S&P Global Ratings has warned the big banks are undermining Australia's ability to hold on to its prized AAA rating.

Key points: Moritz Kraemer says Australia's massive level of external debt is a sticking point for its credit rating

Moritz Kraemer says Australia's massive level of external debt is a sticking point for its credit rating Australia needs to be prepared for downside shocks, such as a hard-landing in China, he says

Australia needs to be prepared for downside shocks, such as a hard-landing in China, he says Economist Willem Buiter warns Australia faces prospect of recession as early as next year

In an exclusive interview with The Business, chief ratings officer Moritz Kraemer pointed to Australia's massive level of external debt, rather than a housing price bubble or budget repair, as the real sticking point in recent deliberations over the credit rating.

S&P kept the Government on tenterhooks for a week after the recent federal budget before reaffirming its top credit rating, despite rival agencies Moody's and Fitch issuing statements almost immediately after the Treasurer's speech.

"Through the banking system, Australia has accumulated a lot of external debt and that's the result of many years of large external current account deficits," Mr Kraemer said.

"Among the AAA rated — the top notch rated sovereigns, of which there are only 12 left in the world — Australia is the only country with a large external debt.

"Actually I will go further and say it's the only AAA sovereign which has any net external debt. This is a clear outlier and a weakness of the credit profile of the country."

Australian foreign debt last year surged through the $1 trillion mark, with most of it racked up by Australia's banks on offshore wholesale credit markets to partly fund the real estate spending spree that has sent property prices surging in Sydney, Melbourne and Brisbane.

Mr Kraemer argued that in order to offset that, Australia needed a very strong government balance sheet.

"The global financial crisis taught us that a significant run up in debt puts economies and financial systems at risk," he said.

Given Australia was one of the developed world's most trade exposed nations — with most trade with just one country — Mr Kraemer said it needed to be prepared for downside shocks, such as a hard-landing in China.

Kraemer doubts government's budget forecasts

When asked whether he believed the rhetoric from the banks and politicians that Australia's banks are the strongest in the world, given the external debt levels, he had a simple answer: "No."

"Not at all, because we have a AAA rating on Australia," he said.

"But we have a negative outlook, meaning that we think that the probability of the rating going down is at least one in three."

While a growing chorus of analysts and economists have expressed alarm at the state of the east coast housing market, Mr Kraemer delivered a more sanguine assessment while noting immediate action was required to bring it under control.

"The longer this goes on the higher the risk of a disorderly adjustment," he said.

"Right now I think it's still very much within control of the authorities and the banks to generate the soft landing but there's so many examples of asset bubbles and usually it doesn't end in a gradual process."

In another blow to Treasurer Scott Morrison, Mr Kraemer also cast doubts on the optimistic forecasts contained in the recent budget, which indicate a return to surplus in 2021.

"We would be positively surprised if the Government's projections really came true," he said.

A raft of problems facing Australia

Sorry, this video has expired 'Never seen a house bubble like the one in Australia that didn't end in a bust,' Willem Buiter says.

In another bleak assessment of the nation's fortunes, Citi's chief global economist Willem Buiter warned Australia faces the prospect of a recession as early as next year — largely driven by a slowdown in China.

Mr Buiter pointed to a raft of problems facing Australia — including high levels of household debt, an out of control property market and the prospect of a China slowdown.

Agreeing with Mr Kraemer's assessment of China, Mr Buiter said that any slowdown in China — even a mild one — would have serious repercussions for Australia.

China's debt levels sit around 278 per cent of GDP, far surpassing Greece, and although it holds more than $US3 trillion in reserves, it has been running them down rapidly as it attempts to shore up its currency and avoid a capital flight.

"No country has ever had a debt problem at the level of debt to GDP and the increase since 2008 and an excess capacity problem to the magnitude that China has, and been able to work its way out without at least a cyclical downturn," he said.

"It's never been done."

Dr Buiter expects the current slowing in growth to accelerate in 2018 into a cyclical downturn.

That, in turn, will lead to declining commodity prices and national income for Australia.

"You will experience an externally driven slowdown in late 2018 early 2019," he said.

Given the Reserve Bank has little firepower left, with official interest rates at record lows of 1.5 per cent, Mr Buiter argued the Federal Government would need to fill the breech with a range of infrastructure projects.

"You need a long list at a federal, state and local government level of shovel ready projects and that apparently has not yet been achieved unfortunately," he said.

But he disagreed with Mr Kraemer's view on the Australian housing market.

"Nothing is inevitable but I have never seen a housing bubble and household leverage boom like the one in Australia, or indeed Canada, that did not end in a bust," he said.