What\'s behind the recent S&P move to downgrade WA\'s credit outlook to "negative" - AAA rating maintained

1. Credit FAQ:
What’s Behind The Negative Outlook
Revision On The State Of Western
Australia?
Primary Credit Analyst:
Claire Curtin, Sydney (61) 2-9255-9882; claire_curtin@standardandpoors.com
Secondary Contact:
Anna Hughes, Melbourne (61) 3-9631-2010; anna_hughes@standardandpoors.com
Table Of Contents
Frequently Asked Questions
What Does The Negative Outlook Mean?
Why Have You Taken This Action Now?
What Is Your Base Case For WA, And How Does It Differ From
Assumptions In The Government's Budget?
What Happens If Your Base Case Turns Out To Be Wrong?
Does This Mean That You Think Australia's Mining Boom Is Over?
What Does The Change To WA's Outlook Imply For The Australian
Sovereign Rating?
Related Research
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2. Credit FAQ:
What’s Behind The Negative Outlook Revision On
The State Of Western Australia?
On Oct 25, 2012, Standard & Poor's Rating Services revised its outlook on the State of Western Australia (WA) to
negative from stable. The outlook revision reflected our expectation that WA may experience weakened budgetary
performance as a result of lower mining royalties and the time-lag before Australia's framework of horizontal fiscal
equalisation between the Australian states and territories adjusts to reflect WA's lower fiscal capacity and the
downside risk to revenues.
In this FAQ we provide insight into our base case expectations for WA.
Frequently Asked Questions
What Does The Negative Outlook Mean?
The negative outlook means that there's a one-in-three chance that we could downgrade WA's ratings in the coming
24 months. We think there is downside risk to revenues, which could lead to a deterioration in operating performance.
If this occurred, we'd expect to downgrade WA by one notch. If this didn't occur, and WA's liquidity buffer improved,
we'd expect to revise the outlook back to stable.
Why Have You Taken This Action Now?
Iron ore prices and the exchange rate between the Australian and U.S. dollars have significantly deviated from WA's
budget expectations. We have re-cast WA's forecast performance through the forward estimates (to fiscal 2016) to
reflect our expectations of the main royalty variables--among other factors (discussed below).
WA's consolidated budgetary performance is currently weaker than some other domestic peers'--notably Victoria,
which has not benefited from a mining-related boost to revenues in the way WA has. With Australia's horizontal fiscal
equalisation (HFE) framework containing a time-lag between a reduction in own-source revenues and the offsetting
increase in HFE payments, and the potential for further downside to WA's own-source revenues, we revised WA's
outlook to negative to reflect a one-in-three chance of a downgrade over the next two years.
We think that any further reductions to expenses that might be made could significantly undershoot and/or lag
revenue reductions. This could lower our view of WA's budgetary performance while increasing the state's debt burden
toward 120% of revenues as it undertakes a large capital-expenditure program.
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3. Credit FAQ: What’s Behind The Negative Outlook Revision On The State Of Western Australia?
What Is Your Base Case For WA, And How Does It Differ From Assumptions In
The Government's Budget?
The main adjustment our base case makes to WA's budget is to commodity prices and the Australian dollar/U.S.
dollar exchange rate, which are two of the main sensitivities of royalty revenues. Our assumptions to these key
variables are set out in table 1, below, along with the assumptions in WA's 2013 budget. The table also shows how
much lower our royalty expectations are compared to the WA budget.
Table 1
Assumption Differences In WA's Budget
2013 2014 2015 2016
WA's Budget assumptions
A$/US$ (cents) 99 92 84.9 77.9
Iron ore (US$/t) (FOB) 127.3 115.2 102.9 90.6
S&P assumptions
A$/US$ (cents) 104 100 100 100
Iron ore (US$/t) (FOB) 115 100 100 100
Impact on royalty revenues (mil.A$) (706) (1,292) (1,467) (1,615)
While our assumptions regarding royalty revenues are the largest adjustment to revenues in our base case, we have
also adjusted the following items:
• GST revenues, to reflect our expectations of a smaller-than-forecast GST pool (anticipating pool growth of 2.5%
through the forward estimates), as well as the benefit to WA's GST relativities from fiscal 2015 from lower
own-source (i.e., royalty) revenues.
• The pace of growth in conveyance duties and payroll taxes from fiscal 2014, making it slightly lower than in the
budget.
• Expectations on the expenditure side, reflecting the government's late-September announcement of additional
savings measures. The pace of expenditure growth has also been slightly flattened.
• Capital-expenditure expectations, on our assumption that WA's capital expenditure program will not decline as
sharply in fiscals 2015 and 2016 as presented in the 2013 budget.
Overall, these adjustments lower WA's budgetary performance metrics versus unadjusted budget data, with a
maximum differential of 1.8 percentage points.
What Happens If Your Base Case Turns Out To Be Wrong?
If WA's budgetary performance exceeds our expectations and there is a buffer to provide some protection against
revenue volatility, we would likely revise the outlook back to stable.
If WA's revenues weakened further than we expect and there were only limited savings measures to offset this, we
would probably lower the long-term rating on WA to 'AA+.' Under this scenario, budgetary performance as measured
by the adjusted cash operating balance to adjusted operating revenues would likely average at or near a deficit, while
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4. Credit FAQ: What’s Behind The Negative Outlook Revision On The State Of Western Australia?
gross debt would be rising toward 120% of revenues.
Does This Mean That You Think Australia's Mining Boom Is Over?
We think that the growth outlook for mining in Australia has moderated, reflective of a number of
challenges--including the foreign exchange rate and commodity prices, which are two of the specific factors that are
challenging WA's revenue outlook. We do not anticipate a sharp fall in production--rather, a slowing of previously
very-strong growth to more sustainable levels.
What Does The Change To WA's Outlook Imply For The Australian Sovereign
Rating?
There's no increased pressure on the (unsolicited) Australian sovereign rating as a result of the negative outlook on
WA. The key risk for the sovereign rating is 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.
Related Research
• Outlook On State Of Western Australia Revised To Negative; Ratings Affirmed At ‘AAA/A-1+’, published Oct. 25,
2012
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