Aussie debt rising faster than Euro region threatens country's AAA rating

The Central Business District of Sydney from the Sydney Tower. Australia's debt, already rising faster than the euro zone's, will keep ballooning as Prime Minister Tony Abbott opts to support growth and his own political fortunes rather than balance
The Central Business District of Sydney from the Sydney Tower. Australia's debt, already rising faster than the euro zone's, will keep ballooning as Prime Minister Tony Abbott opts to support growth and his own political fortunes rather than balance the nation's finances. -- PHOTO: AFP

SYDNEY (Bloomberg) - Australia's debt, already rising faster than the euro zone's, will keep ballooning as Prime Minister Tony Abbott opts to support growth and his own political fortunes rather than balance the nation's finances.

The budget due Tuesday will forecast a wider shortfall in the year to June 2016 of A$40 billion (S$42.21 billion), a Bloomberg survey of 20 economists showed. With little prospect of a return to surplus this decade, net debt could swell to 17.1 per cent of gross domestic product - still a fraction of European levels but up from just 3.3 per cent in 2010.

"The lack of a credible medium-term fiscal consolidation plan is likely to keep the spotlight on Australia's AAA, stable rating," said Su-Lin Ong, head of Australian economic and fixed-income strategy at Royal Bank of Canada in Sydney. "We expect some strengthening in the subtle warnings from the ratings agencies which have emerged in recent months."

Goldman Sachs said last month a commodity slump has spoiled Australia's finances enough to threaten its rating, which would dent investor confidence and further weigh on the economy. The government is reframing a 20-year political narrative of paying down debt to one of creating jobs, after attempts to impose austerity caused its popularity to plummet, helping trigger a challenge to Abbott's leadership.

The economic risk of the strategy is stark. Central bank Governor Glenn Stevens, who has reduced interest rates to a record-low 2 per cent in a three-and-a-half-year easing cycle, has warned the budget position needs to be monitored closely. A significant downturn in the economy would send the deficit from 2 per cent of GDP to 6 per cent "in a heartbeat," he told a parliamentary panel in February.

Treasurer Joe Hockey, who will deliver the budget at 7:30 p.m local time, downplayed the impact of falling government revenue at a press conference in Canberra on Tuesday, saying the deficit would be smaller than market predictions for a shortfall of between A$40 billion and A$41 billion.

"In the last 18 months we've had to write off A$90 billion of expected revenue but yet we are still on a credible trajectory to surplus," Hockey said.

Australia is one of just 12 nations to carry a AAA rating at Standard & Poor's, and one of nine to also hold the same ranking at Moody's Investors Service and Fitch Ratings. S&P said in February it could potentially change Australia's rating or outlook if net debt approached 30 per cent of GDP. The ratio is now the lowest among the world's 10 largest developed economies, data compiled by Bloomberg show.

The two-year sovereign bond yield has fallen 5 basis points in 2015 to 2.12 per cent as the RBA cut rates and the Aussie has slid 3.5 per cent to 78.87 U.S. cents as of 9 a.m. in Sydney Tuesday.

Budget measures already flagged include a A$3.5 billion childcare package, a 1.5-percentage-point cut in the corporate tax rate for small businesses and tighter means testing for state pension payments. The government will tax Internet downloads of books, music and movies, raising A$350 million over four years, and will seek to improve revenue disclosure by about 30 multinational companies to boost tax receipts.

The budget comes as the economy leans heavily on rising house prices in Australia's major cities, which are fueling a residential construction boom, and high immigration levels to boost demand.

Australian households carry a debt burden of 153.8 per cent of income, the highest on record, central bank data show. They have around A$850 billion in bank deposits but owe A$2.1 trillion in debt, so the household sector as a whole benefits from low rates, according to Shane Oliver, head of investment strategy at AMP Capital Investors Ltd.

Australia's general government debt, which includes central, state and local, is projected to climb to 21.6 per cent in 2016 from 3.9 per cent in 2010, according to International Monetary Fund data. The pace of the deterioration is double the average of advanced economies and faster than the euro zone's 12.8 per cent of GDP increase over the period.

The economy is on track to grow below 3 per cent for six of the past seven years and the budget is being hit by a combination of a slumping terms of trade, or export prices relative to import prices, and stagnant wage growth.

"The economic orthodoxy has been shaken and a new narrative on fiscal management is now in the early stages of being woven," said Tim Toohey, chief economist for Goldman Sachs in Australia. "This may well catch the eye of the rating agencies."