Victoria’s looming credit crisis as debt downgrade threat and high-stakes infrastructure gamble continue

Many Victorians are probably blissfully unaware of the dangerous credit rating high wire act that the Allan Government is performing at the moment.

Many will know that the state is deeply in debt with a $26 million a day interest bill and net debt on a path from $156 billion next year to $188 billion by 2028 but the rating on that debt is another story again.

Already Victoria’s AAA debt rating from 2020 has been downgraded two notches to AA, a reduction that has the effect of raising the interest rates actually paid on government borrowings and making the debt less sustainable.

Hopes for lower rates and growth

On the government’s side, the hope is that interest rates are on the way down naturally and if the economy keeps growing along with the tax base and the investment in infrastructure starts to pay off as projects such as the Metro tunnel are finally finished, the debt rating worries will slowly recede.

If things go the other way, with infrastructure projects such as the Suburban Rail Loop first stage busting through their revised budgets and the state budget does not return to surplus as planned, then the chances of the debt rating deteriorating further to AA- or worse will increase greatly.

Rating agencies have clearly said Victoria is on notice

Indeed, the ratings agencies have been very clear about what needs to happen to avoid a negative debt rating but while there have been some signs of government action to increase some taxes and go slow on some projects such as the airport railway, there have been no major changes to the Budget trajectory.

Treasurer Tim Pallas has forecast an operating surplus of $1.5 billion by 2025-26 but any changes to that forecast could prove fatal to Victoria’s debt rating and see taxpayers hit with higher interest on the state’s mammoth debt.

S&P Global Ratings analyst Anthony Walker has clearly said that despite already having the lowest rating of any Australian state, Victoria could face another downgrade to AA- if state debt reached 240% of operating revenues, or if interest payments reached 10% of those revenues.

Gross debt soaring compared to revenues

“We expect Victoria’s gross debt as a proportion of revenues to soar past 200% of operating revenues,” Mr Walker recently said.

“This is the highest among the Australian states and stems from successive operating deficits and its large capex since the pandemic hit in late fiscal 2020.”

“Debt to operating revenues has almost tripled since this time. Victoria’s serviceability costs are also rising.”

Victoria’s net debt is projected to hit $135.5 billion this year, compared to just $94.8 billion in NSW, which recently opened a new and well used Metro line.

Mr Walker said Victoria’s prolonged Covid lockdowns are largely to blame for the debt hangover, with other states around the world having recovered their budget health already.

“They (Victoria) just wanted to get the health outcomes correct. Well, that came at a massive fiscal shock, and they’re still trying to recover from that.”

A history of large budget blow outs

Looking at the history of large capital works programs is not encouraging, with large budget blowouts the rule rather than the exception so the determination to start building the SRL which is currently budgeted at $30 billion to $34.5 billion is by itself a significant risk to the credit rating.

A lower rating would have serious repercussions too, with a AA- rating set to increase borrowing costs by between 0.1% and 0.5% at a time when the overall debt level will keep expanding strongly.

Some of the more recent infrastructure blowouts include the Metro Rail Tunnel which added $837 million to reach $13.48 billion, the West Gate Tunnel Project which is three years late and $4 billion over budget and the North East Link which has blown out by more than $10 billion to $26.1 billion.

It all rests on the new rail loop

A similar blowout on the SRL would virtually doom Victoria’s credit rating to a downgrade and lead to a further annual Budget blowout reaching well into the distance due to the fact that government debt tends to hang around and is not readily repaid.

The optimistic scenario is that economic activity remains strong and pumps up state tax revenue and that as projects are completed, they generate positive returns into the economy in the form of higher productivity and efficiency.

Certainly, compared to spending on Covid, spending on hard assets has more potential for a return but comes with the chance that a cost blowout could lead to another debt downgrade that would have real costs for Victorians well into the future.