Date created:19/4/03
Last modified:19/4/03
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John Quiggin

Being AAA is not the top

Australian Financial Review

27 February 2003

The news that Australia has regained a AAA credit rating from Standard & Poors sounds good, but what does it mean?

The direct benefits of a higher credit rating are small. A one-step upgrade might reduce the interest rate on new bonds by 20 basis points (0.2 percentage points) At the current debt level of $60 billion, the total benefit would be around $120 million per year, and this would only be realised when the entire outstanding debt had been rolled over at the new, lower rate. Such a gain could easily be outweighed by marginal timing variations in debt management.

In view of the small direct benefits of a credit upgrading, the emphasis placed on credit ratings in the Australian policy debate must be attributed primarily to the view that credit ratings represent an impartial judgement of the soundness or otherwise of fiscal strategy. In general, it is true that policies that tend to have a favourable (or unfavourable) impact on the fiscal sustainability of government policy will also have a favourable (or unfavourable) impact on credit ratings. For example, the introduction of unfunded expenditure programs, or cuts in taxes that are not matched by expenditure savings, will tend to reduce credit ratings.

However, this argument does not apply in all cases. Credit ratings are designed specifically to inform and protect the holders of government debt. Policies that specifically improve the position of holders of government debt will be viewed favourably by credit rating agencies even if they are harmful to society as a whole.

Reductions in debt will improve credit ratings even if they are financed by inefficient taxes and charges or by the sale of income-earning assets at inadequate prices. The imposition of inefficient taxes and charges will tend to discourage investment and employment while the sale of income-earning assets at inadequate prices will reduce the net worth of the public sector and, ultimately, the capacity to provide public services.

Similarly, a government will generally improve its credit rating by forgoing investment opportunities, even if the investments have an expected rate of return well above the cost of capital. The same is true for corporations, and it is one reason why very few corporations now seek to maintain a AAA rating - the cost in terms of foregone investments exceeds the benefits.

Corporations that do maintain a AAA rating are generally involved in financial activities where such a rating is required by regulation or where a short-term loss of confidence could prove fatal. Confidence is important to governments too. However, the availability of the taxing power means that there is no real danger of a run on government debt until finances get in really bad shape - far below the levels that have provoked concern in Australia.

More importantly, the political weight attached to credit ratings is based on an exaggerated respect for the financial institutions that issue them. In the 1980s and 1990s, it was easy to believe that the financial wisdom of firms like Standard & Poors and Moodys vastly exceeded that of spendthrift governments in need of fiscal discipline.

The weaknesses of the ratings agencies have been sharply exposed by the financial crises of the last few years, most of which involved some form of crony capitalism. The Asian crisis caught the ratings agencies almost completely by surprise. Even more striking were the failures on their home turf. Firms like Enron and WorldCom, supposedly scrutinised by sophisticated financial analysts, went broke with scarcely any warning from the credit watchdogs.

Unfortunately, the use of dubious fiscal expedients like off-balance sheet partnerships is not confined to Enron. Most of the reduction in Commonwealth debt has arisen from asset sales. The sale of Telstra, which drastically reduced the net worth of the pubic sector, was the biggest contributor. While less significant in quantitative terms, other fiscal expedients have been even more troublesome. They include sale-and-leaseback arrangements very similar to those that formed the basis of the accounting manipulations employed by Enron.

More generally, the adoption of practices such as reliance on commercial confidentiality, a natural accompaniment of faith in the superiority of financial markets over governments, has led to a reduction in the amount of information about the operations of government that is made available to the public. The decline in the usefulness of the Commonwealth Budget papers is particularly noteworthy.

AAA ratings are all very well, but they are no substitute for accurate, comprehensive and comprehensible public accounts. These have been sorely lacking in Australia in recent years

Professor John Quiggin is a Senior Research Fellow of the Australian Research Council, based at the University of Queensland and the Australian National University.

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