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Read this before you trust credit ratings ever again

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by August 18, 2016 General

At 9.14am on Wednesday, the office of the Treasurer Scott Morrison emailed journalists a statement welcoming the decision by credit rating agency Moody’s to affirm Australia’s AAA credit rating.

Sure enough, two minutes later, inboxes pinged with an email from Moody’s announcing its own decision – at least to those not already in the know.

The Moody's AAA credit rating assigned to Australia should be taken with a grain of salt, perhaps a truckload even. The Moody’s AAA credit rating assigned to Australia should be taken with a grain of salt, perhaps a truckload even. Photo: iStock

A little more than an hour later, Morrison had managed to assemble media at Treasury Place in Melbourne to celebrate the decision, and Moody’s pronouncement of the “resilience” of the Australian economy.

Hurrah.

But what exactly are we being invited to celebrate?

Does the Moody’s decision mark a material change to Australia’s economic outlook? Well, no. Is borrowing about to become a lot cheaper because of the government’s creditworthiness? Also, no.

Do new treasurers have an undue tendency to respond to credit rating decisions with the fervour of a kindergarten kid getting their first gold star? Well, yes.

We can expect to hear a lot more about Australia’s AAA credit rating during this Parliament. Although Moody’s has affirmed our AAA rating and kept the outlook as “stable”, another of the big three credit rating agencies, S&P’s, in July downgraded our AAA outlook to “negative”. That’s the equivalent of a yellow card in football. One more infraction and we’ll be booted out of the coveted AAA crowd. The third credit rating agency, Fitch, recently sided with Moody’s, keeping us at AAA, with a stable outlook.

So what does all that mean? Well, for an investor looking to lend money to the Australian government, there is a top-notch chance that they’ll get their money back. Australia is one of just nine countries globally able to boast such a claim, and it’s a nice list to be included in: Canada, Denmark, Germany, Luxembourg, Norway, Singapore, Sweden and Switzerland.

At the margins, a AAA credit rating from the big three agencies might make it easier for the government to secure credit on favourable terms.

Does it mean the Australian economy is suddenly able to create more jobs? No. Does it mean we’ll grow faster? No. It’s just one opinion – albeit one investors give excessive credence to – about our future economic outlook.

And it’s not all roses.

Even the rosy statement from Moody’s manages to point out that Australian government debt is expected to ballooned from 19.1 per cent of GDP in the financial year ended mid-2010 to 36.1 per cent in the financial year ended June 2015. This puts us just shy of the median debt burden of AAA rated sovereigns of 38.1 per cent.

Better yet, government debt is forecast to rise to 41 per cent in two years and just under 45 per cent by the end of the decade.

While consistent with a AAA rating, Australia’s debt burden is “rising and no longer low”.

Whoopie.

And our households are not doing much better. In a world of ugly balance sheets, we’ve managed to take home the crown.

As Moody’s points out, Australian household debt now represents 124.4 per cent of GDP, “at least 25 percentage points above any other high-income economy except for Denmark [AAA stable, 122.5 per cent]”.

This is also higher, as Moody’s helpfully points out, than the US, Ireland and Spain just before their housing markets crashed.

Such indebtedness leaves Australian households particularly vulnerable to any housing downturn, Moody’s concludes.

Overall, it is nice that Moody’s has deemed the Australian government creditworthy.

But it’s premature to pop the champagne cork.

Particularly if you bother to read the long disclaimer that Moody’s includes at the end of its statement. At about 1700 words long, it’s longer than the decision itself.

In the slightly confused manner in which inexperienced parents type text messages, much of the disclaimer appears in capital letters.

“OPINIONS INCLUDED IN MOODY’S PUBLICATIONS ARE NOT STATEMENTS OF CURRENT OR HISTORICAL FACT,” it begins.

Huh, so, not factual, then. Shame, that would have been helpful.

And on it goes.

“PUBLICATIONS DO NOT CONSTITUTE OR PROVIDE INVESTMENT OR FINANCIAL ADVICE.”

Also not very helpful.

Furthermore: “IT WOULD BE RECKLESS AND INAPPROPRIATE FOR RETAIL INVESTORS TO USE MOODY’S CREDIT RATINGS OR MOODY’S PUBLICATIONS WHEN MAKING AN INVESTMENT DECISION.”

OK, so Moody’s ratings are not necessarily fact, not advice, and it would be reckless and inappropriate to invest based on them.

Is that it? Well, no.

Let’s be clear that: “​NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY MOODY’S IN ANY FORM OR MANNER WHATSOEVER.”

And by the way, Moody’s also discloses that – although it is not generally paid to do sovereign credit ratings – it can be paid anywhere between $1500 to $2.5 million to provide appraisals of a company’s credit worthiness. Paid by whom? Well, the company itself. Do you think that creates a potential for a conflict of interest? Well, you should. The European Commission found as much in a recent report and in the wake of the GFC – when agencies gave AAA ratings to junk investments – regulators have moved to force investors to put less emphasis on analysis by the big three in their investment decisions.

So celebrate, if you will, our AAA credit rating.

But take it not so much with a grain of salt, but the dump truck of unrefined rock salt it deserves.

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