DBRS Confirms Province of Ontario at AA (low) and R-1 (middle), Stable Trend

DBRS has today confirmed the long and short-term debt ratings of the Province of Ontario (Ontario or the Province) at AA (low) and R-1 (middle), both with a Stable trend. 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, as demonstrated by the recent budget negotiations, the political environment remains fragile and DBRS believes that implementing the tough measures required to achieve fiscal targets and limit debt growth will be very challenging and will require a significant pickup in fiscal resolve.

Based on preliminary results, the Province recorded a deficit of $15.0 billion in 2011-12. This equates to a shortfall of $22.1 billion, or 3.5% of GDP, on a DBRS-adjusted basis after including capital expenditures as incurred rather than as amortized. In 2012-13, Ontario is forecasting a shortfall of $14.8 billion, or $20.7 billion as calculated by DBRS. The budget reiterates the Province’s objective to return to balance by 2017-18, 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 health care costs and public sector compensation, an area that will be watched closely as most major labour agreements will be up for renewal in the coming months. DBRS notes that the government has cleared its first hurdle with the budget vote being passed on April 24, 2012, after agreeing to impose a new surtax on high-income individuals and other modest budget amendments. The new surtax did not come as a surprise for DBRS, which believes further tax measures may be necessary should growth weaken, if certain spending targets prove too ambitious or to appease the opposition, given the government’s minority position.

For 2012, the budget assumes real GDP growth of 1.7% which is somewhat below the private sector consensus. While growth remains fragile and is expected to lag behind the national average, Ontario should benefit from a gradual strengthening in the U.S. economy and improving net export position. DBRS notes that growth expectations have been notably reduced in relation to last year’s plan. This results in a more balanced economic outlook, although the possibility of a further disruption in global demand, a weak U.S. economy or a strengthening Canadian dollar keep risks skewed to the downside.

Ontario’s debt trajectory remains largely consistent with last year’s plan. In 2011-12, DBRS-adjusted debt is estimated to have grown by 9.3%, resulting in a debt-to-GDP ratio of 39.2%, the third-highest among all provinces. Debt growth is expected to slow in 2012-13, with the debt-to-GDP ratio forecast to reach 41.3% before eventually reaching a peak of somewhat below 45% within the next two to three years. However, DBRS cautions that this is dependent on the Province achieving its fiscal targets, which entail considerable execution risk, especially given the constraints of a minority government.

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.