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

DBRS has today confirmed the Issuer Rating of the Province of Ontario (Ontario or the Province) at AA (low), along with its Long-Term Debt and Short-Term Debt at AA (low) and R-1 (middle), respectively. The trend on all ratings remains Stable, supported by five consecutive years of lower-than-expected deficits, which has helped to limit erosion in the credit profile relative to the original expectations established when the long fiscal recovery plan was first introduced in 2010. Following the election on June 12, 2014, which saw the Ontario Liberal Party achieve a majority government, Ontario has kept intact its plan to return to balance by 2017-18. However, DBRS acknowledges that the medium-term outlook has somewhat weakened since last year, owing to a combination of slightly lower revenues and higher program spending projections, raising doubts that the government will have the fortitude to make the difficult decisions required to adhere to its original targets. Any material slippage may cause DBRS to question the government’s commitment to fiscal discipline and could have negative implications for the ratings.

For 2013-14, preliminary results point to a deficit of $11.3 billion. This equates to a DBRS-adjusted shortfall of $16.1 billion, or 2.3% of GDP, which marks an improvement from the $17.6 billion deficit anticipated at the time of last year’s review. Lower-than-planned revenues were partly offset by underspending across a handful of program areas and by use of the contingency reserve. In addition, lower-than-planned capital spending helped to reduce debt needs. Ontario’s DBRS-adjusted debt (defined as tax-supported debt plus unfunded pension liabilities) continued to grow at a moderate pace, amounting to 5.3% down from 9.5% in 2012-13. As a result, debt reached $298.1 billion at March 31, 2014, pushing the debt-to-GDP ratio up to 43.1% from 42.0% the year before. This remains the second-highest debt burden among provinces.

Ontario’s economic fortunes look brighter in the years ahead, with real GDP budgeted to grow by 2.1% in 2014 followed by 2.5% in 2015. These projections are in line with the current private sector consensus. An improving trade position is expected to be the biggest contributor to growth over the coming years, although this is likely to be partially offset by continued fiscal restraint across all levels of government.

DBRS notes that the 2014 Ontario budget first introduced on May 1, 2014, and re-tabled on July 14, 2014, has kept intact the plan to return to balance by 2017-18. For 2014-15, the deficit is projected to widen to $12.5 billion. On a DBRS-adjusted basis, this would represent a shortfall of $17.2 billion, or 2.4% of GDP. Total DBRS-adjusted revenues are projected to increase by 3.2% based on assumed modest growth in nominal GDP. A number of small tax measures are being implemented to offset the impact of a soft economic growth outlook. Achieving spending targets will continue to present the biggest challenge going forward as overall program spending is forecast to be virtually unchanged over the coming four years. In particular, there are no provisions for increases in public sector compensation costs, meaning any changes will need to be offset through efficiency and productivity gains within existing funding envelopes -- a difficult task, especially in light of the Premier’s statement that the government will not legislate contracts. Over the medium term, the fiscal plan calls for deficits of $8.9 billion in 2015-16 and $5.3 billion in 2016-17, followed by a return to balance in 2017-18. On a DBRS-adjusted basis, this represents deficits ranging between 1.8% of GDP to 0.6% of GDP. As a result, debt-to-GDP is expected to stabilize around 44%. This peak is marginally above what was expected last year, but meaningfully below the peak of almost 50% anticipated when the Province’s rating was downgraded in 2009. Overall, while the recent erosion in fiscal outlook is manageable, the Province remains vulnerable given the extent of fiscal effort needed amidst below-potential economic conditions. This remains a concern for DBRS and highlights the risk of stretching the return to balance over an extended period of time and relying on improving economic conditions to restore fiscal soundness.

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

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodologies are Rating Canadian Provincial Governments and Rating Agents of the Crown, which can be found on our website under Methodologies.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.