Ratings cuts thin end of a big wedge

Ratings giant S&P Global had little choice but to cut the credit ratings on Victoria and NSW. The question is whether the federal government is next.

Egged on by the Reserve Bank, which has fired up the printing presses to the tune of $100bn over the next six months, the two biggest states are borrowing like there’s no tomorrow.

In NSW, the budget deficit is the equivalent to 36 per cent of its revenue this year, heralding a five-fold increase in net debt to well over $100bn in four years.

Elsewhere in the world, far more affected by the pandemic, state governments have been more prudent. Bavaria in Germany, still rated AAA, has a deficit this year equivalent to 17 per cent of revenue, and a stock of debt set to rise to around 40 per cent of its revenue. Saxony’s deficit is on track to shrink to 5 per cent of its revenue. The Canadian provinces have been similarly cautious.

In Victoria, the stock of debt is set to rise to the equivalent of 200 per cent of its revenue. No wonder it was downgraded two notches to AA, whereas NSW is clinging on to AA+.

These ratings downgrades are the first tangible cost of the extraordinary stimulus leading to World War II-style deficits that Australian governments have unleashed to buffer the economy against COVID-19.

For now, it’s largely symbolic, having little impact on the borrowing costs of either state. The borrowing costs of NSW and Victoria — based on the yields of their outstanding bonds — inched up three basis points and five basis points, respectively on Monday. This is small change in the big scheme of things.

But in different times, ratings can matter, as Queensland found out when its borrowing costs blew out 60 basis points during the global financial crisis when S&P stripped the state of its AAA rating in 2009.

It’s probably a forgone conclusion that South Australia, put on “negative outlook” by S&P a few weeks back, will lose its AA+ rating soon too.

Martin Whetton, a senior bond analyst at CBA, expects the federal government to lose its AAA credit rating within a year, and the ACT along with it — now the only AAA state or territory government. That means the big four banks, which in any financial crisis become quasi-nationalised entities, would be downgraded too.

Australia has prided itself on low levels of public debt for a generation. That era is coming to an end.

In Germany, whose death toll from COVID-19 far exceeds Australia’s, government debt is on track to rise from the equivalent of 60 per cent of GDP to 63 per cent of GDP by 2024. Australia’s will go from 46 per cent to 74 per cent.

Central banks everywhere are printing money to buy their governments’ debt issues, holding down borrowing costs at artificially low levels. It remains to be seen how long this process can go on.