Fitch Affirms Australia at 'AAA'; Outlook Stable

(The following statement was released by the rating agency) Fitch Ratings-Hong Kong-May 01: Fitch Ratings has affirmed Australia's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'AAA' with a Stable Outlook. A full list of rating actions is at the end of this rating action commentary. KEY RATING DRIVERS Australia's 'AAA' rating is underpinned by strong governance, high income levels, and a track record of macroeconomic stability. An effective policymaking framework has supported 26 consecutive years of GDP growth without a recession, despite substantial external, financial and commodity price shocks during this period. Fiscal performance has improved in the past year. The general government (Commonwealth, State and Local) fiscal deficit in the year ending June 2017 (FY17) was better than expected at 2.4% of GDP, and Fitch estimates a further narrowing to 1.8% in FY18. Robust revenue collection from higher corporate earnings and commodity prices, along with continued recurrent spending restraint under the Commonwealth's budget repair strategy, have bolstered fiscal consolidation efforts, while still facilitating higher infrastructure spending. Nevertheless, Australia's general government deficit remains high relative to the 'AAA' median of a 0.7% of GDP surplus. The government has reiterated its commitment to achieving an underlying cash surplus by FY21. On current projections, achieving this target is highly sensitive to economic outcomes. The government's decision to scrap the 0.5pp increase in the Medicare levy set to begin in FY20, while still committing to fully fund the National Disability Insurance Scheme, poses a challenge toward achieving this objective. The budgetary impact of the newly proposed income tax cut measures remains to be seen as details will be released in the FY19 budget. Political differences between the House and the Senate have limited the government's ability to push through significant budget-related legislation, and pose an additional downside risk. Australia's general government debt ratio, at 41.2% of GDP in FY17, is in line with the 'AAA' median. Nevertheless, a 22pp rise in public debt since 2010, when debt/GDP was 34pp lower than the 'AAA' median, has eroded the country's previous fiscal strength relative to peers. Fitch continues to expect general government debt to peak in FY18, at 41.8% of GDP, and to maintain a downward trajectory thereafter. Fitch forecasts a modest acceleration in GDP growth from 2.3% in 2017 to 2.7% in both 2018 and 2019, above the 'AAA' median. Growth will be supported by higher non-mining private investment and public infrastructure investment, particularly as the drag from the substantial multi-year decline in mining investment fades. Exports will be supported by strong global demand and higher liquefied natural gas (LNG) exports as more production capacity comes online. Consumption growth has been steady, but is likely to remain subdued given sluggish wage growth, high household debt, and a savings rate which is already low. Monetary policy is likely to remain accommodative and supportive of growth over the next two years in the absence of significant wage growth or inflationary pressures. Fitch expects the Reserve Bank of Australia (RBA) to lag the U.S. Federal Reserve in tightening policy rates, only beginning to gradually lift rates with two 25bp hikes in 2019. Australia's flexible exchange rate provides the RBA with a buffer against tightening global financial conditions. The RBA would be likely to tolerate some depreciation of the Australian dollar, which has been broadly stable against the US dollar to date despite a growing interest-rate differential with the Fed. Macroprudential policies have given the RBA scope to maintain lower rates without substantially contributing to a further build-up in financial-sector risks. Australia's net external debt-to-GDP ratio is the highest within the 'AAA' category, at 56.1%. The heavy reliance on external funding leaves Australia exposed to sustained shifts in capital flows and higher external financing costs, particularly in the context of tightening global financial conditions which would weigh on growth and financial stability. Most external liabilities are denominated in local currency or hedged to reduce currency and maturity mismatches, helping to mitigate risks. Australia is a net foreign-currency creditor, after adjusting for foreign-currency hedges. High household debt, at 188.6% of disposable income in 4Q17, poses a potential downside risk for the economic outlook and financial stability. An interest-rate or employment shock could impair households' ability to service their debt, particularly in the current low-wage-growth environment, thereby pressuring consumption growth. Many households maintain large mortgage offset accounts, which can be drawn down to service debt and smooth consumption, but newer borrowers and more financially weaker households would remain vulnerable. Housing-price growth has continued to cool on the back of tighter credit standards, prudential regulation, and higher supply. A sharp correction in the housing market could flow through to both consumers and the financial sector. However, a severe downturn is not Fitch's base case. We expect Australian house prices to remain relatively stable, with modest price rises nationally in 2018. Australia's banking system scores 'aa' on Fitch's Banking System Indicator (BSI), the joint highest of any sovereign, and is well positioned to manage potential shocks. Sound prudential regulation has improved the resiliency of bank balance sheets by strengthening underwriting standards and limiting exposure to riskier mortgage products. Recent limits on growth rates for investor and interest-only loans have slowed the growth in these products, which Fitch considers riskier than traditional amortising mortgages. Furthermore, the strong capital position of Australian banks provides substantial loss-absorbing capacity in the event of a shock. The ongoing Royal Banking Commission is likely to have an impact on the public's confidence in the banking sector, but has not affected the underlying soundness to date. SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO) Fitch's proprietary SRM assigns Australia a score equivalent to a rating of 'AAA' on the Long-Term Foreign-Currency (LT FC) IDR scale. Fitch's sovereign rating committee did not adjust the output from the SRM to arrive at the final LT FC IDR. Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM. RATING SENSITIVITIES The Rating Outlook is Stable. Consequently, Fitch's sensitivity analysis does not currently anticipate developments with a material likelihood, individually or collectively, of leading to a downgrade. However, developments that may, individually or collectively, lead to negative rating action include: -A sustained widening of the fiscal deficit, leading to a continued rise in the general government debt-to-GDP ratio. -Economic or financial sector distress resulting from impaired household debt-servicing ability in the event of a negative housing or labour market shock, or a sharp rise in interest rates. -A sharp widening in the current account deficit or a sustained reallocation of foreign capital resulting from a negative external shock, such as an acute slowdown in China or severe tightening in global financial conditions. KEY ASSUMPTIONS -The global economy performs broadly in line with Fitch's Global Economic Outlook, particularly China, which is a key destination for Australian exports. -Fitch assumes an average iron ore price of USD55 per tonne in 2018 and 2019 (62% Fe CFR China reference). The full list of rating actions is as follows: Long-Term Foreign-Currency IDR affirmed at 'AAA'; Outlook Stable Long-Term Local-Currency IDR affirmed at 'AAA'; Outlook Stable Short-Term Foreign-Currency IDR affirmed at 'F1+' Short-Term Local-Currency IDR affirmed at 'F1+' Country Ceiling affirmed at 'AAA' Issue ratings on long-term senior unsecured local-currency bonds affirmed at 'AAA' Issue ratings on short-term senior unsecured local-currency bonds affirmed at 'F1+' Contact: Primary Analyst Jeremy Zook Associate Director +852 2263 9944 Fitch (Hong Kong) Limited 19/F Man Yee Building 68 Des Voeux Road Central Hong Kong Secondary Analyst Thomas Rookmaaker Director +852 2263 9891 Committee Chairperson Paul Gamble Senior Director +44 20 3530 1623 Media Relations: Leslie Tan, Singapore, Tel: +65 67 96 7234, Email: leslie.tan@fitchratings.com; Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. 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