I’ve got good and bad news for Australian investors as regards our fiscal outlook and credit rating.
First the bad news. I think Australia should and will lose its triple-A credit rating within the coming year. The reality is that despite several years of close to trend economic growth and declining unemployment, national incomes growth remains weak and our tax base is becoming quite porous.
We just can’t seem to be able to raise the revenue we need to maintain the level of government services at that which we desire. According to the May Budget, the underlying budget deficit for this financial year will be around $37 billion, or 2.2% of GDP. That’s not a bad budget outcome by global standards, but it’s hardly great either. In the United States, the Congressional Budget Office estimate the 2016 budget deficit will be around 3.2% of GDP.
Of course, the Treasury (as always) projects that the budget deficit will shrink overtime – reaching only 0.3% if GDP by 2019-20. But this is largely dependent on bracket creep, whereby average household income tax rates rise over time as rising nominal wages push workers into higher income tax brackets.
And the budget projects are also vitally dependant on the Treasury collecting the level of corporate income taxes that is assumes. But as we’ve seen in recent years, Treasury estimates have missed badly, due to falling commodity prices and the greater than expected ability of firms to reduce their tax bill through deductions or offshore profit-shifting.
Indeed, according to the latest Deloitte Access Economics estimates, the budget deficit this year will be closer to $40 billion, and deficits up to $10 billion higher by 2019-20. That would leave the budget deficit in that year at around 0.8% of GDP – assuming no further downward revisions to revenue estimates.
Of course, while there’s been a surge in commodity prices (which should boost profits from the mining sector) this year, few analysts expect this to last – especially as high prices are likely to eventually usher in higher supply.
The Government is unlikely to quickly count on higher commodity prices being sustained while, meanwhile, mining companies are still able to report depress profits due to the lagged impact of past commodity price weakness.
At the same time, we have the farcical situation where the Government can’t even pass a modest proposal to tax backpackers at 19%, with the fractious Senate instead opting for a 10.5% tax. Given this backdrop, it’s very hard to see the Government being able to push through any serious budget consolidation measures through the Parliament over the foreseeable future.
Rating agencies will no doubt be looking at Australia’s deteriorating fiscal outlook and draw their own conclusions. To my mind, adherence to our triple-A credit rating simply can’t be credibly sustained. I suspect Standard & Poor’s may well downgrade our credit rating within the coming year. I could and probably should cut the rating just after Mid-Year Budget Review is announced on December 19, particularly as the Government has now continually demonstrated its inability to successfully steer budget consolidation measures through the fractious Senate.
So far so bad, but here’s the good news. Despite all the political rhetoric, I suspect a credit downgrade won’t really affect us all that much. Indeed, even newly installed Reserve Bank of Australia Governor Phillip Lowe has said as much in recent months.
After all, markets still form their own conclusions with regard to the riskiness of Australian debt, and a modest downgrade in credit rating won’t directly affect borrowing costs of Government, and hence local companies, all that much. Still working in Australia’s favour is that fact that Federal net public debt is still relatively low (at least for now) and yields are already relatively attractive by international standards.
For more important for the medium-term outlook for borrowing costs are the rise in global bond yields now underway, thanks to rising inflation expectations and the prospects of a US fiscal expansion under President-elect Donald Trump.
That said, a credit downgrade should at least serve as a wake-up call for Canberra that we can’t rest on our laurels and take our past good fiscal record for granted. The myriad of populist parties that now dominate our Senate is a blight on good policy making, and we’re starting to look a little more like Italy every day.