Cross Posted at the new Woolly Days.
On Friday, Queensland became the first Australian state to have its credit downgraded from AAA to AA+. Ratings agency Standard & Poor’s (S&P) said the drop reflected the projected deterioration of the state's budgetary performance and increasing net financial liabilities. S&P said Queensland's balance sheet remains strong but the new rating reflects significant decline in the state's operating revenue due to global conditions and a large capital program. “Queensland's financial performance remains strong but is no longer consistent with an 'AAA' rating,” said the agency.
The announcement came after Queensland Treasurer Andrew Fraser announced the outlook for a $1.6 billion budget deficit for the current year, just two months after the government predicted a modest surplus. Economic growth in Queensland is also forecast to slow further into 2009-10. Fraser blamed the global downturn, rising unemployment and the flood emergency in North Queensland for the revision. He now admits that has said avoiding a recession will be "a close run thing".
Queensland is the only Australian state to lose its AAA credit rating so far. The most obvious implication is that Queensland will have to pay an extra 0.4 per cent in annual interest, equal to around $200 million. State borrowings will cost Queensland $3.2 billion in interest next financial year and total government borrowings for the next three years will be $74 billion. Anna Bligh's Government is forecasting job losses in the coming financial year and a growth rate close to zero. Writing in The Australian yesterday, George Megalogenis says Queensland's collapse is one of Kevin Rudd's darker nightmares because "a Queensland that does no better than the national average will, of itself, increase the risk of recession for the nation."
State Treasurer Andrew Fraser defended Queensland’s position in a press release on Friday. He said the government would “hold its nerve” and retain its economic strategy outlined in December’s Major Economic Statement. He said the infrastructure program will deliver almost 120,000 jobs and accounts for 1 per cent of Queensland’s overall economic growth. “The economy needs the stimulus of the infrastructure spend, to support activity, support demand and support jobs as private investment evaporates,” he said. “We are choosing to put the interests of Queenslanders facing unemployment ahead of the political sanctity of a budget surplus.”
With early election speculation mounting, opposition leader Lawrence Springborg was quick to pounce on the announcement. He said losing the AAA rating was a financial disaster which will cost “the mums and dads” of Queensland hundreds of millions in increased interest payments and will affect jobs. "Quite frankly Labor should be ashamed of putting Queensland behind an economic basket case like New South Wales, which still has its AAA rating,” he said. “We are now the only State in Australia that doesn't have an AAA rating. It's embarrassing.”
Embarrassing or not, Dr Nicholas Gruen thinks the downgrading could spread to other states. Gruen is the CEO of Lateral Economics and writes for Club Troppo and is a frequent contributor to the Australian Financial Review. He told Woolly Days today that although he was not across the specific budgetary details of each government, it seems likely there will be a trend given worsening budget positions. He also defended Fraser’s position saying that now is not the time to cut back on capital works. As Gruen wrote in the AFR in September (unfortunately no link, the article is behind a paywall) “the electorate likes to see governments investing in the future. And the alternative – arbitrarily restricting investment whilst commuters nurse their resentments in traffic jams or waiting for late trains – is a political road to nowhere.”
Meanwhile UQ academic and economist John Quiggin believes that an AAA rating is overrated and rating agencies are themselves part of the problem. He says the global crisis has exposed fundamental weaknesses in the way in which ratings are determined and adjusted. According to Quiggin, the likes of Standard and Poor’s and Moody’s have suffered credibility issues in the crisis and a need a lot of improvements to restore independence and transparency. “The privileged position held by these agencies can no longer be justified,” he writes.
In any case, downgrading is not a purely Australian problem. Both Spain and Greece were downgraded earlier this year. Now the Telegraph.co.uk reports that Britain too could be stripped of its AAA rating. The Telegraph says Standard & Poor’s have indicated it might downgrade Britain’s rating because of its asset protection scheme. The scheme provides insurance for so-called “toxic debt” but the Telegraph warns the scheme leaves “the taxpayer exposed to losses on billions of pounds of bad loans made by the banks.” Yet as the article itself points out, it is very unlikely the UK Government will ever default on its debt commitments. A credit rating downgrade is clearly not the end of the world.
Nicholas Gruen thinks credit ratings should be taken seriously but governments need to take risks in tough times. That means taking on projects and debts that the private sector is now shying away from. He says that an obsession with an AAA rating now stands as an obstacle to governments playing their rightful role in dealing with the economic crisis. “There’s a dynamic to fiscal responsibility and fiscal management,” he said today. “Had the Queensland Government invested more in the easy times, it would be worth more now.”