DBRS Comments on 2012 Ontario Budget: Encouraging but Ambitious

DBRS notes that the Province of Ontario (the Province or Ontario; rated AA (low)) presented its 2012 budget yesterday afternoon. The highly anticipated fiscal plan is encouraging, as it reiterates the Province’s objective to return to balance by 2017-18, maintains the deficit and debt projections for the years to come, and finally sheds more light on the strategy to be used to restore fiscal sustainability. However, the plan continues to rely on some bold assumptions, especially with respect to future growth in public sector compensation and health-care costs. In DBRS’s view, this entails considerable implementation risk and is expected to test the resolve of the government.

According to the budget, the Province is expected to end 2011-12 with a deficit of $15.3 billion, or $1 billion better than budgeted, owing primarily to lower-than-expected program spending and debt-servicing costs and the fact that the $700 million reserve was not needed. On a DBRS-adjusted basis, this should translate into a shortfall of approximately $23 billion, or 3.6% of GDP, still the largest imbalance of all provinces. Despite weaker growth prospects relative to what was anticipated a year ago, deficit projections for the years to come remain consistent with the prior year’s plan. This includes a shortfall of $15.2 billion for 2012-13, or $21 billion on a DBRS-adjusted basis, with downward revisions to tax collection offset by new expenditure restraint and revenue measures.

Annual expense growth is projected to be contained to 1.5% through 2014-15, with much of the new funding earmarked for health care, education and social services. Most other programs will see their funding kept stable or reduced. The budget provides no funding for salary increases under new collective agreements, which will affect all major public employee groups, and caps annual health-care cost growth to 2.1% with the help of a major reform of the sector involving, among other things, a shift to patient-centered funding, greater focus on community-based service delivery, income-testing of the drug program for high-income seniors and no compensation adjustment for doctors. Other key initiatives identified to contain spending include reforming public pension plans to enhance sustainability and reduce pressure on employer contributions, delaying or cancelling more than $3 billion in capital projects over six years to reduce debt needs, and increasing efficiency in the education sector, in part through the amalgamation of school boards and underutilized sites.

Total revenue is projected to grow at a decent pace, averaging 3.5% over the forecast horizon. This will be mainly driven by slow though improving economic growth and rising corporate profits, as well as by the deferral of previously planned cuts to the corporate income tax and business education tax rates until fiscal balance is restored. Sustained growth in federal transfers, efficiency gains required from major government agencies and broad-based increases in user fees closer to full cost recovery are also expected to support revenues. The budget assumes real GDP growth of 1.7% in 2012, 2.2% in 2013 and 2.4% in 2014. This is slightly below the private sector consensus, although DBRS notes that the outlook still entails unusually high downside risk owing to the strong Canadian dollar and the fiscal challenges faced in the United States and Europe.

With the fiscal outlook unchanged, tax-supported debt appears likely to follow a trajectory similar to that highlighted last year. Slower economic growth anticipated in the years ahead will translate into slightly higher debt-to-GDP but the ratio is still expected by DBRS to peak around 45% by 2014-15, barring significant fiscal or economic slippage. This level remains below the peak of 50% foreseen when Ontario first introduced its fiscal recovery plan.

Overall, DBRS views the continuation of the fiscal recovery plan and the increasing emphasis on cost containment as an encouraging step in the right direction. However, the budget has yet to receive legislative approval. More importantly, the hardest part of the recovery plan – that is, its implementation – still lies ahead. In particular, achieving the salary freezes targeted in the budget and sharply curtailing growth in health-care costs amid significant demand pressure will require considerable effort from the government, whose track record on discipline has been mixed since the beginning of its fiscal woes.

This commentary will be followed by a formal in-depth review of the Province and publication of a full report on the credit within the next three to four weeks. If you are interested in receiving this report, 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.