DBRS Confirms Government of Canada at AAA and R-1 (high)

DBRS has today confirmed the Long-Term Local Currency and Long-Term Foreign Currency Issuer Ratings of the Government of Canada (the Government or Canada) at AAA, along with the Short-Term Foreign Currency and Short-Term Local Currency Issuer Ratings, both at R-1 (high). The trends on all ratings remain Stable.

Canada’s Stable trend is supported by the steady progress made toward fiscal recovery from the global financial crisis, efforts to reduce public debt and the soundness of the financial sector. In addition, as a result of an improved outlook for the U.S. economy, downside risks appear to be less pronounced than a year ago, with real gross domestic product (GDP) forecast in the budget to grow by 2.3% and 2.5% in 2014 and 2015, respectively. At the general government level, Canada’s fiscal balance has been on an improving trend for the past four years and general government gross debt appears to have peaked around 89% of GDP. For the central government, fiscal balance is expected to be restored by 2015-16, or possibly earlier, and central government gross debt is already on a declining trend. As a result, DBRS believes Canada has ample flexibility to address unforeseen fiscal challenges without causing a significant deterioration in its strong credit profile.

Canada’s credit profile could come under pressure if financial sector vulnerabilities were to increase significantly, triggered by imbalances in the housing market due a combination of increased unemployment, notably higher interest rates and a severe downturn in housing prices that results in a significant burden on the public sector. However, this risk is reduced by recent macro-prudential measures to tighten mortgage lending, which have slowed the growth in household borrowing and reduced the risk of an abrupt decline in house prices.

At 89% of GDP in 2013-14, Canada’s general government gross debt is high. Nevertheless, a prudent fiscal policy and good debt management have resulted in placing the debt ratio on a firm downward path. The Government maintains a thorough budgeting process with economic assumptions that are based on a survey of private-sector forecasters and incorporate an element of prudence through a below-average forecast for nominal GDP. Furthermore, owing to steady debt reduction through the late 1990s and early 2000s, Canada’s debt burden remains manageable despite the increase during the global financial crisis, and compares favourably with G7 peers. The Government actively pursues a predetermined debt structure and well-distributed maturity profile in order to reduce refinancing risk and minimize interest costs. An effort is also being made to ensure that the market for Government benchmark debt continues to be well functioning and liquid, which will require careful management as borrowing needs gradually decline. The Government has implemented a prudent plan aimed at maintaining liquidity at levels sufficient to cover at least one month of projected cash flows, including debt service requirements.

Throughout the most recent downturn, a relatively sound financial system allowed the Government to focus more on precautionary measures to preserve confidence during the financial crisis, rather than directly intervening to bail out financial institutions as was required in other countries. This strength has been recognized by the World Economic Forum, which has ranked Canada’s banking system as the soundest in the world for six years running.

However, a long period of accommodative monetary policy has enticed Canadian households to assume a steadily increasing debt burden, as measured by household debt-to-disposable income. This has contributed to an increase in average house prices, which are up 150% since 2000. Since consumption accounts for nearly 55% of Canadian economic activity, this poses risks to the broader economy should household spending become squeezed as interest rates rise. Encouragingly, household debt-to-disposable income has begun to moderate, declining in the most recent two quarters, partly due to slowing growth in consumer spending.

While not overly large (12% of GDP in 2013-14), unfunded pension liabilities of the federal public sector, along with the non-pension employee future benefits, represent a future strain on Government finances and have the potential to increase central government debt.

Over the past two decades, Canada’s productivity growth has underperformed both the United States and many other Organisation for Economic Co-operation and Development (OECD) countries. This has slowed the rate of growth in potential output and, consequently, Canada’s standard of living. Additionally, the emergence of developing economies pursuing export-led growth strategies presents a significant competitive challenge to the Canadian manufacturing sector – a challenge that is felt disproportionately in certain provinces. Lower labour and production costs have led to the dislocation of labour-intensive industries, such as textiles, and the relocation of factories and jobs from Canada to abroad.

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

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