DBRS Comments on 2015 Ontario Budget: Meeting Expectations and One Step Closer to Balance

DBRS Limited (DBRS) today notes that the Province of Ontario (the Province or Ontario; rated AA (low) and R-1 (middle) with Stable trends) introduced its 2015 budget on April 23, 2015, reiterating its goal of restoring fiscal balance by 2017–18. Supported by a more favourable economic backdrop, and provided spending discipline continues, Ontario’s DBRS-adjusted debt burden (defined as tax-supported debt, including unfunded pension liabilities and local government debt) is expected to peak in 2015–16 at 43.8% of GDP, a slightly lower level than anticipated last year.

Overall, DBRS views the budget as consistent with last year’s plan and potentially manageable for the credit profile. However, due to the notable run-up in debt since the onset of the recession, the Province has yet to restore sufficient flexibility to withstand another economic downturn without negatively impacting the credit profile.

For 2014–15, preliminary results point to a deficit of $10.9 billion, compared to a budgeted shortfall of $12.5 billion. After making adjustments to recognize capital expenditures as incurred rather than as amortized, this equates to a DBRS-adjusted shortfall of approximately $15.9 billion, or 2.2% of GDP, marking the sixth year that Ontario has met or exceeded its fiscal targets. Total revenues are projected to be slightly below plan, largely due to lower than anticipated tax receipts, although this has been offset by lower than planned spending on education, social services and interest costs. Furthermore, strong investment performance and ongoing wage restraint efforts have helped to reduce pension expense, providing further relief.

The deficit is projected to continue on a downward track in 2015–16, to $8.5 billion. On a DBRS-adjusted basis, this equates to roughly $11.7 billion, or 1.6% of GDP. Total revenues are projected to grow by approximately 5.2%. The revenue forecast is based on assumed nominal GDP growth of 4.2%, reflecting Ontario’s reliance on an improving economy. According to the Province’s own fiscal sensitivities, it estimates that a 1.0% decline in nominal GDP could have a negative impact on the revenue forecast by roughly $900 million. DBRS notes that this year’s budget is devoid of any material revenue measures, although the Province has announced plans to introduce a cap-and-trade carbon pricing system which may provide some revenue uplift over the longer term.

Expenditure control remains of paramount importance with DBRS-adjusted spending estimated to grow by just 1.3% in 2015–16. Of the major program areas, social services will see the largest year-over-year increase at 4.7%, reflecting targeted new initiatives, while health and education are projected to experience only 1.2% and 0.6% growth, respectively. There continues to be no additional funding for the renewal of upcoming collective agreements. With compensation costs accounting for the bulk of provincial spending, DBRS believes that maintaining a firm handle on these costs will be key to achieving longer-term fiscal targets. Encouragingly, the Province has been successful in its efforts to negotiate a new agreement with its management employee group (AMAPCEO), which is expected to set a precedent for agreements with other groups. Gross capital spending, the centerpiece of this year’s budget, is forecast to grow by 1.5% to $13.5 billion in 2015–16 and to be funded in part through the government’s asset monetization efforts, including the recently announced sale of up to 60% of Hydro One.

Over the medium term, the fiscal plan calls for a deficit of $4.8 billion in 2016–17, followed by a return to balance in 2017–18, or, on a DBRS-adjusted basis, shortfalls of approximately 1.2% of GDP and 0.6% of GDP, respectively. As a result, the debt-to-GDP ratio is expected to reach a peak of 43.8% in 2015–16 and begin declining in the following two years. This is a slightly lower level than anticipated in last year’s plan.

The budget assumes real GDP growth of 2.7% in 2015, followed by 2.4% in 2016, potentially making Ontario one of the provincial growth leaders. These projections are just slightly below the current private sector consensus, which is consistent with past practices. Strengthening U.S. economic growth and a weaker Canadian dollar provide support to the forecast. Meanwhile, tax cuts at the federal level and lower oil prices could provide a modest boost to consumer spending.

The above noted DBRS projections are based on high-level estimates, but will be refined along with DBRS’s views of the budget over the weeks to come as part of DBRS’s detailed annual review of the Province.

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.