DBRS Comments on Canada 2014 Budget: Fiscal Balance and Declining Debt Within Reach

DBRS today notes that the Government of Canada (the government; rated AAA and R-1 (high), with Stable trends) unveiled its 2014-15 budget on February 11, 2014, moving one step closer to balance while maintaining a tradition of prudent fiscal stewardship. The government expects to restore balance in 2015-16, if not sooner, and while domestic economic activity remains somewhat soft, an improving external environment, particularly in the U.S., provides promise. As a result, Canada’s debt burden should resume a downward trend, further strengthening an already sound credit profile.

For 2013-14, fiscal projections point to a shortfall of $16.6 billion. This marks an improvement from the $17.9 billion deficit foreseen at the time of the Fall Update, and equates to less than 1.0% of GDP – a very favourable position in relation to G7 peers. A budgetary deficit of $2.9 billion is projected for 2014-15 before turning to a surplus of $6.4 billion in 2015-16. After posting nominal GDP growth of 3.2% in 2013, the budget assumes growth will pick up to 3.9% and 4.5% in 2014 and 2015, respectively. DBRS notes that, consistent with past practice, the government has adjusted downward the private sector average nominal GDP forecast for planning purposes each year of the forecast horizon. This results in a revenue forecast with a prudent $3.0 billion buffer each year, which could be used to absorb any unanticipated pressures or, if not needed, potentially achieve balance in 2014-15 – one year earlier than planned.

Incorporating the revenue buffer noted above, this is expected to translate into revenue growth of 4.7% in 2014-15, and average 4.3% annually between 2015-16 and 2018-19. With the exception of an increase in excise taxes on tobacco and further efforts to combat tax avoidance, the budget is absent of any material revenue changes.

Meanwhile, total expenditures are budgeted to decline slightly in 2014-15 based on a notable reduction in direct program spending that is forecast to more than offset moderate increases in transfers to persons and other levels of government. Starting in 2014-15, departmental spending will be frozen for two years as was previously announced in the Fall Update, which follows reductions implemented in past budgets. DBRS notes that the plan relies in part on the successful renewal of all public sector collective agreements in 2014. The government will be seeking significant concessions from its employees groups in order to implement a new sick leave management system and move to equal cost sharing of post-employment health benefits, while also increasing the minimum years of service required for eligibility. DBRS believes this is likely to be a challenging task and represents a key risk. The deferral of some defense capital dollars until later years will also contribute to a more manageable spending profile. Monies for new initiatives are relatively limited and include apprenticeship grants to support youth and further infrastructure investments. For the remainder of the forecast horizon, total expenditures are projected to grow by an average of 3.9% annually.

As anticipated at the time of DBRS’s last review, Canada’s debt burden appears to have reached an inflection point and reducing debt remains a long-term goal of the government. Gross market debt (the measure tracked by DBRS) is projected to fall by 3.1% to $647 billion by March 31, 2014, resulting in a debt-to-GDP ratio of roughly 35%, down from 37% a year earlier. For 2014-15, market debt is expected to remain relatively flat, pointing to a debt-to-GDP ratio of 34%. Total borrowing requirements are forecast at $232 billion in 2014-2015, comprised almost entirely of refinancing needs. The government plans to continue to reduce refinancing risk by replacing maturing treasury bills with longer-term bonds, which should lengthen the average term to maturity of the debt portfolio. In addition, the issuance of 50-year bonds is being contemplated, after having considered 40-year issuance in the previous budget.

DBRS notes the steady progress made toward fiscal recovery, efforts to reduce debt and the soundness of the financial sector provide considerable support to Canada’s strong credit profile with ample flexibility to address unforeseen challenges.

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

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