August 30, 2017 / 10:41 AM / in 10 months

Fitch Affirms South Australia at 'AA'; Outlook Stable

(The following statement was released by the rating agency) HONG KONG/BARCELONA, August 30 (Fitch) Fitch Ratings has affirmed the Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) of the State of South Australia at 'AA'. The Outlooks are Stable. At the same time, Fitch has affirmed the Short-Term Foreign- and Local-Currency IDRs at 'Fl+' The affirmation incorporates the Commonwealth of Australia's strong institutional framework, the state's sound fiscal performance, which remains in line with its rating category, low direct debt levels, sound liquidity and prudent debt management. Sustained operating and current balances should improve debt metrics and will be positive for the ratings. The Stable Outlooks reflect Fitch's expectation that South Australia, despite some economic headwinds, will maintain its sound budgetary performance by adhering to its fiscal principles. KEY RATING DRIVERS Australia's institutional framework supports South Australia's ratings. Grant income accounts for over 50% 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 potentially lower fiscal capacity. In addition, the Australian sovereign (AAA/Stable) has mechanisms to limit the financial effects on a state from natural catastrophes. As per Fitch's base-case scenario, we believe the state will maintain its strong current balance through to our forecast period FYE20. The state continues to demonstrate adequate expense control, but we have factored in lower tax revenue growth than that projected by the state due to weak wage growth and employment uncertainty in mining and manufacturing sectors. South Australia estimates that its gross state product increased by 2.3% in FYl7 (FYl6: 1.9%) supported by better-than-expected household consumption growth and higher tourism. The state forecasts similar growth for FY18-FY20. 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 threats to growth. However, state infrastructure spending, job growth initiatives and defense industry spending will help mitigate these potential pressures over the medium term. South Australia forecasts capex to average AUD1.9 billion over FY18-FY20. This is lower than the average of AUD2.2 billion in the previous three years, but in FY17 the figure included the recognition of AUD2.8 billion in capital expenditure for the new Royal Adelaide Hospital undertaken as a public-private partnership. Stronger fiscal performance will allow the state to fund its capex from internal resources. In Fitch's base case, we calculate that the state will report Fitch-adjusted net surpluses over the forecast period, although this is distorted by a one-off capital revenue of around AUD1.3 billion from the sale and lease back of government building projected for 2018 and land sales. We estimate South Australia's ratio of direct-debt/current-revenue was 41% at FYE17, which was well below that of peers. However, its net overall risk/current-revenue of 157% at FYE16, 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. RATING SENSITIVITIES Positive rating action could occur if consistent strong operating balances result in a Fitch-adjusted net direct risk/operating balance ratio, including unfunded pension liabilities, at around 60% (presently just under 100%) and operating margins hovering above 5%. 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. Contact: Primary Analyst Samuel Kwok Associate Director + 852 2263 9961 Fitch (Hong Kong) Limited 19/F Man Yee Building 68 Des Voeux Road Central Secondary Analyst Fernando Mayorga Managing Director +34 93 323 8407 Committee Chairperson Vladimir Redkin Senior Director +7 495 956 2405 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email:; Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: Additional information is available on Summary of Data Adjustments: The financial data used in Fitch's calculations is taken from South Australia's budget papers. We have made the following adjustments to the reported numbers: - On-passed grants are excluded from revenue and expense figures and depreciation is excluded from expenditure. 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