How states and big banks could lose if Australia’s AAA credit rating goes down

Australia is a member of this exclusive financial club. The US doesn’t make it and the UK is not even close. Being stripped will be felt right through the economy.

There’s a lot more at stake than pride in the loss of a rolled-gold “AAA” sovereign rating. Any downgrade would have a costly knock-on effect throughout the economy.

There are plenty of others that get a benefit from the commonwealth’s top-notch rating, namely state governments and the nation’s banks.

Although they run their own balance sheets, the implied support from the commonwealth means a downgrade in Canberra would be very bad for these borrowers.

A downgrade works like financial shock treatment, pushing up borrowing costs. This is where the real pain will be felt in the economy through any downgrade.

Australia is one of just nine countries to have an AAA rating from all three agencies – S&P. Moody’s and Fitch. Other members of the club include Germany, Sweden and New Zealand.

The debt-heavy US doesn’t even make into the three-A clubhouse, where the UK is now sitting at AA-. France is at risk of being bumped to A.

S&P has issued the warning shot, but the reality is that even with gross debt next financial year forecast to pass the $1 trillion barrier, Australia has a stronger government balance sheet than most others in the exclusive “3 x AAA” club.

At these levels Australia’s gross debt-to-GDP comes in at 35.5 per cent, frugal Germany is currently just over 62 per cent; the Canadians are sitting with a debt level that represents 100 per cent of the size of the economy.

Still, it’s the direction of travel the ratings agencies are more interested in, particularly if there’s a loosening of fiscal policy across the political spectrum. So far in the election campaign, both Labor and the Coalition have been talking up easy spending, but there’s little around savings.

The ratings would be “at risk if election promises result in larger, structural deficits, and debt and interest expenses rising more than we expect,” S&P analysts Anthony Walker and Martin Foo said in a report.

They said the budget is already regressing to moderate deficits that are locked in as public spending hits post-war highs, global trade tensions intensify, and growth slows.

There’s a long way to go from the commonwealth sitting with stable credit rating to being bumped to a downgrade, but if it did happen, it would put pressure on the debt-heavy east coast states.

Which states are most at risk?

Since the Covid pandemic, S&P has cut its rating on NSW to AA+ from AAA. Victoria has the lowest rating among the state governments as its free-spending ways saw it bumped down to AA from AAA. Queensland has its AA+ rating, but this is under review. Mining rich Western Australia is the only state to have its ratings upgraded to AAA.

If the Commonwealth went to the AA band it’s possible the states could be bumped down to single A, even WA could lose its top rating.

This is also true for the nation’s big four banks that each enjoy an AA- rating, among a small handful of banks in the world to carry the rating. This also helps them secure funding at a lower cost.

Part of their high ratings rely on Canberra’s strong balance sheet, given it is implied that systemically important banks would be in line for some sort of bailout. A downgrade by the commonwealth would be an automatic trigger for a bank downgrade.

During the GFC, Australia’s banks were able to temporarily “rent” Canberra’s AAA rating to help them lock in lower funding costs.

Treasurer Jim Chalmers says responsible economic management had been a defining feature of the Albanese government, and he intended that to continue.

“A big part of our strategy has been budget repair,” Chalmers says.

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