Apparently, it’s not a matter of if Australia loses its coveted AAA credit rating, so much as when.

The bleak scenario has arisen because the three big ratings agencies, Standard & Poor’s, Moody’s and Fitch, disagree with how the economy is being run.

Simplistically, the agencies focus on the ability to pay back borrowed money. The agencies award a AAA rating to the countries seen as having the least risk, so a change in this assessment will signal Australia’s risk has increased.

Locally, a lower credit rating may increase the cost of government borrowing, which may be felt most keenly by the state governments. However, a rise in borrowing costs is not always certain.

Japan’s borrowing costs fell after it was downgraded because of factors other than reduced the credit rating.

Banana republic revisited

A downgrade would not be a new thing for Australia. We last lost our AAA rating in 1986, after then Treasurer Paul Keating warned that Australia risked becoming a ‘banana republic’ if the economy wasn’t fixed.

The current account and budget deficits were sky high, the terms of trade and the dollar were sinking, the jobless rate was 7.8 per cent and official interest rates were approaching a mind-numbing 16 per cent.

Keating was incensed that Moody’s didn’t trust the ‘world’s greatest treasurer’, as he was named two years earlier, to have a fiscal plan to deal with the situation.

Political shock

But what did the downgrade actually mean for Australia? Arguably, the biggest effect was the shock felt by politicians and public servant mandarins. It was a huge kick in the pants and galvanised them into action. Complacency was no longer an option.

It took 16 years, a long recession, savage budget cuts and the introduction of a goods and services tax for Moody’s to restore our AAA rating.

Today, because there’s been so much talk about it and because internationally some big names have had their ratings cut – the US, France and the UK, for example – the effects may be felt less obviously.

Perhaps the most palpable result will be a hit to national pride and public confidence in the government.

With the government on the political back foot as independents are poised to hold the balance of power in the Senate in the next parliament, the temptation will be to keep buying votes with spending initiatives. There will be little taste for austerity.

We can only hope that the effect of a downgrade this time will be the same as it was last time – to kick the government into action.

Power, power, power

What a downgrade would also show once again is that while the credit ratings system is open to distortions, voodoo economics and general mischief, the ratings companies hold enormous power.

This is clear from the part they played in the 2008 global financial crisis, for which they are now being punished. Moody’s has agreed to pay nearly US$864 million to settle with US federal and state authorities over its ratings of risky mortgage securities in the run-up to the crisis.

Standard & Poor’s entered into a similar accord in 2015, paying out US$1.375 billion. These companies now have to ensure the integrity of their credit ratings, including keeping analytics employees out of commercial discussions. The world paid a high price for that piece of common sense.