Fitch Affirms South Australia at 'AA'; Outlook Stable
The affirmation reflects no change in our assessment of Australia's strong institutional framework, the state's relatively weak but improving fiscal performance, low direct debt levels, sound liquidity and prudent debt management. Higher sustained operating and current balances will reduce deficits before debt variation and support stable debt metrics. However, Fitch expects operating and current margins to remain weak relative to other 'AA' rated international peers, limiting financial flexibility.
The Stable Outlooks reflect Fitch's expectation that South Australia, despite some economic headwinds, will maintain its improved budgetary performance by adhering to its fiscal principles.
KEY RATING DRIVERS
Australia's institutional framework supports South Australia's ratings. Grant income accounts for around 52% of the state's operating revenue and helps offset high operating expenditure in service areas, such as education and health. In addition, goods and services tax adjustments mean weaker states and territories receive a greater relative share of the distribution, mitigating potential financial underperformance. In addition, the Australian sovereign (AAA/Stable) has mechanisms to limit the financial effects on a state from natural catastrophes.
South Australia reported an improved Fitch-adjusted current balance of AUD878m (current margin of 5.5%) in its estimates for the financial year to end-June 2016 (FY16), up from AUD560m in FY15, and we believe improved balances are sustainable through to FYE20. The state continues to demonstrate good expense control, but we have factored into our estimates lower tax revenue growth as a result of weak wage growth, and employment uncertainty in mining and manufacturing sectors.
South Australia expected its gross state product to grow by 1.5% in FY16 to around AUD100bn (FY15: 1.6%), and is forecasting a 2% increase for FY17 and 2.25% for FY18. South Australia's population of 1.7 million has increased at an annual rate of 1% over the decade to t end-2015. Low interest-rates have supported household consumption and dwelling construction, but the potential drag on employment from the end of the state's car manufacturing industry and a mining sector dealing with lower commodity prices pose significant threats. However, state infrastructure spending, job growth initiatives and defence industry spending will help mitigate these potential pressures over the medium term.
South Australia forecasts capex to average AUD2.2bn (around 13% of total spending) over FY16 to FY20. This is up from the average annual capex of AUD1.7bn over FY11 to FY15 and includes the recognition of the AUD2.8bn finance lease liability for the new Royal Adelaide Hospital undertaken as a public-private partnership. Stronger fiscal performance will reduce the size of the state's deficits before debt variation, despite the higher capex. We calculate deficits, measured against total revenue, to average 3.4% over FY16 to FY20, down from an average 7.2% over FY11 to FY15.
We estimate South Australia's ratio of direct-debt/current-revenue, including finance lease obligations, was 32% at FYE16, which was well below peers. However, its net overall-risk/current-revenue of 146%, which incorporates the state's unfunded defined pension liabilities and the South Australian Government Financing Authority's guaranteed financial liabilities, was more in-line with peers. We estimate a direct-debt/current-balance ratio of 5.8 years at FY16 and forecast it to average 12.4 years over FY17 to FY20.
Negative rating action could occur if the state unexpectedly departs from its budgeted constraint and fiscal strategy, and forecast current balances turn negative. The negative effect would be compounded should local economic performance be much weaker than Fitch expects.
Positive rating action is unlikely under our base case scenario, but could occur if consistent current balances resulted in a direct-debt/current-ratio maintained below 50% and a direct-debt/current-balance consistently below six years.