Following the outcome of the United Kingdom’s ‘Brexit’ referendum last week, Standard & Poor’s has downgraded the UK’s sovereign credit rating from AAA to AA, leaving only twelve AAA-rated countries left. However, soon there might only be eleven, as Australia’s credit rating is also starting to look shaky in the wake of the Federal Elections, which were held on Saturday July 2nd.
Australia’s AAA credit rating is now under threat due to the political uncertainty stemming from the outcome of the Federal Elections. The elections could result in a hung parliament, as no clear winner was produced during Saturday’s voting session. As postal votes are still being counted, it is considered unlikely that current Prime Minister Malcolm Turnbull will reach the needed 76 seats in the parliament to form a new administration. Counting will continue until Tuesday when all postal votes have been tallied up. After the initial election results, Labor leader Bill Shorten stated that Prime Minister Turnbull’s coalition had lost its mandate to govern.
In the current status quo, both parties could end up forming coalitions with independents to form a hung parliament, which would pave a very bumpy road towards a new budget. That, in turn, will affect how markets and credit rating agencies perceive Australia and its future economic performance. If a new budget is not signed off soon, it will be unlikely that Australia will manage to curb its increasing sovereign debt levels. Hence, it is rumored that rating agencies will act soon and downgrade Australia’s sovereign rating.
How would a downgrade affect Australian assets?
If Standard & Poor’s, or either of the other two main rating agencies (Fitch and Moody’s), decides to downgrade Australia, it would increase the cost of borrowing for the Australian government and local governments, such as Queensland and New South Wales.
Australian banks would also come under pressure if Australia were to be downgraded. A credit ratings downgrade would increase interest rates on home loans, adding at least $200 million a year to Australia’s big four banks’ funding requirements, according to conservative estimations. As a result, spreads on bank bonds would widen, which would increase funding costs for the banks, and bank’s share prices would take a hit. Some of the banks would potentially have to raise more equity to capitalize their balance sheets.
Currency traders looking to capitalize on the event will keep a close eye on the Australian dollar in the next few days and weeks, as political uncertainty will lead to volatility and downward pressure on the currency. A downgrade of Australia’s credit worthiness would cause the Aussie dollar to weaken against other currencies, especially the US dollar. The Aussie dollar has taken a hit, recently, due to overall market uncertainty stemming from the UK’s vote to leave the EU, which, in turn, has lead investors to move their funds into ‘risk off’ currencies, such as the US dollar and the Swiss franc, and away from ‘risk on’ currencies, such as the Australian dollar.
The values of Australian property would most likely also decline, should its sovereign rating be cut. If investors can get similar returns from bond yields, which would increase after a ratings downgrade, there will be less demand for property, as rental yields wouldn’t be as attractive as before. Hence, foreign investors would think twice before buying an Australian property if they can get similar returns by investing in Australia’s government bonds instead. While rental yields in Australia are still quite a bit higher than government bond yields, a convergence of the two could decrease Australian property values across the board.
[Image Courtesy of Wikipedia]