On Wednesday, global investment bank Goldman Sachs warned its clients that Australia is at risk of losing its coveted AAA credit rating.
The warning coincided with a huge plunge in the ASX 200, hitting its lowest point since the February rate cut, after two months of flirting with a seven-year high of 6000 (though never quite reaching it).
It came after five months of economic gloom, studded with occasional, unconvincing glimmers of hope, as the government struggled unsuccessfully to take the nation’s economic woes in hand.
But Goldman Sachs’ warning has embedded in it a positive story, and one which is all too often forgotten: Australia remains a member of an exclusive club of nine developed nations with three AAA credit ratings.
That gives us a fair claim to the title of quintessential first world country.
What Goldman Sachs said
In a note to clients, the bank’s chief economist Tim Toohey warned that ratings agency Standard & Poor’s was months away from putting Australia on a “negative outlook” – the first step towards a downgrade.
“A mix of sharply lower commodity prices, weak growth and political impasse have resulted in an unprecedented degree of fiscal slippage over recent years,” he wrote.
The Australian government’s current AAA rating – the top rating – means it is considered the safest possible bet for potential lenders. This allows the government to borrow at very low rates of interest.
Given the budget is operating at a $48 billion deficit – i.e. the government is spending $48 billion more than it is taking in tax revenue – the ability to borrow at low rates of interest is very useful.
But with the coming budget also predicted to deliver a similarly-sized deficit, and with no evidence that the Abbott government has a workable plan to end this run of budget deficits, global bond buyers may be beginning to lose confidence.
What a downgrade would mean
Mr Toohey said a downgrade would push Australian government bond yields up by 11.7 basis points. Today, that would push the interest paid on a 10-year government bond up from 2.59 per cent to 2.71 per cent.
In real terms, that would cost the government an extra $58 million a year in interest payments on a bond issuance of $48 billion.
In itself this is not a huge figure; however, a credit downgrade would be a blow to investor confidence and would likely have flow-on effects to the general economy.
In particular, it would make the big banks less attractive to investors. One major reason why people love investing in big banks is that they are ‘too big to fail’. That means it is pretty much guaranteed that if they fall into financial strife the government will bail them out.
But with the government’s ability to raise cheap debt hampered, its ability to bail out the banks is equally hampered. This makes investing in banks – either through equities or bonds – a riskier proposition.
Given the big four banks together make up almost 30 per cent of the ASX 200, any significant fall in their value would have a pronounced effect on the entire share market – and the nation’s collective retirement savings.
On the bright side
While Goldman Sachs’ prediction is bad news, it serves as a reminder that Australia is still one of the strongest, most reliable investment destinations in the world.
Australia is one of only nine nations in the world to boast AAA credit ratings from all three internationally-recognised ratings agencies – S&P, Moody’s and Fitch.
According to Trading Economics, only Canada, Denmark, Germany, Luxembourg, Norway, Singapore, Sweden and Switzerland can claim the same accolade.
Meanwhile, Trading Economics gives Australia a rating of 98 out of 100, behind only Denmark, Germany, Luxembourg, Sweden and Switzerland.
By comparison, the United Kingdom gets a score of 94, the United States 97, New Zealand 88 and China 79.
So what’s so special about Australia? Political stability aside, a look at the historical movements of our credit ratings suggests it was the mining boom that gave us our triple whammy of AAA ratings.
Australia’s first AAA rating since 1986 came at the dawn of the mining boom in 2002, when Moody’s lifted its rating from AA2. S&P promoted us to the top spot the following year.
The last agency to give us the AAA rating – Fitch – came at the very peak of the mining boom in 2011.
If Goldman Sachs is right about an imminent downgrade, it will coincide neatly with the end of the mining boom.
Good times over, next stop Greece?
In March, Prime Minister Tony Abbott declared: “Under the former Labor government we were heading to a Greek-style economic future.”
The implication was that his government would stop that from happening, though how it plans to do that is a great unknown, after it failed to get last year’s budget through the Senate.
So, are we headed for a Greek-style economic future? Seen through the lens of credit ratings, this is what that embattled nation looks like at the moment:
That’s pretty much as bad as it gets. Trading Economics gives Greece a score of 20 out of 100, the fifth-lowest score above Cuba, Pakistan, Ukraine and Venezuela.
The government’s 10-year bond yield, meanwhile, is 11.05 per cent, compared to Australia’s 2.59 per cent.
In credit rating terms, then, Australia is just about as far away as you can possibly be from Greece. Mr Abbott’s consistent comparisons to the basket case economy of Europe are misleading in the extreme.
If past experience is anything to go by, should Australia get downgraded, it is unlikely in the long term to slip past the AA mark. That would put it in the company of France, New Zealand and the United Arab Emirates.
Could be worse.