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. Fitch has also affirmed the Foreign- and Local-Currency Short-Term IDRs at 'F1+'. The Short-Term IDR is 'F1+', as the Long-Term IDR lies between 'AAA' and 'AA-', in accordance with our criteria.
South Australia has a 'Stronger' risk profile and debt sustainability assessment in the 'a' category under Fitch's International Local and Regional Governments (LRG) Rating Criteria, which lead to a Standalone Credit Profile (SCP) of 'aa+'. The Long-Term IDRs are driven by the SCP with no other factors affecting the ratings.
The affirmation reflects a rebounding local economy following the Covid-19 pandemic, which has supported a recovery in South Australia's fiscal performance, providing capacity to invest in key policy initiatives while maintaining adherence to fiscal targets. The state's 2023-2024 budget estimates a modest operating deficit for the fiscal year ended June 2023 (FY23) before a resumption of surpluses from FY24 and progressive rises to FY27. This is on the back of low but steady economic growth supporting a similar trend in revenue growth, and includes new spending commitments in key service areas, such as the state's health system, and cost of living support.
Borrowings will continue to climb steadily across Fitch's projected period to FY27 as the state continues to invest in a large capital programme, including major projects to improve health services and transport networks, although they will remain at manageable levels.
Key Rating Drivers
Risk Profile: 'Stronger'
The 'Stronger' assessment reflects a negligible risk compared with international peers that South Australia's ability to service debt with its operating balance may weaken unexpectedly over the scenario horizon to FY27 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 large and diversified economy and strong underlying taxation base support a stable revenue growth outlook, along with a large federal grant system from a strong sovereign counterparty - Australia (AAA/Stable) - that contributes over half of total state revenue.
South Australia's economic growth is slower than that of its larger state peers but is steady, rising at an average annual rate of 1.6% in the 10 years to FY22, compared with national growth of 2.3%. State tax revenue growth rebounded strongly following the pandemic, rising at a CAGR of 4.5% in the five years to FY22, supporting operating revenue growth of 4.8%.
Revenue Adjustability: 'Stronger'
Similar to other Australian states, South Australia has unrestricted ability to adjust its own-source revenue, supported by strong affordability of tax hikes by international standards. South Australia is a relatively low-tax jurisdiction, driven by a focus on moderating the tax burden on its citizens while maintaining competitiveness of the state tax system, which promotes inward investment and supports a sturdy labour market.
The large share of state revenue provided by government transfers restricts budgetary flexibility but also offsets possible revenue or cost weaknesses of the state via a fiscal equalisation mechanism.
Expenditure Sustainability: 'Stronger'
Expenditure responsibilities include major public services of education and healthcare, which the state estimates accounted for 52% of total spending in FY23. We view expenditure as reasonably predictable, assisted by the central government covering the highly counter-cyclical cost of social welfare, although states do typically commit to stimulus spending via capital investment during downturns.
Capex is relatively modest, however, estimated at around 12% of total state spending in FY23 under Fitch's adjusted fiscal calculations. South Australia has a good record of control over its expenditure growth, generally at or below revenue growth, aligning to a 'Stronger' assessment under Fitch's criteria.
Expenditure Adjustability: 'Midrange'
We believe South Australia's cost base offers moderate flexibility. A relatively high proportion of staff costs and critical spending areas of health and education - which we view as largely inflexible - are balanced by the contingencies built into budgets for unplanned spending increases and the ability to reduce capex. We estimate inflexible costs account for 70%-90% of total costs, aligning to a 'Midrange' assessment under our criteria. Health and education will remain the key spending areas over the medium term, while capex accounts for only a small share of spending, typically at slightly over 10%.
Liabilities and Liquidity Robustness: 'Stronger'
South Australia takes a prudent approach to its debt and liquidity management, supported by the strong governance structure and established market discipline of the state's central financing vehicle, the South Australian Government Financing Authority (SAFA). In the absence of prudential regulation, the state maintains tight control over its treasury management and a disciplined approach to borrowing levels and debt-servicing capacity.
SAFA issues debt into deep and liquid domestic and international financial markets at a range of maturities, led by fixed-rate domestic issuance, with careful oversight of debt maturities and overall liquidity. The state has a large unfunded superannuation liability, similar to most Australian states, but remains committed to fully funding it by 2034.
Liabilities and Liquidity Flexibility: 'Stronger'
SAFA's established access to capital markets and large stores of liquid assets provide it with a strong liquidity position. A broad investor base, both domestic and offshore, provides solid demand for SAFA's regular debt issuance, supported by robust internal liquidity settings. SAFA's policies include a minimum base liquidity buffer of AUD1.5 billion, or sufficient to cover debt maturing in the next 60 days on a rolling basis, full funding of maturities 12 months in advance and a liquidity base sufficient to meet cash needs for 90 days at all times.
A strong institutional framework provides additional liquidity support in times of market disruption, recently demonstrated by the Reserve Bank of Australia's inclusion of state government bonds in its temporary bond-buying programme during the pandemic.
Debt Sustainability: 'a' Category
We classify South Australia as a Type A LRG under our LRG criteria on its sovereign-like features, such as a high share of total government spending and ability to incur structural deficits. Under a FY23-FY27 rating-case scenario, based on the state's budget and estimates with additional economic and fiscal stresses through a possible economic downturn, the primary metric - the economic liability burden ((net adjusted debt + a pro rate share of central government debt)/state GDP) - rises to 62.3% in FY27, from 59.6% in FY22. This is comfortably within the 'aa' category assessment of 40%-70%.
Secondary metrics include a payback ratio (net adjusted debt/operating balance) in the 'bb' category at 24.6x in FY27, improved from 59.8x in FY22, a synthetic debt-service coverage ratio (operating balance/15-year mortgage-style debt payback) in the 'b' category at 0.4x, and a fiscal debt burden (net adjusted debt/operating revenue) of 136.6%, in the 'a' category. The primary metric's 'aa' category assessment is lowered to the 'a' category when combined with the weaker secondary metrics. The score also considers the state's guarantee of SAFA's debt, which we classify as a contingent liability.
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 solely by the SCP.
Key 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'
Budget Loans (Notches): N/A
Ad-Hoc Support (Notches): N/A
Asymmetric Risks (Notches): N/A
Floor: N/A
Cap (Foreign-Currency IDR): N/A
Cap (Local-Currency IDR): N/A
Quantitative Assumptions - Issuer Specific
Our rating case is a 'through-the-cycle' scenario, which incorporates a combination of revenue, cost and financial risk stresses. It is based on FY18-FY22 figures and FY23-FY27 projected ratios. The key assumptions for the scenario include:
Operating revenue CAGR of 2.9% in FY23-FY27 (FY18-FY22: 4.8%);
Operating expenditure CAGR of 2.1% in FY23-FY27 (FY18-FY22: 5.7%);
Net capex to average AUD2.8 billion a year in FY23-FY27 (FY18-FY22: AUD1.3 billion);
Cost of funds to average 4.5% in FY23-FY27 (FY22: 2.3% Fitch-estimated average cost of funds).
RATING SENSITIVITIES
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.
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.
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.
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 (pensions), and nets out cash and short-term liquid investments.
Net adjusted debt in FY22 is derived as follows: direct debt including intergovernmental debt of AUD23.3 billion + other Fitch-classified debt of AUD11.4 billion - Fitch-calculated unrestricted cash, liquid deposits and sinking funds of AUD11.0 billion = AUD23.7 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.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' 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. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.
SAFA SYSTEMS & TECHNOLOGIES LIMITED 
