Fitch Ratings has affirmed the State of South Australia's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'AA+'.
The Outlook is Stable.
The affirmation reflects South Australia's 'Stronger' risk profile and debt sustainability assessment in the 'a' category, which lead to a Standalone Credit Profile (SCP) of 'aa+'. Fitch expects the state economy to continue to recover from the Covid-19 pandemic to underpin a steady increase in the state's operating balance over our rating-case projections to the financial year ending June 2026 (FY26). We also expect an upward trajectory in borrowings as the state continues to invest in a large spending programme that includes improving health services and transport networks, providing additional funding for the education sector and promoting economic growth.
Fitch classifies Australian states and territories as 'Type A' local and regional governments (LRGs), based on their structural attributes, such as their large share of general government expenditure, including responsibilities for health and education, tax-sharing arrangements with the federal government and ability to incur and sustain budgetary deficits.
KEY RATING DRIVERS
Risk Profile: 'Stronger'
We evaluate South Australia across six risk factors, which we assess as 'Stronger' or 'Midrange'. We do not assess any factors as 'Weaker'. The 'Stronger' assessment reflects a negligible risk that the issuer's ability to service debt with its operating balance may weaken over the scenario horizon to FY26 due to revenue that is below or expenditure that is above our expectations, or because of an unanticipated rise in liabilities or debt-servicing requirements.
Revenue Robustness: 'Stronger'
South Australia's 'Stronger' revenue robustness assessment is driven by its stable underlying economy that has grown at an average annual rate of 1.2% between FY11 and FY21, and a diverse and expanding revenue base. Federal transfers contribute slightly over half of the state's total revenue and state taxes around a quarter.
Fitch-adjusted operating revenue grew at a CAGR of 4.0% for FY17-FY21, underpinned by growth in state taxes (2.0% CAGR) and federal transfers (5.4% CAGR). Population and GDP growth are low compared with domestic peers, but are steady and underlie a broad and productive taxation base, while the system of federal grants is well-established and considered highly predictable.
Revenue Adjustability: 'Stronger'
South Australia is a relatively low-tax jurisdiction, driven by the state's focus on moderating the tax burden on its citizens while maintaining the competitiveness of the state's tax system, which in turn acts as a competitive advantage for business and inward investment and supports job creation. Similar to other Australian states, South Australia has unrestricted ability to adjust its own-source revenue, which we believe offers strong ability to offset budgetary pressures, supported by strong affordability of tax hikes by international standards.
This is despite the large portion of the state's revenue provided by government transfers, which restricts budgetary flexibility although it also offsets revenue or cost weaknesses via a robust fiscal equalisation mechanism.
Expenditure Sustainability: 'Stronger'
States are responsible for major public spending areas such as education and healthcare, while social welfare is covered by the central government. South Australia has a good record of control over its expenditure growth, generally at or below the revenue growth trend. Prior to the onset of the pandemic in FY20, the state's revenue growth outstripped expenditure growth, reflecting the 'Stronger' assessment of expenditure sustainability.
This dynamic reversed due to the additional spending associated with the pandemic with Fitch-adjusted operating expenditure CAGR of 4.9% for FY17-FY21, above that of operating revenue at 4.0%, although we expect this to be temporary as the state returns to stronger fiscal performance when pandemic-related spending unwinds.
Expenditure Adjustability: 'Midrange'
Fitch believes South Australia's cost base offers moderate flexibility, balanced by the relatively high proportion of staff costs and key spending areas of health and education, which we view as largely inflexible, and the leeway built into budgets for unplanned spending increases and the state's ability to reduce capex in need.
Fitch estimates inflexible costs account for 70%-90% of total costs, aligning to a 'Midrange' assessment. Fitch expects health and education to remain the key spending areas over the medium term. Capital spending accounted for a modest 12% of total spending in FY21 although the state has flexibility to adjust the timing or scope of major projects.
Liabilities & Liquidity Robustness: 'Stronger'
South Australia's prudent approach to debt and liquidity management is supported by the strong governance structure and established market discipline of the state's central financing vehicle, the South Australian Government Financing Authority (SAFA). SAFA sources both short- and long-term funds from domestic and international financial markets by issuing a range of debt instruments and uses its robust market access to effectively manage its debt maturity profile and liquidity.
The weighted-average maturity was slightly over five years at end-June 2022, with over 90% issued on fixed rates. The state has a large unfunded superannuation liability, similar to most Australian states, and remains committed to fully funding it by 2034.
Liabilities & Liquidity Flexibility: 'Stronger'
SAFA has established access to capital markets and maintains large liquid assets to support its liquidity needs. The entity has a broad investor base both domestically and offshore. Asset and insurance managers and financial institutions were the main investors in SAFA's FY22 primary issuance, making up over 65%, while Australian investors made up 84%.
SAFA's liquidity management is robust, with policies requiring a minimum base liquidity buffer of AUD1.5 billion, or sufficient to cover debt maturing in the next 60 days on a rolling basis. The entity must also fully fund maturities 12 months in advance and demonstrate that it is able to remain liquid for at least 90 days. SAFA held surplus liquidity of AUD6 billion at 7 June 2022, sufficient to fund its obligations for 377 days.
Debt Sustainability: 'a category'
Fitch's rating case scenario for FY22-FY26 projects South Australia's economic liability burden ((net adjusted debt + a pro rata share of central government debt)/local GDP) will rise to 68.7% in FY26, from 65.8% in FY21. This lies within the threshold of 40%-70% for an 'aa' assessment. The economic liability burden is the primary metric of the debt-sustainability assessment for 'Type A' LRGs. South Australia's secondary metrics are weaker, including a payback ratio of 26.2x in FY26, improved from 48.2x in FY21. This is in the 'b' category.
The rise in the economic liability burden results from South Australia's high debt-funded capex and modest but improving operating surpluses over the projected period, in addition to an upward trajectory in federal debt. The state's weaker payback ratio and contingent liabilities related to the state-guaranteed SAFA debt weigh on the overall debt sustainability score, resulting in the 'aa' assessment indicated by the primary metric being lowered to 'a'.
Derivation Summary
South Australia's SCP reflects the state's 'Stronger' risk profile and debt-sustainability score in the 'a' category. The Long-Term IDR of 'AA+' is driven by the SCP. Fitch does not regard Australian state ratings as directly linked to the sovereign rating, although credit quality aspects of the sovereign may also affect our opinion of the states' credit profile.
South Australia is automatically assigned a Short-Term IDR of 'F1+' as its corresponding Long-Term IDR lies between 'AAA' and 'AA-'. This is based on the short-term ratings correspondence contained within the local and regional government rating criteria.
Key Assumptions
Qualitative assumptions:
Risk Profile: 'Stronger'
Revenue Robustness: 'Stronger'
Revenue Adjustability: 'Stronger'
Expenditure Sustainability: 'Stronger'
Expenditure Adjustability: 'Midrange'
Liabilities and Liquidity Robustness: 'Stronger'
Liabilities and Liquidity Flexibility: 'Stronger'
Debt sustainability: 'a'
Support (Budget Loans): 'N/A'
Support (Ad Hoc): 'N/A'
Asymmetric Risk: 'N/A'
Sovereign Cap: 'AAA'
Sovereign Floor: 'N/A'
Quantitative assumptions - Issuer Specific
Fitch's rating case is a 'through-the-cycle' scenario, which incorporates a combination of revenue, cost and financial risk stresses. It is based on FY17-FY21 figures and FY22-FY26 projected ratios. The key assumptions for the scenario include:
Operating revenue CAGR of 2.7% in FY22-FY26 (FY17-FY21: 4.0%)
Operating expenditure CAGR of 2.1% in FY22-FY26 (FY17-FY21: 4.9%)
Net capex to average AUD2.4 billion per year in FY22-FY26 (FY17-FY21: AUD0.9 billion)
Cost of funds to average 4.0% in FY22-FY26 (FY21: 2.3% Fitch-estimated average cost of funds).
Liquidity and Debt Structure
Fitch's calculation of South Australia's net adjusted debt includes senior unsecured debt and other liabilities that we consider debt-like, such as public-private partnerships, leases and unfunded superannuation liabilities, and nets out cash and short-term liquid investments.
Net adjusted debt in FY21 is derived as follows: direct debt including intergovernmental debt (AUD21.0 billion) + other Fitch-classified debt (AUD14.0 billion) - Fitch-calculated unrestricted cash, liquid deposits and sinking funds (AUD11.2 billion) = AUD23.8 billion.
Issuer Profile
South Australia is Australia's fourth-largest state by land area, the nation's fifth-largest economy and, with a population of around 1.8 million, accounts for 7% of Australia's total population.
It is a self-governing state that represents the second tier of government in Australia. It also controls a third lower-tier of local governments. The state's economy is diverse, with primary industries of health care and social assistance, financial and insurance services, construction, manufacturing, and education and training.
Rating Sensitivities
Factors that could, individually or collectively, lead to negative rating action/downgrade:
South Australia's Long-Term IDRs could be downgraded in the event of a deterioration in its budgetary performance beyond our rating-case forecasts, weak fiscal discipline or failure to control capex, resulting in an economic liability burden closer to 80% for a sustained period in our rating-case scenario with no significant improvement in the payback ratio.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Positive rating action could result from an improved fiscal position via continued adherence to prudent fiscal discipline that enables the state to strengthen its operating balance and improve its debt metrics. This would be evident in an economic-liability burden that is closer to 40% on a sustained basis in our rating-case scenario, together with a significant improvement in the payback ratio.
ESG Considerations
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg
Best/Worst Case Rating Scenario
International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
References for Substantially Material Source Cited as Key Driver Rating
The principal sources of information used in the analysis are described in the Applicable Criteria.
RATING ACTIONS
Entity / Debt
Rating
Prior
South Australia,State of
LT IDR
AA+
Affirmed
AA+
ST IDR
F1+
Affirmed
F1+
LC LT IDR
AA+
Affirmed
AA+
LC ST IDR
F1+
Affirmed
F1+
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VIEW ADDITIONAL RATING DETAILS
Additional information is available on www.fitchratings.com
PARTICIPATION STATUS
The rated entity (and/or its agents) or, in the case of structured finance, one or more of the transaction parties participated in the rating process except that the following issuer(s), if any, did not participate in the rating process, or provide additional information, beyond the issuer's available public disclosure.
SAFA SYSTEMS & TECHNOLOGIES LIMITED 
