, citing uncertainty as a result of the recent tight election.

The move serves as a warning to the incoming parliament that action must be taken to reduce the size of the deficit, as a lower bond rating would mean higher interest payments on government debt.

ACIL Allen Consulting executive director (WA & NT) John Nicolaou said that one result of a future reduction from the AAA rating could be reduced discipline in government around fiscal management.

That’s because a ratings downgrade can become a slippery slope, with each additional negative move likely to have a greater and greater impact on yields, or the cost of borrowing.

Once a rating is lost, governments may try to downplay the impact.

“The importance of having a AAA credit rating I think first and foremost is the discipline it imposes on the government of the day to ensure that its a sound financial manager,” Mr Nicolaou said

“I think the warning by S&P gives you an indication of how concerned credit rating agencies are now with the state of financial affairs in Australia.”

That could impact the real economy when investors have concerns about future tax changes, for example, which they might fear would be made as the outlook worsens and becomes more unstable.

Western Australia appears to have recently fallen to the slippery slope fate, with Premier Colin Barnett reportedly saying earlier this year that he didn’t have much confidence in ratings agencies, while in 2014 he said their analysis of the state’s debt position had been ‘weak’.

Mr Nicolaou said a downgrade for the national rating would have an impact on the cost of debt.

“It does increase the cost of borrowing,” he said.

“When you’re talking about billions of dollars of borrowing… it does add up.

“There is a big opportunity cost that comes with higher interest payments.”

The national government debt stock is about $421 billion, with about $30 billion of bonds reaching maturity in 2017, according to the Australian Office of Financial Management.

A ten basis point rise in the interest rate on those instruments would cost about $30 million.

St George Bank senior economist Janu Chan said the announcement of the change in outlook had not had a significant impact on the Commonwealth bond market, with 10 year yields up two basis points.

An actual downgrade, however, could have a larger impact.

Flow through

Among economists consulted by Business News, views differed as to whether a downgrade would impact other interest rates across the economy, including commercial paper or even mortgage rates.

UWA Business School professor Richard Heaney said there would be a range of factors that would influence interest rates for companies.

A sovereign rating change would not impact large international corporates at all, he said.

One example was during ongoing crises in South America during the 1990s, where sovereign debt was hammered while high quality corporate debt didn’t face the same challenges.

Nor was he convinced that changes in sovereign rates would impact interest rates for small businesses.

ACIL’s Mr Nicolaou said there was some evidence to suggest a downgrade would have flow on impacts.

“Broadly other borrowers, whether it be consumers, businesses, local government agencies, state governments or the federal government need to factor in a bit of risk that comes with a more unstable financial outlook,” Mr Nicolaou said.

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