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Fitch Affirms Australia at 'AAA' on credit strengths

October 26, 2012 Fitch Ratings
Fitch Ratings-Hong Kong/Sydney-26 October 2012: Fitch Ratings has today affirmed Australia's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'AAA' with Stable Outlook. The Short-Term IDR is affirmed at 'F1+' and the Country Ceiling is affirmed at 'AAA'.
The 'AAA' ratings reflect Australia's fundamental credit strengths including the country's high-income developed economy, credible macroeconomic policy framework with scope for policy flexibility, and standards of governance that rank among the world's strongest.

Australia's ratings also benefit from low gross and net general government debt ratios relative to 'AAA' peers. Gross general government debt (including Commonwealth, state and local government debt) is projected to peak as a ratio of GDP at 28% in 2013 and then to begin declining. The median for 'AAA' sovereigns is projected at 52% for end-2012. Moreover, debt composition is a rating strength: the average duration and maturity of the debt have risen since the global financial crisis. Government debt is almost entirely denominated in Australian dollars.

There is a strong cross-party consensus on fiscal consolidation. The Labor government remains committed to returning the Commonwealth (central government) budget to surplus in the fiscal year to June 2013 (FY13). The latest Mid-Year Economic and Fiscal Outlook (MYEFO) introduced some modest additional revenue-side measures to offset softer projected real and nominal GDP growth and deliver a AUD1.1bn (0.1% of GDP) budget surplus for FY13.

The government cut its FY13 growth forecast to 3% from 3.25% in the latest MYEFO. The Reserve Bank has cut its policy rate by 100bps to 3.25% over the course of 2012, citing in particular downside risks stemming from the global environment. The slowdown in China has already affected prices of Australia's coal and iron ore exports. Australia could be disproportionately hit if China has a "hard landing", although this is not Fitch's expectation.In any case, Australia has strong buffers against potential economic shocks including low government debt, a freely-floating exchange rate, and a nominal policy rate well above zero.

The external finances are a rating weakness compared with 'AAA' peers. Net external debt is projected at 51% of GDP by end-2012, well above the medians for the 'AAA' range (23%) or the OECD (25%). However, net external indebtedness is projected to fall over the forecast period. Banks' reliance on external wholesale-market funding has declined. Banks' gross external debt declined to 43.5% of four-quarter-rolling GDP by June 2012, from 52.5% at end-September 2008.

Australia has a combination of chronic current account deficits and relatively high household indebtedness that merits attention given experience in other high-income economies like the US and parts of the euro area before the global financial crisis. However, Australia's external deficit primarily reflects net income debits by foreign-owned firms. Domestic savings and investment have not moved out of alignment, unlike the US or some euro area countries. The household savings rate has sharply increased since 2007, and household debt ratios have stabilised, albeit at a relatively high level on some metrics. Still, delinquency rates on household lending remain low.

Fitch regards Australia's banks as among the world's strongest on a stand-alone basis, while the supervisory regime is strong. Dependence on external wholesale market funding remains a risk for the banks, although as noted, a diminishing one. A shock to the real economy that led to a sustained rise in unemployment and/or interest rates could stress household debt service capacity and damage bank and sovereign credit profiles, although Fitch judges the degree of risk as consistent with Australia's 'AAA' ratings.

A sustained shock to funding conditions for Australia's banks that led to tighter funding conditions across the economy, beyond the ability of the authorities to offset fully, could put negative pressure on the ratings. However, Australia navigated the global financial crisis without succumbing to recession, implying the shock would have to be more severe.

Meanwhile, the economy faces a longer-term challenge of adjusting to ramped-up minerals exports as the mining investment boom reaches maturity. This implies a higher real effective exchange rate, which will place pressure on non-resource sectors to strengthen their productivity to remain competitive. An inadequate adjustment could lead to lower employment levels and potentially put pressure on the public finances and sovereign credit profile. However, Fitch does not view this issue as a likely near-term rating driver.
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