Barry O’Farrell has spent the weekend basking in the glory of his landslide victory, but he knows that he faces a tough struggle ahead — ensuring that NSW keeps its triple-A credit rating.

One of his first acts as Premier will be to announce an audit into the state’s finances: he wants to know for sure how bad a situation he’s facing. And he’s likely to defer the state budget to September, rather than the traditional July, in order to give himself time to come up with a credible response for tackling the state’s budgetary woes.

Seasoned observers believe that the state’s finances are likely to have deteriorated since January, when the previous Labor government released its half-yearly review. Not that the January review was exactly encouraging.

Falling tax revenues — the state was getting less money from transfer duties as the property market cools — saw estimates of the state’s budget surplus slashed. The NSW budget surplus is now expected to come in at $167 million this year, well below the previous estimate of a $773 million surplus for 2010-11.

Even more alarming was the sharp rise in the state’s debt compared to its revenues. Last July, NSW Treasury estimated that the state’s net debt and unfunded superannuation liabilities would rise from 100.5% of total revenues in June 2011 to 108.3% three years later. But in January, these forecasts got much worse. It’s now predicted that the state’s debt to revenue ratio will increase from 105.8% in 2011 to 112% by June 2014.

Now, the problem is that ratings agencies look very closely at this debt-to-revenue ratio. For instance, Standard & Poor’s puts states on review for a possible downgrade whenever their net debt and unfunded superannuation liabilities climb above the trigger point of 120% of total revenue.

Even more alarming is that the projections of debt-to-revenue ratio rest on some decidedly optimistic assumptions. For instance, they depend on the NSW government getting a boost in revenue from government trading enterprises over the next few years. But this will mean higher electricity and water prices, which will be highly unpopular.

What’s more, the projections are built on the rather shaky assumption that the NSW government will be able to generate cost savings in the public service, and keep a lid on wage increases.

But NSW has shown little aptitude for keeping wages under control in recent years. According to the latest NSW budget papers, about half of all NSW government spending goes on wages for the state’s public servants. And they’ve been enjoying a bigger boost in wages than workers in other areas.

Since September 1997, public sector wages in NSW have risen by 9.6% more than in the state’s private sector, and by 5.6% more than in the public sector in the rest of Australia.

If the state’s wages bill rises at anywhere near the same rate as it has in the past, the state’s triple-A rating will quickly be jeopardised.

Of course, the NSW budget will be under even more stress if the federal government refuses to allow $2.1 billion in funding that it has promised for the Epping-Parramatta rail link to be redirected to the new government’s preferred north-west rail link. (One of the few big promises the Coalition made during the election campaign was to begin work on a heavy rail link for Sydney’s north-west suburbs in its first term of government).

Of course, one possibility would be for O’Farrell to simply forfeit the state’s triple-A rating. After all, a ratings downgrade would only cost the state about $30 million or so each year in higher borrowing costs. And a recent Herald/Nielsen poll found that given a choice between maintaining the state’s triple-A rating and increasing borrowings to pay for new infrastructure, only 29% of those polled opted to keep the credit rating.

But O’Farrell is far too cautious a politician to take that option. He knows that a state’s credit rating is seen as a measure of the government’s financial competence. And having just scored a massive electoral win, O’Farrell will be keen to demonstrate that his ability to deliver stable, honest and competent government.

As a result, his first budget is likely to contain some tough measures aimed at guarding the state’s triple-A rating.

*This article first appeared on Business Spectator.

Peter Fray

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