"There is nothing that's presented itself that suggests our banks have an external financing problem. None at all.

"[S & P] made the point that our banking system is arguably one of the strongest in the world."

Despite the Treasurer's remarks, speculation is growing that the spectre of a downgrade will increase pressure on the Reserve Bank of Australia to cut official interest rates in coming months.

In news that initially triggered a sharp fall in the Australian dollar that later unwound, S & P said it had put the nation on notice that there was now a one-in-three chance the rating will be cut within two years if the next Parliament fails to either increase taxes or cut spending enough to curb ballooning deficits and debt.

Crucially for the next Parliament, S & P signalled that its actions over the next 12 months will be make or break for 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."

A downgrade would be the first time Australia has lost its coveted top-notch rating since the 1980s, driving home fears that the nation is failing to use enough of its debt for productivity enhancing investment.


It would also mean the loss of membership to a dwindling club of highly rated countries. Only 14 nations still hold an S & P AAA rating and four are on negative watch – the Netherlands, Germany, Finland and Luxembourg.

"The latest credit rating update from S & P Global Rating is sombre reading for the nation," shadow treasurer Chris Bowen said. "S & P calls out the government on three years of fiscal failure, based on unrealistic budget revenue forecasts and savings measures that will never pass the Parliament."

Mr Morrison said the warning was aimed at the new Parliament over the reality of the budget and global economic environment.

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

Mr Morrison also rejected questions from reporters about whether the S & P statement was the Treasurer's "banana republic moment", a reference to the 1986 current account deficit crisis.

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

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

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


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

It said there are several pointers to "weakness" in the external position.

These included household debt to disposable income of more than 180 per cent, the fact that the level of offshore public and banking sector debt is more than three times income through the current account.

They estimated that Australian governments, businesses and households via the banking sector will need to borrowing the equivalent of $US630 billion this year, or more than half of GDP.

S & P analysts also delivered a sharp rebuke over the property market, saying much of the surge in offshore debt liabilities had been used to fund a rise in "unproductive household borrowing for housing" during the 1990s and 2000s.