We haven’t seen it for a while, so it’s a delight that a dear old friend of long acquaintance has dropped in on our economic debate: banks are warning about the possibility of Australia’s sovereign credit rating being downgraded. On Monday, according to a report by The Australian Financial Review‘s Jacob Greber, two of the major banks warned that ratings agencies had been “very patient” with Australia, but that our level of debt was starting to become a problem. Today, a JP Morgan analyst joined in, invoking that signal moment of Australian political economy, Keating’s “banana republic” reference.
Greber correctly noted on Monday that the big banks have a particular stake in this game, given that we still — despite the efforts of David Murray’s inquiry and APRA via its capital requirements — have a de facto bank guarantee in place for at least the big four banks, and thus they benefit from the Australian government’s strong credit rating.
“Too Big To Fail” has never really gained the same traction here as it has in the US because of the way the Reserve Bank and the Rudd government kept our banking and financial system alive in late 2008. But it has been a belief that that support will again be extended in any similar crisis (the RBA has, in fact, put in a place a system that achieves that, at a cost of several hundred million dollars a year to the banks), which have allowed the rating agencies to maintain AA ratings on our big four banks. Without that government support, the ratings would fall one to two notches and drive up their borrowing costs.
Indeed, banks are central to the whole question of the Australian government’s credit rating, because the really important question isn’t how much debt the government is carrying, but how much capacity it has to bail out one or more banks if things go dystopic either locally or globally; a government with weaker finances has less capacity to bail out a troubled bank. And that, in turn, reflects on the banks’ credit standards and levels of household debt, both of which are a factor in the risk — low as it may be — that a big bank might be go belly up.
The problem is, the banks might want to be careful what they wish for. The reason that the Abbott government — inept as it was — decided not to pursue a vigorous program of budget cuts when it was elected was for the same reason that then-treasurer Wayne Swan abandoned plans to wield the knife in the 2008 budget: out of concerns the economy couldn’t stand it. For Swan, it was the ominous signs of a collapsing financial system from around the world; for Abbott and Hockey, the persistently anaemic level of economic growth despite years of deficit spending and record-low interest rates. And while economic growth returned to trend in the second half of 2015, it’s not clear at all that the return to trend is permanent, or that unemployment is going to continue its recent, if somewhat mild, downward trend.
Taking the banks’ advice and slashing the budget might end up bringing on the kind of economic conditions — rising unemployment, low growth — that will put the banks at greater risk from household indebtedness. On the positive side, however, a credit rating downgrade might help push the dollar, which is now lifting to uncomfortable heights as commodity prices stop falling, back down again. And it will probably have little effect on the interest rates at which the government can borrow. In fact, there are plenty of A- and AA-rated economies that borrow more cheaply than the Australian government — including the Italians, whose economy is a mess of high debt, flat growth, persistently high unemployment and a broken and corrupt political system.
And there’s the growing belief that Australia should be using the current global low interest rates to restructure our maturity profile (as France, the UK, US and other leading economies are slowly doing) by extending our longest dated bond past 15 years to 20 and 30 years — something that would strongly appeal to many classes of investors. Australia would provide a debt profile that insurance companies, pension funds and the infrastructure sector would love, while pushing the duration/rollover risk out into the next generation, easing pressure on government finances.
But if the economic and fiscal impacts of a downgrade might be minimal for the government, the political impacts might be more significant. Voters still reflexively assume the Coalition fields superior fiscal managers, but that flies in the face of the evidence. Not merely has the Coalition maintained huge budget deficits and growing debt (for reasons discussed above), it has kept spending at well above the levels it inherited from Labor. Bizarrely, Treasurer Scott Morrison actually thinks the current budget projections, under which government spending will fall to “just” 25.3% of GDP, is something worth boasting about, when Wayne Swan got spending below 25% three years running from 2010-13.
The government has gotten away with this hypocrisy so far, but a credit rating downgrade would focus voters’ minds on the fact that the Coalition’s rhetoric on the budget is entirely at odds with its behaviour — and let’s not forget the supposedly better party of fiscal management managed to engineer a credit downgrade for Western Australia by entirely wasting the proceeds of the resources boom in that state.