DBRS Comments on 2014 New Brunswick Budget: Limited Room Left for Further Erosion

DBRS notes that the Province of New Brunswick (the Province or New Brunswick; rated A (high) with a Stable trend) kicked off the provincial budget season with its 2014 budget on February 4, 2014, which calls for a slow and protracted path back to balance by 2017-18. Although last year’s budget incorporated no firm time commitment to restore balance, the plan presented in 2012-13 did point to a balanced budget by 2014-15. DBRS was aware that some slippage had been incurred in light of weak economic performance but did not expect the full extent of deterioration revealed in yesterday’s budget. As a result, the revised fiscal targets raise the possibility of as much as $400 million to $500 million in additional debt over the next four fiscal years, which was not factored into last year’s rating review. While the revised outlook is potentially manageable for the credit profile, DBRS remains concerned that continued sluggish economic growth for an extended period of time or weakening fiscal resolve could push credit metrics to levels no longer consistent with the current ratings.

According to the budget, the Province is expected to record a deficit of $564 million in 2013-14, a notable deterioration from the $479 million shortfall originally projected. On a DBRS-adjusted basis, this translates into a shortfall of $607 million, or 1.9% of GDP, potentially the fourth-largest fiscal gap among provinces. Economic growth has remained stubbornly weak in New Brunswick, with nominal GDP estimated to have grown by just 0.5% in 2013. As a result, personal income tax and sales tax receipts along with lower earnings at New Brunswick Power Holding Corporation are expected to be the primary drivers of lower revenues. Encouragingly, the Province has shown considerable success at containing expenditures below budget in 2013-14, but efforts have not been sufficient to fully offset the revenue shortfall.

For 2014-15, the budget points to a deficit of $391 million. This represents a DBRS-adjusted shortfall of $530.6 million, or 1.7% of GDP, exceeding the deficit of roughly 1% of GDP anticipated at the time of DBRS’s last review. The government is becoming increasingly mindful of the impact that additional austerity measures would have on the economy. As such, no new tax increases or spending reduction efforts are being implemented beyond those already underway. However, continuous improvement and performance excellence initiatives aimed at finding further efficiencies in program delivery will proceed. New Brunswick is continuing with its efforts to manage labour costs through attrition, reduced use of sick leave and pension reform.

Deficits are projected to gradually decline, with an eventual surplus of $119 million forecast in 2017-18. DBRS notes that the fiscal plan is based on identifying further cost savings or increased revenues over the forecast horizon. Starting in 2015-16, $125 million in additional measures will be required, rising to a cumulative $300 million by 2017-18. At more than 3% of total revenues in the final year of the plan, the measures are not insignificant and present considerable execution risk, especially if economic growth continues to disappoint.

The budget assumes real GDP growth of 1.1% in 2014, following anemic growth in 2012 and 2013, which appears to be conservative relative to the private sector consensus. However, for 2015, the Province’s real growth forecast of 2.1% is above consensus, potentially posing a risk to fiscal targets. A weakening Canadian dollar and improving U.S. economic outlook should be supportive of stronger export performance, although this may not be sufficient to offset a very weak domestic economy.

Based on the revised fiscal forecasts, DBRS-adjusted debt is estimated to have risen by 5% in 2013-14 to $12.5 billion. As a result of Statistics Canada’s downward revisions to historical GDP figures in December 2013 combined with very slow nominal GDP growth in 2013, debt-to-GDP is forecast to reach almost 40% at March 31, 2014. The Province’s debt burden is expected to peak around 41% in 2015-16. This exceeds the peak at the time of last year’s review and, more importantly, is well above pre-recession levels of less than 30%. As a result, even if the Province successfully executes its fiscal recovery plan as currently envisioned, DBRS believes little flexibility will be left within the current rating for further erosion. Additional fiscal slippage pushing the debt-to-GDP ratio toward 45% would be cause for concern for DBRS and could result in downward pressure on the rating.

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 four to six 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.