DBRS Comments on 2015 Alberta Budget: Confronting Fiscal Reality; Ambitious Plan

DBRS Limited (DBRS) today notes the Province of Alberta (the Province or Alberta; rated AAA and R-1 (high) with Stable trends) introduced its much-anticipated 2015 budget on March 26, 2015, outlining a new long-term fiscal strategy as the Province adjusts to an environment of lower energy prices. The plan presents ambitious efforts to curtail spending growth, and introduces a number of new revenue measures with the objective of restoring fiscal balance by 2017-18. In addition, the Province retains considerable flexibility to raise revenues, if required, to limit erosion in fiscal performance if resource prices do not recover as planned, or spending restraint proves too difficult to implement. Furthermore, significant capital investment will continue to drive debt growth, although DBRS acknowledges the considerable financial flexibility afforded to Alberta given its low debt burden.

For 2014-15, the budget points to a small surplus of $248 million. On a DBRS-adjusted basis, after recognizing capital costs as incurred rather than as amortized, this equates to a shortfall of $2.1 billion, or 0.6% of GDP. Encouragingly, total DBRS-adjusted revenues are estimated to have grown by 2.8% year over year, as higher tax receipts and federal transfers have more than offset the impact of lower resource royalties from a deterioration in oil prices. Expenditure growth is estimated to have outpaced revenues, rising by 3.6% with increases experienced across all major program areas.

For 2015-16, the budget projects a deficit of $5.0 billion. On a DBRS-adjusted basis, this translates into a shortfall of $8.2 billion, or a sizable 2.5% of GDP. Total revenues are forecast to decline by more than 11.0%, driven by a significant reduction in non-renewable resource revenues, and weakness in corporate income tax receipts and investment income. Revenue projections are based on USD 55/barrel WTI in 2015-16, rising to USD 63/barrel in 2016-17 and USD 75/barrel by 2017-18. A USD 1/barrel change in WTI is estimated to have an impact on the fiscal plan of roughly $148 million. This compares to a sensitivity of $215 million in last year’s plan, highlighting reduced fiscal sensitivity at lower prices and a weaker Canadian dollar.

To combat weak resource royalties and reduce its reliance on this volatile revenue source, Alberta has announced plans to introduce new tax measures, despite a historical reluctance to do so. These include a new health care contribution levy beginning July 1, 2015; two new personal income tax brackets beginning January 1, 2016 – one for those earning greater than $100,000, and another temporary one for those earning more than $250,000; increased taxes for tobacco, liquor and fuel, as well as higher traffic fines; and implementing a user pay model by increasing fees for vehicle registrations, parks and land title registrations. In total, these new revenue measures are expected to generate $1.5 billion in 2015-16. In addition, DBRS notes that Alberta maintains the lowest tax burden of all provinces and has considerable flexibility to raise taxes further if necessary, to ensure adherence to fiscal targets.

By far the most ambitious part of the Province’s plan is the desire to hold the line on program spending for the coming three years, especially when considering Alberta’s track record of lax spending control. After adjusting for capital expenditures, total DBRS-adjusted spending is budgeted to grow by less than 1.0% in 2015-16. Ministries will generally be required to absorb cost pressures related to population growth, salary increases and inflation within existing budgets. In fact, Alberta is even targeting a reduction in health care spending of $160 million in 2015-16, partly driven by efforts to minimize labour costs through better workforce management, reduced overtime and fewer non-clinical staff. Meanwhile, education will see a modest increase as a result of existing labour agreements, although rising enrolment will not be funded, which will result in larger class sizes. The government has indicated that it will honour all existing collective agreements, but restraint measures will result in a reduction of more than 2,000 FTEs, or approximately 1.0% of the workforce, in 2015-16. A working group is being established to provide recommendations on how to modernize labour negotiations and ensure future settlements are consistent with fiscal objectives.

Over the medium term, the deficit is projected to decline to $3 billion in 2016-17 before returning to balance in 2017-18. This translates into DBRS-adjusted deficits of 1.7% to 0.5% of GDP. With an estimated balance of $6.5 billion as of March 31, 2015, Alberta will continue to draw on the contingency account to avoid borrowing to fund operations. Furthermore, the 2015 budget lays a framework to begin a gradual reduction of Alberta’s reliance on non-renewable resource royalties to fund operations. Beginning in 2018-19, only 75% of resource royalties will be used to fund program spending. This will be reduced to 50% the following year, with 25% being used to grow the Heritage Fund and 25% to fund debt repayment and rebuild the contingency account. At first blush, this looks encouraging, but DBRS believes it to be a lofty goal.

After being one of the growth leaders among Canadian provinces for the past five years, Alberta is expected to fall to near the bottom of the growth charts in 2015, with real GDP budgeted to grow by just 0.4%. Real GDP growth is expected to remain subdued in 2016 at 1.7% before advancing to 3.0% in 2017. This forecast appears to be roughly in line with the current private sector consensus tracked by DBRS. Slowing investment in the energy sector is the primary factor behind this weaker growth outlook, although a relatively strong outlook for the U.S. economy and weaker Canadian dollar should help to boost demand for real exports.

Based on budget estimates, DBRS-adjusted debt-to-GDP − defined as tax-supported debt plus unfunded pension liabilities, net of heritage fund liquid assets − is forecast to reach 8.0% in 2014-15, up from 6.9% in 2013-14. This was somewhat better than expected by DBRS as a result of strong growth in nominal GDP and lower than planned capital-related borrowing. Based on the medium-term forecast, debt-to-GDP is now expected to peak around 11.0% by 2017-18. This is higher than the 9.0% peak anticipated last year, but is by far the lowest debt burden among all provinces and should continue to remain manageable within existing ratings.

The above noted projections on a DBRS-adjusted basis are based on high-level estimates, but will be refined as part of DBRS’s detailed annual review. Although an election is not required until May 2016, it is widely anticipated that the governing Progressive Conservative Party, led by Jim Prentice, will call an election early and campaign on the basis of the newly tabled budget. Should an election occur prior to the budget being passed, DBRS will wait to complete its annual review until after the election and a subsequent budget is introduced.

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.

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