Moody's comments on Western Australia's 2015/16 budget

Moody's Investors Service says that Western Australia's latest budget, released 14 May 2015, shows that a record high deficit is expected for FY2015/16, as lower income from iron ore royalties and Goods and Services Tax-backed (GST) Commonwealth grants has not been offset by commensurate adjustments to current expenditures, which remain elevated. The projected budget gaps for FY2015/16 and over the medium term will push up the state's debt burden, a development which is a credit negative.

In FY2015/16, the state is projecting a sizeable deficit of AUD3.6 billion (net lending basis including capital outlays), equal to 13.8% of revenues, and considerably more than the AUD427 million, or 1.4% of revenues, forecast last year for FY2015/16, and also higher than the more recent mid-year estimate of AUD1.3 billion, or 4.8% of revenues. The expected deterioration largely reflects a reduction in royalties -- which comprise a much larger portion of income for Western Australia than for other Australian states -- amounting to 21.6% of revenues in FY2013/14, but projected to fall to a smaller 13.9% in FY2015/16, as projections for iron ore prices fall to USD47 a ton from USD120 in last year's budget.

The state is still forecasting strong growth in taxes -- at 7.8% -- in part due to revenue measures implemented to counteract revenue weakness, but GST-backed grants are also projected to fall, reflecting the impact of Western Australia's earlier years of strong revenue growth on the equalization formula. These latter reductions in part have been offset by a Commonwealth capital grant for road projects of AUD500 million that has not yet been factored into the budget figures.

The budget also updated results for FY2014/15, with the deficit now estimated at AUD3.1 billion, or 11.6% of revenues, a near doubling from a budgeted gap of AUD1.6 billion, or 5.7% of revenues. The projected shortfall reflected a 3.3% decline in revenues due in turn to a large drop in royalties and weaker growth in taxes because of slower economic growth as investment in the mining sector eased. At the same time, current expenditures still grew by 4.0%, driven by a 5.8% rise in the costs for public-sector employees.

The state government implemented some important revenue and expenditure measures earlier this year and also announced others in today's budget to narrow its budget deficit over the medium term. For example, it announced voluntary redundancies for 1,500 public-sector positions, increases in dividends from electric utilities and had implemented an efficiency dividend in December 2014. In this year's budget, Western Australia has focused more on revenue measures, including further and significant increases to land taxes. At the same time, however, it has injected new funds into health care, education, child protection and the police force, partially offsetting the effects of its measures on savings. The state is also contemplating some asset sales, which even though one-off in nature, could ease an expected accumulation in debt.

Over the medium term, the state expects its deficits to narrow and average 8.5% of revenues for FY2014/15 through FY2017/18, which is higher than the 2.5% average forecast last year for the same period. The new projections for the comparable timeframe rely upon revenues growing by 2.8% while expenditures are set to rise by a lower 2.6%. Following this in FY2018/19, Western Australia expects to move into a surplus position equal to 5.1% of revenues, but that figure presumes a large reduction -- which we think unlikely -- in capital expenditures.

The projected improvement in its financial performance will rely to a large extent on a strengthening in the state government's resolve to lower current expenditures, particularly as the growth in revenues is not expected to return to the more robust pace seen in earlier years, given slower economic growth as the economy transitions from a reliance on mining investment to production and related exports.

Achieving an average growth rate in expenditures of 2.5% for the four years through to FY2018/19 -- compared to the 6.2% for the four years through to FY2014/15 -- will be difficult, given the service and infrastructure demands of a still rapidly growing population. Furthermore, the state's reliance on more volatile commodity-based income will continue to prove challenging.

As part of Moody's normal monitoring process, we will conduct an in-depth analysis of the Western Australia's budget and its medium-term impact on its financial and debt profile. Moody's will focus on the state's commitment to a credible plan to budgetary redress and slowing the anticipated pace of debt accumulation.

This announcement represents an update to markets and does not constitute a rating action.

Moody's assigns long-term issuer and debt ratings of Aa1/stable to the Western Australian Treasury Corporation (WATC), the entity that issues debt on behalf of the State of Western Australia and its state- owned corporations. WATC's debt is guaranteed by the State of Western Australia and the rating is based on the credit quality of the state.