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Western Australia's credit rating juggling act: what price triple-A? Western Australia's credit rating juggling act: what price triple-A?
(about 1 hour later)
The decision last week by credit agency Standard & Poor’s to downgrade Western Australia’s credit rating from AAA to AA+ highlighted the difficulty of managing the economy and pleasing the ratings agencies.The decision last week by credit agency Standard & Poor’s to downgrade Western Australia’s credit rating from AAA to AA+ highlighted the difficulty of managing the economy and pleasing the ratings agencies.
The downgrade reflected Standard & Poor’s view that the Western Australian government was not as committed to paying off debt as the WA premier, Colin Barnett, would have everyone believe.The downgrade reflected Standard & Poor’s view that the Western Australian government was not as committed to paying off debt as the WA premier, Colin Barnett, would have everyone believe.
In its statement, the ratings agency noted:In its statement, the ratings agency noted:
“... while the fiscal action plan announced in WA’s fiscal 2014 budget improves the state’s path, in our view there is likely to be slippage, reflecting our view of limited political will as evidenced by the early revision of some budget revenue and expenditure measures.”“... while the fiscal action plan announced in WA’s fiscal 2014 budget improves the state’s path, in our view there is likely to be slippage, reflecting our view of limited political will as evidenced by the early revision of some budget revenue and expenditure measures.”
The key term is “political will” and reflects that, while talking the talk of cutting spending and returning to surplus is rather easy, actually doing it is tough.The key term is “political will” and reflects that, while talking the talk of cutting spending and returning to surplus is rather easy, actually doing it is tough.
The main consequence of the downgrade is that, notionally, it will make raising money for the WA government more expensive as investors may now demand a higher interest rate (or bond yield) on WA government bonds.The main consequence of the downgrade is that, notionally, it will make raising money for the WA government more expensive as investors may now demand a higher interest rate (or bond yield) on WA government bonds.
The main purpose of ratings agencies is to let investors know the relative risk of governments’ and companies’ bonds. It doesn’t always follow, however, that a ratings downgrade will mean the yield a government pays for its bonds will go up. In September last year, when Fitch downgraded Queensland’s credit rating from AA+ to AA, the yields on Queensland Treasury Corporation (QTC) bonds fell in the following quarter.The main purpose of ratings agencies is to let investors know the relative risk of governments’ and companies’ bonds. It doesn’t always follow, however, that a ratings downgrade will mean the yield a government pays for its bonds will go up. In September last year, when Fitch downgraded Queensland’s credit rating from AA+ to AA, the yields on Queensland Treasury Corporation (QTC) bonds fell in the following quarter.
The yields are now higher, but this is mostly because state government bonds follow the value of Australian government’s bonds. And in the past year, the yield on Australian government bonds has risen – albeit from record lows.The yields are now higher, but this is mostly because state government bonds follow the value of Australian government’s bonds. And in the past year, the yield on Australian government bonds has risen – albeit from record lows.
And, similarly, Australia’s bond yields follow the yields on bonds of the major economies in the world, such as the USA, UK and Germany, whose yields have also increased in the past year.And, similarly, Australia’s bond yields follow the yields on bonds of the major economies in the world, such as the USA, UK and Germany, whose yields have also increased in the past year.
The important thing about bond yields is as much the difference (or spread) between yields as their nominal rate. Thus a downgrading of a state’s credit rating would logically see the spread between its yield and that of Australian government bonds increase – because notionally that state has become a riskier place to invest. This is in some ways a better way of measuring the cost of raising debt because it explains the extra amount a state government has to pay compared with both other states and the federal government. A state government will always have to charge higher interest than the federal government; the issue is by how much.The important thing about bond yields is as much the difference (or spread) between yields as their nominal rate. Thus a downgrading of a state’s credit rating would logically see the spread between its yield and that of Australian government bonds increase – because notionally that state has become a riskier place to invest. This is in some ways a better way of measuring the cost of raising debt because it explains the extra amount a state government has to pay compared with both other states and the federal government. A state government will always have to charge higher interest than the federal government; the issue is by how much.
However, the spread doesn’t always increase when a credit downgrade occurs. In the past 12 months the spread of QTC 10-year bond yields to Australian government bonds has actually shrunk.However, the spread doesn’t always increase when a credit downgrade occurs. In the past 12 months the spread of QTC 10-year bond yields to Australian government bonds has actually shrunk.
The downgrade in WA does, however, highlight not only that keeping a triple-A rating is tough, but that tougher still is doing it without wrecking your economy.The downgrade in WA does, however, highlight not only that keeping a triple-A rating is tough, but that tougher still is doing it without wrecking your economy.
The ALP was right during the election to boast that under their watch, and for the first time, the three major ratings agencies – Standard & Poor’s, Moody’s and Fitch – rated Australia as AAA. Given the collapse in revenue experienced after the GFC, it took some pretty tough spending cuts and tax increases to achieve the balance of keeping the ratings agencies happy and not sending the economy into an austerity-driven tailspin. The ALP was right during the election to boast that under its watch, and for the first time, the three major ratings agencies – Standard & Poor’s, Moody’s and Fitch – rated Australia as AAA. Given the collapse in revenue experienced after the GFC, it took some pretty tough spending cuts and tax increases to achieve the balance of keeping the ratings agencies happy and not sending the economy into an austerity-driven tailspin.
As it is, the cuts made in the 2012-13 budget came at a time when unemployment was rising and growth stalling. It was a bold decision by Wayne Swan, one which received little credit from those who believe governments should cut spending in tough times, and less from those who believe the opposite. Little wonder he was never able to sell his achievement.As it is, the cuts made in the 2012-13 budget came at a time when unemployment was rising and growth stalling. It was a bold decision by Wayne Swan, one which received little credit from those who believe governments should cut spending in tough times, and less from those who believe the opposite. Little wonder he was never able to sell his achievement.
But while you can argue whether it was good for the economy for Swan to attempt to return the budget to surplus so quickly, it is clear that since Standard & Poor’s downgrading of the USA’s credit rating to AA+ in August 2011, and Fitch’s upgrading of Australia’s credit rating to AAA two months later, the spread between Australian and US bond yields has declined appreciably.But while you can argue whether it was good for the economy for Swan to attempt to return the budget to surplus so quickly, it is clear that since Standard & Poor’s downgrading of the USA’s credit rating to AA+ in August 2011, and Fitch’s upgrading of Australia’s credit rating to AAA two months later, the spread between Australian and US bond yields has declined appreciably.
Australia is now one of only 11 countries with a triple-A rating from all three agencies, and of those 11, Australia’s growth in the past 12 months is second only to Singapore’s.Australia is now one of only 11 countries with a triple-A rating from all three agencies, and of those 11, Australia’s growth in the past 12 months is second only to Singapore’s.
So it is pretty obvious that Australia, to this point, has achieved the balance of economic performance and fiscal responsibility better than just about everyone.So it is pretty obvious that Australia, to this point, has achieved the balance of economic performance and fiscal responsibility better than just about everyone.
It’s a tough balance though. And thus far, Colin Barnett appears a bit flummoxed about what to do in WA. He explained the increase in state debt in quite sensible terms:It’s a tough balance though. And thus far, Colin Barnett appears a bit flummoxed about what to do in WA. He explained the increase in state debt in quite sensible terms:
“Debt is high and rising. Why? Because this state is growing. We’ve invested in hospitals, in schools, in improving our capital city, road projects, regional development and the like – and I don’t apologise for that.”“Debt is high and rising. Why? Because this state is growing. We’ve invested in hospitals, in schools, in improving our capital city, road projects, regional development and the like – and I don’t apologise for that.”
But he then announced, in response to criticisms from the WA opposition:But he then announced, in response to criticisms from the WA opposition:
“Labor calls for fiscal responsibility. Well, get ready because there’s going to be a fair dose of it. The most immediate and direct way of reducing debt is to sell something, or sell several things. There will be a program of asset sales and that will be introduced very quickly.”“Labor calls for fiscal responsibility. Well, get ready because there’s going to be a fair dose of it. The most immediate and direct way of reducing debt is to sell something, or sell several things. There will be a program of asset sales and that will be introduced very quickly.”
It is an odd world in which fiscal responsibility is equated with the ability to sell things (if you get to the point when you have to sell things you can't have been very fiscally responsible in the first place).It is an odd world in which fiscal responsibility is equated with the ability to sell things (if you get to the point when you have to sell things you can't have been very fiscally responsible in the first place).
Credit agencies are concerned primarily with the budget, not the actual economic situation of the state. If slashing spending and selling off valuable assets helps lower the state’s debt then the ratings agency will be happy, regardless of what that might do to the Western Australian economy.Credit agencies are concerned primarily with the budget, not the actual economic situation of the state. If slashing spending and selling off valuable assets helps lower the state’s debt then the ratings agency will be happy, regardless of what that might do to the Western Australian economy.
A top credit rating is a nice thing – and certainly of value – but no government should start viewing it as the objective of economic policy.A top credit rating is a nice thing – and certainly of value – but no government should start viewing it as the objective of economic policy.
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