State’s finances face gathering threats, including potential stranded assets in coal exports, analysts warn

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The New South Wales economy could be facing a “vicious cycle of spending and debt” with taxpayers having to spend potentially billions more on interest payments to bondholders, according to a new report.

NSW’s newly minted treasurer, Matt Kean, who presides over a third of the Australian economy, is expected to release a post-lockdown recovery package within days as Covid-imposed curbs are lifted.

But according to a new report by the Institute for Energy Economics and Financial Analysis, NSW’s finances also face gathering threats not least from the need to end the state’s dependence on coal exports to meet its climate pledges. Its own Treasury also forecasts the bill from global heating impacts will triple by mid-century.

Trista Rose, author of the IEEFA paper and a former trader with global banks in London, New York and Sydney, says some recent quirky behaviour in bond markets suggests investors are becoming more twitchy about investing in debt from a state normally considered to be the engine of Australia’s economy.

For a few months earlier this year, at the time of NSW’s latest budget, the NSW government had to pay investors more to buy its debt than any other big state, including Queensland.

“This is unprecedented in my understanding,” Rose said of the widening of the so-called spread between the yield paid on NSW bonds versus other states’ debt. “It was the markets’ kind of expectations of how indebted New South Wales was.”

That spread has lately narrowed in part because of the NSW government’s sale of the rest of its giant WestConnex venture, the country’s biggest toll road project, for $11.1bn to pay down debt.

The higher debt costs could add in the order of $200m-$300m in annual repayments for NSW taxpayers, Rose said.

They also serve as a reminder that, according to the state’s own Treasury estimates, NSW faces rising debt loads for decades to come. By 2060, that net debt will climb to the equivalent of NSW’s annual economic activity, known as gross state product.

If anything, though, the outlook could deteriorate faster than Treasury expects.

“The combined effect of drought, bushfires, floods and the first round of Covid-19 lockdowns have taken debt in NSW to unprecedented levels,” Rose says.

“NSW could wind up in a vicious cycle of spending and debt related to environmental costs and interest expenditure, rather than a virtuous cycle of spending which results in broader economic gain which benefits the residents of NSW.”

For now, the rating agencies are taking a more sanguine approach. Moody’s has retained NSW’s top-notch “triple A” rating, but has noted concerns about plans to lift state debt to $171bn by 2025.

“While record-low interest rates will enable NSW to absorb such a sharp rise in borrowing, the rapid and sustained increase in the debt burden will significantly constrain its operating profile over time and test institutional capacity as the state targets fiscal repair, which includes asset sales, over the next ten years where material execution risks are at play,” Moody’s said in a recent note.

Rival agency S&P cuts NSW’s debt rating one notch to AA+ last December and has a stable outlook for now.

“I would emphasise that it’s still very very strong on a global basis,” Martin Foo, an associate director of S&P, says. “[NSW is] still rated on par with the US, and other big countries.”

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Longer term, increased investor concern over environment, social and governance issues, particularly climate change, could prompt a review of NSW – and Australia’s – exposure, Foo says.

“We are looking at things like exposure to physical risks as well as, particularly for Australia, for transition risks [as fossil fuel industries decline],” he says adding that those threats include “the world might move ahead on climate and Australia will left with stranded assets”.

Independent economist Saul Eslake said that most people would view NSW as being in a “pretty strong financial position”.

Still, “New South Wales, Victoria and Queensland have by comparison to the other states, a more difficult task in reducing the carbon dioxide intensity of their electricity generation, because they are far more dependant on coal.”

“The issue for New South Wales and Queensland about coal in particular, is that either Australia decides how quickly we get out of the business of thermal coal exports [used in power plants], or our customers will decide for us,” Eslake says.

“It’s likely to be much more abrupt and disruptive if we choose the latter path, which we will by default if we don’t consciously choose the first one.”

Treasurer Kean said NSW “has a AAA credit rating [with Moody’s] with record levels of business confidence underpinning what we expect to be a strong recovery from the Covid pandemic”.

“The world’s move to decarbonise is a massive opportunity for our state,” Kean says. “We have some of the best renewable energy resources on the planet and a world-class heavy industry infrastructure.”

“NSW has recently legislated the nation’s largest renewable energy plan which has since been backed by record levels of investor interest in our renewable energy zones. We have also just announced the most ambitious hydrogen strategy in the country,” he says.

His Labor counterpart, Daniel Mookhey, said the NSW budget was under pressure before lockdown and that rebuilding afterwards won’t be cheap.

The treasurer, he said, should reverse “crazy schemes” such as borrowing for the new NSW Generations Fund, which contributed to the blowout in spreads.

“Matt Kean should abandon Dominic Perrottet’s plan to borrow $20bn to gamble through the NSW Generations Fund,” Mookhey says.

“Then he should rule out spending $10bn on Mr Perrottet’s plan for a massive new toll road on Sydney’s Northern Beaches.”

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