DBRS Comments on Ontario Budget: Deterioration Has Slowed but Heavy Lifting Remains

The 2010 budget presented yesterday by the Province of Ontario (the Province or Ontario) reveals that the near-term fiscal outlook has improved modestly relative to last October’s forecast, which may be a signal that the worst is now over. However, DBRS notes that considerable efforts still need to be made in order to restore fiscal balance and limit the pace of debt accumulation. Furthermore, the revised fiscal plan stretches the string of deficits by two years, with a return to balance now foreseen by 2017-18. While this situation is viewed as manageable within the current AA (low) rating, the extended path to recovery leaves the Province susceptible to any unforeseen economic and fiscal challenges along the way.

The Province is now forecasting a deficit of $21.3 billion for the fiscal year about to end, a modest improvement from the $24.7 billion expected in the Fall 2009 Economic Outlook and Fiscal Review. This points to a DBRS-adjusted deficit of approximately $29 billion, or 5.1% of GDP (after adjusting for capital expenditures on a pay-as-you-go basis rather than as amortized). The medium-term plan calls for deficits ranging between $16 billion and $20 billion over the next three years, which translates into DBRS-adjusted deficits of $24 billion to $28 billion, or approximately 4% to 5% of GDP, and highlights the considerable debt pressures that lie ahead. The Province does not expect to achieve fiscal balance until 2017-18 – two years later than what was indicated in last year’s budget and the slowest recovery plan of all Canadian provinces so far.

After a difficult year in 2009-10, revenues, as reported by the Province, are expected to grow by over 10% in 2010-11, driven by a combination of higher federal transfers and tax revenue. Growth in federal transfers reflects additional infrastructure funding, equalization payments and transition funding as part of Ontario’s move to implement the harmonized sales tax (HST). Corporate income and sales tax receipts will be the primary drivers on the tax side, benefiting from improving economic conditions and the introduction of the HST.

Total expenditures, on the Province’s basis, are expected to rise by close to 7% in 2010-11 before declining in 2011-12 as stimulus measures expire. Health and education will continue to command the bulk of additional funds, while a larger debt portfolio and rising interest rates will drive up interest expense. In the years ahead, the Province aims to contain overall program spending growth to around 2% per year, in part by holding the line on compensation and limiting health-care spending increases to a meager 3%, which is likely to be challenging given the steady upward trend observed in health budgets of all provinces in recent years. DBRS notes that the budget forecast includes a reserve of $0.7 billion for 2010-11, growing to $1.0 billion annually for the remainder of the forecast horizon. This represents a smaller reserve than what was included in last year’s budget but is consistent with reduced uncertainty in the economic outlook.

Real GDP is assumed to grow by 2.7% in 2010, followed by growth of 3.0% to 3.2% through 2011 to 2013, consistent with the private sector consensus. Due to Ontario’s reliance on manufacturing and export-oriented sectors, the Province’s growth pattern will rely heavily on a recovery in U.S. economic activity. A 1.0% reduction in provincial GDP growth is estimated to result in a $750 million revenue shortfall.

Fuelled by the large deficit and capital program, total debt is expected to have risen by 21% in 2009-10 to $208 billion. This will bring the debt-to-GDP ratio up to 36.7%, consistent with DBRS’s expectations. Over the next three years, the debt-to-GDP ratio is expected to continue rising steadily, reaching approximately 44% by 2012-13. Although in line with the forecast presented last October, this level is well in excess of the previous highs reached in the 1990s and highlights the slow pace at which Ontario aims to realign revenues and expenditures. The Province has announced that some capital projects may be delayed and others revisited, which could help to dampen debt growth over the forecast horizon.

Overall, DBRS views the current plan as manageable within the AA (low) rating of the Province. Although the fiscal outlook remains weak and maintains pressure on the debt profile, some of the downside risks prevalent at the last rating review have subsided, which should be supportive of a gradual improvement in fiscal results. Nevertheless, the recovery plan does rely on ambitious assumptions with respect to expenditure growth and compensation costs. As such, stronger fiscal resolve will likely be required over the years to come in order to adhere to the current plan and bring the Province back to a sustainable fiscal position.

This commentary will be followed by a formal in-depth review of the Province and the publication of a full report on the credit within the next four to five weeks. If you are interested in receiving this report, please contact us at info@dbrs.com.

Notes:
All figures are in Canadian dollars unless otherwise noted.

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

This is a Corporate (Public Finance) rating.