OREANDA-NEWS. Fitch Ratings has affirmed Australia's Long-Term Foreign - and Local-Currency Issuer Default Ratings (IDR) at 'AAA'. The Outlook is Stable. Australia's senior unsecured local-currency bond ratings are also affirmed at 'AAA'. The Country Ceiling is affirmed at 'AAA', and the Short-Term Foreign - and Local-Currency IDRs at 'F1+'.

KEY RATING DRIVERS

- Australia's strong institutions, effective governance and high income are key supports for the 'AAA' rating. The economy has grown consistently over the past two decades, benefiting from the flexibility offered by a free-floating exchange rate, credible monetary policy framework and low public debt. External finances are a longstanding structural weakness, but partly mitigated by the country's strong financing flexibility, as marked by its long track record of sustaining current account deficits.

- Australia's fiscal position has continued to deteriorate. Fitch estimates the general government (includes state and territory governments) deficit at 3.0% of GDP in the fiscal year ended 30 June 2016 (FY16), 0.4pp higher than the forecast in our March 2016 review, and higher than the 'AAA' median of 0.3% of GDP. Lower revenues accounted for most of the difference from our forecast, driven by the impact of the fall in the terms of trade (5.3% over the year to 2Q16) on nominal growth and weaker wage inflation.

- Fitch expects Australia's general government deficit to rise to 3.2% of GDP in FY17, before falling to 2.2% in FY18 and 1.6% in FY19. We expect fiscal consolidation to be slower than the path outlined by the Treasury in the FY17 Budget, reflecting our forecast for slower nominal GDP growth, higher public investment by the New South Wales government and our view that some unlegislated measures included in the FY17 Budget projections could be blocked or delayed in the Senate. Fitch projects the general government debt to GDP ratio to stabilise at around 40% from FY18 onwards, converging with the median for 'AAA' rated sovereigns.

- The political climate adds to fiscal policy uncertainty. The Coalition's share of seats in the Senate fell following the general election in July, and more support from cross-benchers will be required to pass legislation if compromise with the Opposition cannot be reached. The passage of the Budget Savings (Omnibus) Bill 2016 through Parliament was a positive start in realising some of the unlegislated savings assumed in the Budget projections, but reaching agreement over remaining unlegislated measures could be more challenging.

- Fitch's forecast for public finances is highly dependent on the macroeconomic outlook. Fitch expects Australia's real GDP to grow 2.9% in 2016, faster than the 'AAA' median of 1.9%. Strong services growth, resilient consumption and rising volumes of commodity exports have helped to offset a sharp decline in mining investment. A decreasing drag from mining investment, higher public spending on infrastructure, continued low interest rates and increased production of natural gas should help maintain real GDP growth around current levels over the next two years. Nominal GDP, which is more correlated with government revenues, should also grow quicker should the terms of trade stabilise as Fitch expects.

- Australia's high household debt, which has risen from 166.6% of disposable income in 4Q11 to 186.9% in 1Q16, increases the economy's vulnerability to shocks. The high debt burden has been sustainable due to low interest rates, but households could struggle to meet interest payments should unemployment increase, or interest rates rise sharply. Fitch views the latter as unlikely to occur in isolation given the current low inflation environment, but could occur in a scenario where external financing conditions tighten substantially for a prolonged period.

- House prices have risen rapidly, but indicators now generally point to a cooling of the market as lending standards tighten and the supply of residential property grows. Further downward pressure on the market could arise from the failure of off-plan apartment purchases to settle, particularly by foreign buyers unable to obtain financing due to tighter lending restrictions. A gradual slowing of house price appreciation would prevent prices from reaching potentially unsustainable levels. A sharper adjustment could impair economic growth prospects, although Fitch does not expect this to lead to economic and financial instability absent a broader economic shock.

- The Australian banking system is one of the strongest globally on a standalone basis, scoring 'aa' on Fitch's Banking System Indicator (BSI). The banks' strong capital and liquidity position reduce the likelihood of sovereign support in the event of a downturn, or a sharp contraction in lending that amplifies an external shock. However whether financial stability is maintained ultimately depends on the breadth and severity of the shock involved.

- Australia's net external debt/GDP is the largest in the 'AAA'-rated category at 62.0%. However, a diversified pool of foreign investors willing to lend to Australian entities in local currency, and sophisticated hedging of currency and maturity mismatches in the financial sector, help to mitigate some of the external liquidity risks and reduce the economy's vulnerability to a sharp depreciation of the Australian dollar. A sustained reallocation of capital flows away from Australia by foreign investors could raise financing costs and put downward pressure on economic growth.

SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)

Fitch's proprietary SRM assigns Australia a score equivalent to a rating of 'AAA' on the Long-Term Foreign-Currency IDR scale.

Fitch's sovereign rating committee did not adjust the output from the SRM to arrive at the final Long-Term Foreign-Currency IDR

Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a Long-Term Foreign-Currency IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.

RATING SENSITIVITIES

The Outlook is Stable, reflecting the fact that Fitch does not currently anticipate developments with a high likelihood of leading to a rating change. However, future developments that could individually, or collectively, result in a downgrade of the ratings include:

- A sustained widening of the fiscal deficit without remedial policy actions, leading to continued upward trajectory of the general government debt-to-GDP ratio.

- A negative shock to the housing market that leads to widespread household and banking system distress.

- A negative external shock, such as a continued rapid decline in the terms of trade following a severe slowdown in China, which could lead to a sharp increase in the current-account deficit and/or a sustained reallocation of foreign capital.

KEY ASSUMPTIONS

-The global economy performs broadly in-line with Fitch's Global Economic Outlook, particularly China, which has become a key destination for Australian exports. Fitch expects China to grow by 6.5% in 2016, 6.3% in 2017 and 5.8% in 2018.

- Fitch assumes an average iron ore price of USD45 per tonne in 2016, and remain at an average of USD45 in the long-term (62% Fe CFR China reference).