Ratings On The Australian Capital Territory Affirmed At #AAA/A-1+#; Outlook Remains Stable

Stocks and Financial Services Press Releases Friday September 26, 2014 17:23
Australian--26 Sep--Standard & Poor's
RATING ACTION
On Sept. 26, 2014, Standard & Poor's Ratings Services affirmed its 'AAA/A-1+'ratings on the Australian Capital Territory (ACT). The outlook remains stable.
RATIONALE

The ratings affirmation on the ACT reflects our view of the extremelypredictable and supportive institutional framework benefiting state andterritory governments in Australia, plus the ACT's very strong economy andfinancial management, and its strong budgetary flexibility. The ratings alsoreflect the ACT's exceptional liquidity and its very low contingentliabilities. The ACT's weak budgetary performance and moderate and rising debtburden partially offset these strengths.

Australia's institutional framework underpins the ratings on the ACT. Theinstitutional framework governs the relationship between the Commonwealthgovernment and the states and territories, and we consider it to be extremelypredictable and supportive, and one of the strongest in the world. Within this

system, however, there is a degree of structural imbalance between revenuepowers and expenditure responsibilities. The bulk of revenues raised inAustralia are by the Commonwealth government, while the states and territorieshave significant expenditure responsibilities including health and education.

Under Australia's horizontal fiscal equalization system, the Commonwealthgovernment distributes revenues from the goods and services tax (GST) to thestates and territories. This contributes to our assessment of budgetarylexibility for most Australian states and territories as being average.

Strengthening the ACT's average starting point for budgetary flexibility isits above-average capability to generate revenue from asset sales such as A$2billion of land, resulting in strong overall budget flexibility. TheAustralian fiscal equalization system means that, like other Australian states

and territories, less than 50% of the ACT's operating revenues are modifiable.Further, capital expenditure contributes about 14% of total expenditurebetween 2013 and 2017, but is expected to fall to about 11% in 2017 when theACT winds back its capital program by 20%. In our view, the ACT's plans to

sell more than A$2 billion of land between 2013-2018 via its Land DevelopmentAgency support its revenue flexibility. The rollout of the land releaseprogram has slowed from the previous budget but will still contribute between5% and 8% of operating revenues per year during this period. The ACT also

holds about A$600 million of cash and investment-grade assets on hand (afterStandard & Poor's haircuts) that could be liquidated to raise additionalrevenue, if required.

We consider the ACT's financial management to be very strong. In our view, theinstitutional framework promotes a strong management culture and fiscaldiscipline across Australian jurisdictions. The ACT's political and managerialstrengths, debt and liquidity management, and its management of

government-related entities support our very strong view of its financialmanagement. We expect the ACT's tax reforms to be successfully implemented.Further, the ACT has demonstrated its willingness to release land as part ofits growth strategy to offset weakening revenue streams. Somewhat offsetting

these strengths are sizable revisions in forecasts, including weaker budgetaryperformance and higher capital expenditure that are resulting in much higherthan expected borrowing levels.

The ACT's economy is very strong, with a very high per capita income ofA$88,800 (US$90,300) between 2011 and 2013, compared to the national averageof A$65,000 (US$64,600). The ACT's high-income economy reflects its role asAustralia's national capital, and home of the Commonwealth government. The ACTeconomy's high reliance on the government sector (about 30% of output) makes

it more vulnerable than other Australian jurisdictions to fiscal tightening bythe Commonwealth. At this stage, we do not expect the recent changes inCommonwealth government to have a material impact on the ACT's revenue basebecause Commonwealth departments are exempt from payroll tax, or our view ofits economy.

The ACT has very low contingent liabilities which supports its ratings. As atJune 30, 2013, its contingent liabilities were A$129 million and primarilyconsisted of the cost of remediating sites with contaminated land, and somelegal claims.

Partially offsetting these strengths is the ACT's weak budgetary performance.We expect the ACT to average cash operating surpluses of 1.8% of operatingrevenue, and after-capital account deficits of about 10.6% of total revenuesfrom 2013-2017. The ACT ran a cash operating deficit of 1.7% in 2013, and weforecast it achieve a surplus in 2014 before returning to a small operatingdeficit of about 0.7% of operating revenues in 2015. We forecast the ACT'soperating position to strengthen in 2016 and 2017. Slower revenue growth,combined with pushing out its capital program, is forecast to result in weakerbudgetary performance than previously forecast. We consider the main risks tothe ACT's budgetary performance relate to its ability to achieve revenuetargets from its land release program, which are currently set at more thanA$2 billion between 2013-2017.

In addition, the ACT's debt burden is moderate and rising. We forecast theACT's debt burden to reach about 93% of operating revenues in 2017 up fromjust 37% in 2011, reflecting our expectation of weaker budgetary performance.Total tax-supported debt will reach about A$5 billion in 2017, up from A$1.6billion in 2011. We previously expected the ACT's total tax-supported debt topeak at about A$4 billion or 80% of operating revenues in 2015. ACT's interestexpenses are forecast to be about 3.7% of operating revenues between 2014 and2016.

The ACT's unfunded superannuation position is material and we forecast theliabilities to be about 67% of operating revenues in 2017 after accounting forfinancial assets held on the ACT's balance sheet and based on a discount rateof 5%. We consider the government's plan to extinguish the liability by 2030as credible, and therefore, the liability does not affect the ACT's alreadymoderate debt burden.

Liquidity
We consider the ACT's liquidity to be exceptional. This reflects the ACT'saverage level of coverage of its upcoming debt maturities and interest ofabout 200%, as well as its strong market access.

We forecast that the ACT will hold on average about A$216 million inunrestricted cash and A$387 million of liquid bonds (after Standard & Poor'shaircuts) over the next 12 months to cover upcoming maturities of A$117million and interest payments of A$185 million. We have not included the ACT's

superannuation assets in our assessment of its liquidity because these assetsare held for the specific purpose of funding the government's upcomingsuperannuation liabilities.

The ACT's access to external liquidity is strong, in our view. Similar toGermany and Canada, the Australian states utilize a well-developed capitalmarket for their funding. The capital markets in Australia are deep andliquid, and are expected to remain so. The ACT's individual characteristics

support its access to external liquidity. Historically, the ACT has notexperienced difficulty in accessing Australian and international markets, andour expectation is that this will continue. We also expect the Commonwealth toprovide support if needed. A recent example of the type of support a state may

receive was the Commonwealth guarantee of Australian state government debtduring the 2008 2009 financial crisis.
OUTLOOK

The stable outlook reflects our expectation that the ACT will manage itsbudgetary performance and debt burden, as well as successfully execute itsfinancial strategy, which would further support its very strong financialmanagement.

Downward pressure on the rating could occur if the ACT's budgetary performanceweakens more than our forecasts with consistent operating deficits, and/oraverage after-capital account deficits of more than 15% of total revenues overa sustained period of time. This could result in the ACT's total-tax supporteddebt reaching 120% of operating revenues or its interest expenses rising to 5%

of operating revenues on average.

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