Treasurer Scott Morrison said S & P's statement had provided an important reminder to the incoming parliament about the reality of the fiscal environment and the global economic environment.

"We all, the government in particular, need to live within our means," Mr Morrison said in Sydney. "Fiscal consolidation cannot be postponed or slowed.

"This is an important reminder of something the government has always known and sought to deliver upon in the three budgets we've sought to deliver over the last three years."

Mr Morrison rejected questions from reporters about whether the S & P statement represented the Treasurer's "banana republic moment".

"I remain very determined to ensure the warnings that are in this report are not realised," he said.

Offshore debt too high

Most damning is the agency's concern that offshore debt levels are becoming too high to justify the top-notch rating.

"We believe that without remedial action the government's fiscal stance may no longer be compatible with the country's high level of external indebtedness," it said in a statement on Thursday.


S & P signalled that the actions of the incoming parliament over the next 12 months would determine what happens with the rating.

"We will continue to monitor, over the next six to 12 months, the success or otherwise of the new government's ability to pass revenue and expenditure measures through both houses of parliament," it said.

"We could also lower the rating with any further weakening of Australia's external position.

"This could come from current account deficits remaining at the higher end of the historical range, from a further weakening of terms of trade, or from an increase in the banking sector's cost of external funding."

Messy election outcome

The Australian dollar fell as low as US74.67¢ from an intra-day high of US75.38¢ shortly before the statement was released.

"Being put on negative credit watch by a ratings agency is not surprising," AMP Capital economist Shane Oliver said. "Australia has now seen years of slippage in returning the budget to surplus and the messy election outcome threatens more slippage whichever way it goes.

"Of course being put on negative watch is not the same as a downgrade and a country can remain on a negative outlook for up to two years without being formally downgraded


"But I suspect it's probable that a formal downgrade will follow unless the new government is able to hold the line on the budget deficit projections, which will be hard given the likely state of the Senate," Mr Oliver said.

The Aussie fell slightly on the news, from about $US0.753 to about $US0.747 but later recovered to $US0.75. Bond yields were little changed.

Wake-up call

S & P's statement is "a wake-up call to the federal politicians that they must support the next government to take urgent action to repair our budget", Australian Chamber of Commerce and Industry chief executive James Pearson said.

In a sharp blow to Mr Morrison, S & P said: "We are more pessimistic about the central government's revenue outlook than the government was in the latest budget projections."

Shadow Treasurer Chris Bowen said S & P had condemned the Coalition for three years of fiscal failure by passing a "vote of no confidence in this government's ability to deal with the budget situation".

"Today is a sombre day for the Australian economy," he said.

Mr Morrison challenged S & P's suggestion that one solution would be to increase overall taxes to reduce the debt.


"You have to be very careful if you increase the tax burden on the Australian economy at such a sensitive time as this," he said. "The idea of 'let's tax the economy more because it will raise more revenue', I think, really is a fairly short-sighted approach in terms of how you grow the economy."

S & P said Australia's budget needed to be stronger than other AAA-rated countries, and net debt needed to stay lower.

"This is because Australia's economy carries a high level of net external debt," the agency said.

It said several ratios highlighted this weakness, including the fact that the level of offshore public and banking sector debt was more than three times receipts from the current account.

"Australia's 2016 gross external financing requirement of $US630 billion is over half of GDP," it said.