Interest rate rises to delay Vic, NSW surplus returns

A predicted return to surplus in the Victorian and NSW budgets will be knocked off course by more interest rate rises, a leading credit agency says.

Moody's Investors Service has singled out Australia's two most populous states in a new report, sounding the alarm about the impact of rising healthcare spending, soaring inflation and a weakening housing market.

John Manning, vice president of the service, said the housing market downturn would lower stamp duty revenue and largely offset stronger GST, payroll tax and mining royalty collections.

"Softer-than-expected residential prices and transactional activity through 2024 are likely to weigh more on NSW and Victoria because transfer duty represents a higher proportion of total revenue in these states than for their domestic peers," he said.

"While the states have generally kept longer-term commodity price forecasts unchanged, Western Australia and Queensland both benefited from stronger commodity prices, while Queensland also benefited from the state's new progressive coal royalty tiers."

Moody's stripped Victoria of its AAA credit rating in February 2021 and its status was further downgraded from AA1 to AA2 last year as the state's debt continued to mount following the COVID-19 pandemic.

NSW has retained its AAA credit rating throughout the global health crisis, a point of pride for Premier Dominic Perrottet.

"Our debt position in four years time, as a percentage of GSP (gross state product) is half as much as Victoria whilst building twice as much infrastructure," he told reporters this week.

"That's what good financial management looks like."

NSW Treasurer Matt Kean has committed to returning the state budget to surplus in 2024/25, a year ahead of Victoria.

But rising borrowing costs and debt have led to an increase in interest expense forecasts, heaping further pressure on the states with higher debt burdens such as Victoria and NSW.

To make matters worse, the Reserve Bank last month hinted at more interest rate hikes to curb sky-high inflation, which has further increased so-called "debt affordability risks".

"With debt burdens in Victoria and NSW forecast to increase to 224 per cent and 152 per cent, respectively, by 2026, additional significant increases in interest rates above the budgeted levels would delay the return to operating surpluses," Mr Manning said.

"Although high debt burdens pose a risk for all states, NSW and Victoria are more affected than the others given the significant forecast increase in their debt burdens in the period up to 2026 and amid additional expenditure headwinds from high healthcare spending and wage inflation.

"However, the states' fiscal positions are supported by strong institutional frameworks, which we expect to allow them to adjust capital expenditure as required if borrowing costs continue to rise."

Victorian minister Melissa Horne said Treasurer Tim Pallas had laid out a "strong pipeline" for the state to get back in the black, and pointed to low unemployment as cause of optimism.

"Having that pipeline of economic growth makes the state feel very confident that we'll able to achieve that return to surplus," she told reporters on Friday.

Shadow Treasurer Brad Rowswell said Victoria is in a debt crisis and the Andrews government cannot tax its way out of trouble.

"The way through to prosperity is by growing the economic and opportunity pie," he said at the Avalon Airshow.

Mr Pallas will hand down Victoria's state budget in May, while NSW voters head to the polls on March 25.