Australia (Commonwealth of

)
Primary Credit Analyst: Kyran A Curry, London (44) 020-7176-7845; kyran_curry@standardandpoors.com Secondary Contact: KimEng Tan, Singapore (65) 6239-6350; kimeng_tan@standardandpoors.com

Table Of Contents
Major Rating Factors Rationale Outlook Related Criteria And Research

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Major Rating Factors
Strengths:
• A wealthy, open, and resilient economy and a financial system that appears to be sound. • High fiscal flexibility, underpinned by low public debt and strong fiscal discipline. • Political stability, strong institutions, and transparency in economic decision-making. Sovereign Credit Rating
AAA/Stable/A-1+

Weaknesses:
• High current account deficits and external debt burden. • High vulnerability to weakening commodity export demand, particularly from China. • High household debt.

Rationale
The unsolicited ratings on the Commonwealth of Australia reflect Standard & Poor's Ratings Services' view of the country's ample fiscal and monetary policy flexibility, economic resilience, public policy stability, and a financial sector that appears to be sound. We believe these factors demonstrate Australia's strong ability to absorb large economic and financial shocks, such as the global recession in 2009. These strengths are moderated by Australia's high external imbalances, dependence on commodity exports, and high household debt, all of which weigh on its growth prospects. The Australian economy performed relatively well in the fiscal year ended June 30, 2012, as mining exports and private investment in mining and liquefied natural gas offset weaknesses in domestic consumption and export sectors exposed to the high Australian dollar, such as education, tourism, and manufacturing. Yet considerable risks remain for Australia's growth prospects, prosperity, and credit quality. These stem from its growing dependence on trade with China. If demand for Australia's resources were to weaken, this could lead to a range of disorderly dislocations in its economy, including in its labor and property markets. However, while strong demand for its commodities continues--from emerging Asia, and particularly China--we believe Australia's economic prospects remain favorable (see "Weaker China Trade Threatens To Take the Wind Out Of Australia's Economic Growth Sails," published March 12, 2012, on RatingsDirect on the Global Credit Portal). In our view, Australia's overall economic resilience reflects decades of structural reforms, wages restraint, and a national savings rate of roughly 25% of GDP. However, we believe that Australia's financial sector relies more heavily on external savings than do banking systems in other highly rated sovereigns. This reflects Australia's heavy external borrowings to partly fund investment in its mining sector and lending for residential real estate. Despite recent private-sector deleveraging, including by households, we believe that subdued demand for credit against the backdrop of a still-high debt burden will constrain domestic consumption growth over the next three years as the government withdraws fiscal stimulus. That said, we expect that the robust outlook for commodity prices, allied with a strong

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pipeline of mining investment, will underpin a return to trend GDP growth of 3.5% by 2015. Although Australia's public finances have worsened as a result of the global recession, the deterioration has been more contained than for most 'AAA' rated peers, whose steep deficit increases have been more pronounced and may well persist for longer. We estimate that Australia's general government (federal, state, and local) will record a deficit of 2.5% of GDP in 2012, and return the balance to surplus in 2015. We estimate that the general government debt burden will rise by 1.3% of GDP to 23.4% in 2012. In view of our forecast of a deficit of 1.1% of GDP in 2013, we project that Australia's general government debt burden will remain about 23% of GDP in 2013, before trending lower as the deficit shrinks further. This level of government debt is considerably lower than that of other 'AAA' sovereigns. That said, we believe that Australia's private sector debt is among the highest of any rated sovereign and remains a key vulnerability. The federal government outlined a three-year fiscal consolidation program (starting 2009-2010) worth A$56.3 billion (4.3% of GDP). More than half of this is expected to come from keeping average real growth in spending to about 1% over the outlook period (2012-2015). This is one of the fastest consolidation programs among 'AAA' rated sovereigns. The government intends to contain its spending by placing a 2% average annual cap on real spending growth until surpluses are at least 1% of GDP, for as long as the economy grows at or above trend. We believe this conservative stance on public finances has strong bipartisan political and community backing and we also observe stable political consensus on fiscal, monetary, and exchange-rate policies. Like other developed sovereigns, Australia faces long-term age-related spending pressures on health, pensions, and aged care. In this respect, Australia's longer term fiscal consolidation will benefit from the continued build-up of assets to fund government pension obligations, of which the central government's unfunded component was well below most 'AAA' peers at an estimated A$138.5 billion (9.3% of GDP) at June 30, 2012. Although Australia's public sector finances are not strained, its private-sector balance sheets--particularly in the banking system--carry high external liabilities. Net of liquid assets, these were an estimated 224% of current account receipts (CARs) in 2012. Australia's banks have been a principal channel to fund the country's current account deficits. This external bank debt has helped fund lending for domestic residential housing and businesses (about two-thirds and one-quarter of financial system lending, respectively). We expect Australia's current account deficits to widen to about 5% of GDP by 2014 (from 2.4% in 2011) partly due to higher private investment in the mining sector, which should eventually help boost export capacity. We expect this widening will be financed mainly through foreign direct investment (which funded 71% of Australia's current account in 2011 and is expected to fund around 65% in 2013) and supplemented by long-term debt corporate external debt. Australia's gross external financing requirement (the current account balance plus amortization of long-term external debt plus stock of short-term external debt) was about 225% of CARs in 2012, which is high compared with peers. In our opinion, the risks associated with Australia's high private-sector external debt are manageable because of the strength of its financial system, the large degree of foreign currency debt hedging, and an actively traded currency. Although we believe banking system loan losses will likely remain low by international standards, cautious consumer sentiment, intensifying competition for retail deposits, and stricter regulatory requirements may continue to dampen lending growth and profit margins in the sector. Nevertheless, we expect the credit profile of Australia's banking sector

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will remain sound, supported by the banks' conservative risk appetite and good capitalization and the economy's sound outlook generally (see "We Still Call Australia Home: Banks Down Under Likely To Retain Domestic And New Zealand Focus," published July 30, 2012 and "Banking Industry Country Risk Assessment Update: August 2012," published Aug. 2, 2012). Furthermore, we observe that Australia has an independent monetary policy with a free-floating currency that historically has allowed external imbalances to adjust. The Australian dollar is also the fifth-most actively traded currency in the world. A large portion of the nation's external debt is denominated in Australian dollars, while much of the remainder finances companies with revenue in foreign exchange or is hedged. We view Australia's financial and capital markets as well-developed and supportive of the rating.

Outlook
The stable outlook reflects our view that Australia's public finances will continue to withstand potential adverse financial and economic shocks, and our belief that the country's consensus in favor of prudent budgetary policies will remain. Moreover, our base-case scenario assumes that fiscal consolidation will continue, and that the general government debt burden will remain low and on a declining trajectory. We could lower the ratings if external imbalances were to grow more than we currently expect, either because the exchange rate no longer adjusts to terms of trade movements, the terms of trade deteriorates quickly and markedly, or the banking sector's cost of external funding increases sharply. Such an external shock could lead to a protracted deterioration in the fiscal balance and the public debt burden. It could also lead us to reassess Australia's contingent fiscal risks from its financial sector. Over the longer term, the aging population will continue to present a challenge to the public finances. Although Australia is well ahead of most peers in reducing these intertemporal imbalances, continued commitment to pre-funding age-related spending will be required to bolster public sector savings and ensure the long-term sustainability of government finances.
Table 1

Commonwealth of Australia - Selected Indicators
2005 GDP per capita ($) Real GDP (% change) Real GDP per capita (% change) General government balance (% of GDP) General government debt (% of GDP) 34,448 3.2 1.7 2.3 2006 35,605 3.0 1.5 2.5 2007 42,485 3.8 2.2 1.4 2008 51,390 3.8 1.8 1.7 2009 43,239 1.4 (0.2) (2.5) 2010 51,428 2.3 1.2 (5.3) 2011 66,111 1.9 0.5 (4.1) 2012e 65,325 3.4 2.4 (2.5) 2013f 67,155 2.8 1.6 (1.1) 2014f 68,762 3.2 2.0 (0.6) 2015f 72,665 3.5 2.3 0.1 Median AAA 52,239 0.7 0.3 (1.6)

22.9

18.7

15.8

12.9

14.6

19.5

22.1

23.5

23.3

22.4

20.9

50.0

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Table 1

Commonwealth of Australia - Selected Indicators (cont.)
Net general government debt (% of GDP) General government interest exp. (% of revenues) Domestic credit to private sector & NFPEs* (% of GDP) Consumer price index (average; % change) Gross ext. financing needs¶ (% of CARs and usable reserves) Current account balance (% of GDP) Narrow net external debt§ (% of CARs) 19.6 14.0 9.4 6.7 8.7 16.4 19.6 21.2 21.1 20.3 18.9 12.4

1.9

2.0

1.6

1.6

1.7

2.4

3.2

1.9

2.4

2.5

2.6

2.9

107.3

113.6

119.1

131.5

134.0

139.4

136.4

140.1

137.8

135.7

134.5

132.8

2.4

3.2

2.9

3.4

3.1

2.3

3.1

2.3

3.1

3.0

3.0

2.3

210.7

182.1

208.9

216.9

259.2

236.7

209.4

238.6

230.5

252.1

255.3

188.4

(6.3) 252.1

(5.4) 249.3

(5.6) 246.2

(6.2) 250.5

(3.0) 235.2

(4.3) 266.7

(2.3) 236.1

(2.8) 243.3

(4.0) 240.2

(5.2) 243.7

(5.4) 251.8

6.6 76.2

*Gross external financing needs are defined as current account outflows plus short-term debt by remaining maturity. §Narrow net external debt is defined as the stock of foreign and local currency public and private sector borrowings from nonresidents (including nonresident deposits in resident banks) minus liquid nonequity external assets, which include official foreign exchange reserves, other liquid public sector foreign assets, and financial institutions' deposits with and lending to nonresidents. A negative number indicates net external lending. f--Forecast. e--Estimate. NFPEs--Nonfinancial public sector enterprises. CARs--Current account receipts.

Related Criteria And Research
• Sovereign Ratings And Country T&C Assessments, Aug. 16, 2012 • Banking Industry Country Risk Assessment Update: August 2012, Aug. 2, 2012 • We Still Call Australia Home: Banks Down Under Likely To Retain Domestic And New Zealand Focus, July 30, 2012 • Sovereign Risk Indicators, June 27, 2012 • Economic And Political Risks Could Undermine Australia Budget's Fiscal Consolidation Strategy, May 8, 2012 • The Asia-Pacific Sovereign Seesaw: If Oil Prices Soar, Some Ratings Could Fall, April 26, 2012 • Weaker China Trade Threatens To Take the Wind Out Of Australia’s Economic Growth Sails, March 12, 2012 • Australia's No. 1 Economic Worry: China's Slowdown, March 7, 2012 • What A Slowdown In China Could Mean For Australia’s Economic Outlook, Feb. 15, 2012 • Sector Review: China's Sliding Demand For Commodities Could Sap Strength Of Australian Miners, Feb. 15, 2012. • A Slowdown In China Is Likely To Hurt Australian Bank Ratings, Feb. 23, 2012 • China Soft Landing Would Moderately Impact Australia's Housing Market, March 8, 2012 • Australian LMI Providers Likely To Stand Firm Amid China Jitters, March 8, 2012 • A Soft Landing In China Is Unlikely To Affect Australian RMBS, March 8, 2012 • Government Rating Methodology And Assumptions, June 30, 2011 • Methodology: Criteria For Determining Transfer And Convertibility Assessments, May 18, 2009

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Ratings Detail (As Of September 18, 2012)
Australia (Commonwealth of) (Unsolicited Ratings) Sovereign Credit Rating Transfer & Convertibility Assessment Senior Unsecured Greater China Regional Scale Senior Unsecured Senior Unsecured Senior Unsecured Senior Unsecured Sovereign Credit Ratings History 16-Feb-2003 17-May-1999 21-Aug-1996 27-Jul-1992 27-Jul-1992 Local Currency Foreign Currency AAA/Stable/A-1+ AA+/Stable/A-1+ AA/Positive/A-1+ AAA/Stable/A-1+ AAA/Stable/-AAA/Stable/A-1+ AAA cnAAA A-1+ AAA AAA/A-1+ AAA/AAA

*Unless otherwise noted, all ratings in this report are global scale ratings. Standard & Poor's credit ratings on the global scale are comparable across countries. Standard & Poor's credit ratings on a national scale are relative to obligors or obligations within that specific country.

Additional Contact: Sovereign Ratings; SovereignLondon@standardandpoors.com

This unsolicited rating(s) was initiated by Standard & Poor's. It may be based solely on publicly available information and may or may not involve the participation of the issuer. Standard & Poor's has used information from sources believed to be reliable based on standards established in our Credit Ratings Information and Data Policy but does not guarantee the accuracy, adequacy, or completeness of any information used.

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