Fitch Affirms Australia at 'AAA'; Outlook Stable

(The following statement was released by the rating agency) Fitch Ratings-Hong Kong-April 17: 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 an effective policymaking framework that has supported 27 consecutive years of GDP growth in the face of substantial external, financial and commodity price shocks. A credible commitment to fiscal consolidation from a debt level that is broadly in line with the 'AAA' median also supports the rating. Momentum in the economy has decelerated in the near term, but still compares well with 'AAA' peers. Fitch forecasts GDP growth will slow to 2.0% in 2019 from 2.8% in 2018, before rebounding to 2.5% in 2020. The slowdown is due in part to spillovers from a weakening housing market on dwelling investment and household consumption. Sluggish wage growth and high household debt levels have also weighed on consumption. A sizeable pipeline of public infrastructure spending and recently proposed tax cuts should help support growth. A sharper contraction than Fitch forecasts in the housing market and a significant weakening in the Chinese economy pose downside risks to the economic outlook. Australia has high export exposure to China - roughly 30% of total goods exports - making the economy particularly sensitive to developments in China's economy. Monetary policy is likely to remain accommodative to support economic growth and employment. The unemployment rate has continued to trend downward to 4.9% in February 2019, despite weakening GDP growth. Fitch expects slowing growth to begin to weigh on the labour market, pushing the unemployment rate up to 5.3% over 2019 and leading the Reserve Bank of Australia (RBA) to cut its policy rate by 25bp to 1.25%. Inflation is forecast to remain low and stable just below the RBA's target band of 2.0%-3.0%. Fitch estimates a federal government fiscal deficit of 0.2% of GDP (Government Finance Statistics basis) in the fiscal year ending June 2019 (FY19), based on the proposed budget announced on 2 April, before the government reaches its first surplus in 11 years at 0.1% of GDP in FY20. Fiscal consolidation continues to be bolstered by buoyant commodity revenue, a strong labour market and sustained spending restraint. Strong revenue growth provided scope for the government to pass personal income taxes last July and announce further tax cuts in the April 2019 budget without abandoning its target of achieving an underlying cash surplus by FY20. However, using some of the recent upswing in revenue makes the fiscal trajectory more sensitive to commodity prices, as well as GDP and wage growth. Fitch estimates the general government FY19 fiscal deficit to remain stable relative to last year at 1.0% of GDP, due to higher state and local infrastructure spending, particularly in New South Wales. Fitch forecasts the general government deficit to fall to 0.6% of GDP in FY20. General government gross debt is the 'AAA' median at 41.2% of GDP. A 22pp increase in government debt since 2010, due to sustained fiscal deficits, has eroded what was once a strength for Australia's credit profile relative to peers. Fitch forecasts debt-to-GDP to begin a downward trajectory in light of the improvement in fiscal performance. Federal elections are scheduled for 18 May 2019, which could alter the policy outlook over our two-year forecast horizon. Recent polls show the ruling Liberal-led coalition behind the opposition Labor Party. Fitch believes that there is generally strong cross-party support for prudent fiscal management, and both parties have called for a return to budget surpluses. Nevertheless, the fiscal policy mix would shift in the case of a Labor Party victory. Fitch expects the ongoing housing market correction to remain orderly. House prices in March 2019 are down 7.4% nationally from their October 2017 peak. Fitch forecasts an additional price decline of about 5pp nationally over 2019, before prices stabilise in 2020 due to demand associated with migration inflows and resilient economic growth. The slowdown appears driven by lower investor demand, due in part to targeted macroprudential policies, as well as tighter lending standards and increased housing supply. Housing market weakness has been most pronounced in Sydney and Melbourne, but other cities have seen some recent softening. Household debt, at 189.6% of disposable income in 4Q18, is high and poses an economic and financial stability risk, particularly in the context of declining house prices, in the event of a shock. An interest rate or employment shock could impair households' ability to service their debts. A rapid increase in mortgage rates appears to be unlikely, taking into account Fitch's outlook for RBA policy rates and a more gradual pace of global monetary policy tightening. Some households have prepaid their mortgages or maintain mortgage offset accounts that can be used to service debt in the case of difficulties, but newer borrowers and financially weaker households could be vulnerable. Mortgage arrears have inched up slightly in recent years, but are still at a very low level of about 0.9% in total. Less than 3.0% of mortgage loans are in negative equity, according to RBA estimates. Australia's banking system, which scores 'aa' on Fitch's Banking System Indicator (BSI), is well positioned to manage a housing market shock. Sound prudential regulation and ongoing strengthening of underwriting standards have improved the resilience of bank balance sheets and limited their exposure to riskier mortgage products. Australia's net external debt-to-GDP ratio is among the highest within the 'AAA' category, at 53.6%. The heavy reliance on external funding leaves Australia exposed to shifts in capital flows and higher external financing costs. Banks, which have significantly reduced their reliance on external funding since 2010, did experience an uptick in external financing costs last year, contributing to a modest increase in mortgage rates by about 10bp on average. Most external liabilities are denominated in local currency or hedged to reduce currency and maturity mismatches, helping to mitigate risks. Strong terms of trade, on the back of high commodity prices, narrowed Australia's current account deficit to 2.2% of GDP in 2018. Fitch forecasts the current account deficit to rise to 3.0% by 2020. 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 IDR scale. Fitch's sovereign rating committee did not adjust the output from the SRM to arrive at the final Long-Term Foreign-Currency 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 Long-Term Foreign-Currency 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 main factors that, individually or collectively, could trigger a negative rating action are: - 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 sustained widening of the fiscal deficit leading to a continued rise in the general government debt-to-GDP ratio. - 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 global risk appetite. KEY ASSUMPTIONS - The global economy performs in line with Fitch's global economic outlook, particularly China, which is a key destination for Australian exports - Fitch forecasts an average iron ore price of USD75 a tonne in 2019 (USD70 a tonne in 2018) and USD70 in 2020 (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' 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 Ed Parker Managing Director +44 20 3530 1176 Media Relations: Yee Man Ko, Hong Kong, Tel: +852 2263 9953, Email: alanis.ko@thefitchgroup.com; Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@thefitchgroup.com. 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