A state’s total funding cost depends on both the size of its debt and the interest rate paid on it. Queensland’s debt ratio increased from 2012 to 2017 to well above that of NSW. At the time, however, low bond yields cushioned the cost of carrying that higher debt.
Since the pandemic, debt levels and interest rates have both risen, pushing interest payments to a larger share of state output and government expenditure. States are now confronting the reality of higher debt stocks and higher yields. The effects are significant, with interest payments in NSW and Queensland more than doubling since the pandemic.
The very low yields before and during the pandemic increasingly look like the aberration. With governments worldwide running fiscal deficits, defence spending increasing and AI-related investment surging, interest rates are likely to remain above pre-pandemic levels.
For the total cost of state debt, the large rise in yields and the increase in debt stocks dwarf the additional 10 or even 20 basis points associated with a downgrade.
NSW debt has more than doubled since before the pandemic to around $180b. At an average interest rate of 5%, annual interest payments on that additional debt would be around $4.5b. A 2 percentage point rise in the average yield would eventually increase annual debt-servicing costs by around $3.6b. By contrast, a 10 basis point increase in borrowing costs following a downgrade would add only around $0.2b.
A credit downgrade matters less for the small increase in borrowing costs than for its warning of a rising debt stock that carries a much larger funding burden.
