DBRS Confirms Province of Ontario; Trends Stable but Limited Flexibility Remains

DBRS has today confirmed the short- and long-term ratings of the Province of Ontario (the Province or Ontario) at R-1 (high) and AA, respectively. All trends remain Stable based on the Province’s moderately low debt burden and diversified economy and DBRS’s belief that the credit profile can weather the downturn as currently forecasted. However, DBRS foresees very challenging times ahead for the credit, as the global recession has led to a particularly marked economic downturn in Ontario and a sharp deterioration in the fiscal outlook and financial position. This will erode credit metrics and may put the ratings at risk in the event of fiscal slippage or a protracted recession.

The extent of the fiscal reversal was revealed in the 2009 budget released in March, which points to annual deficits of 3% to 4% of GDP over the next three years on a DBRS-adjusted basis (including capital expenditures on a pay-as-you-go basis rather than as amortized) owing to lower tax revenues, rising capital spending to stimulate economic activity and sustained cost pressure in social programs. The poor results will translate into debt increases of 8% to 14% over the three-year period, with pressure slowly receding afterward as the Province hopes to gradually return to balance by 2015-16. As a result, debt-to-GDP should jump from 29% at March 31, 2009, to at least 37% by 2012, a level unmatched since Ontario’s tax-and-spend era of the mid-1990s. While potentially manageable within the current ratings, the fiscal plan leaves little room to sustain the unusually high downside risk carried in economic projections, raising the possibility of deficits markedly higher than foreseen and downward pressure on the rating.

Based on the private sector consensus, Ontario will see a 2.4% contraction of its real GDP in 2009, about twice the provincial average, followed by a projected rebound in growth to the 2% range next year. Manufacturing will account for most of the headwinds, with retail sales and residential construction adding to the weakness. This is expected to drive the provincial unemployment rate beyond 9%, up from 6.5% in 2008, and is likely to lead to a slower recovery in 2010 than forecast in the budget.

The crisis faced by the North American auto sector may also dampen the recovery and, in DBRS’s view, constitutes a key risk to the ratings, as a sharp, permanent contraction of the sector would likely have lasting adverse effects on Ontario’s growth prospects. The auto industry directly accounted for 3.7% of Ontario’s GDP in 2008 but undoubtedly has a much larger influence on the provincial economy once all externalities are factored in. Government assistance should help the sector weather the downturn, but considerable uncertainty remains with respect to the extent of the contraction to be experienced by the three Detroit-based automakers, which remain in a precarious position, and Ontario’s ability over the longer term to retain a meaningful portion of U.S.-bound production amidst the growing proficiency of emerging markets.

DBRS intends to review the credit late in the fall in order to assess progress against the fiscal plan and potential changes in economic conditions.

Notes:
The applicable methodology is Rating Canadian Provincial Governments, which can be found on our website under Methodologies.

This is a Corporate (Public Finance) rating.