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

DBRS Limited (DBRS) has confirmed the Long-Term Local and Foreign Currency Issuer Ratings of the Government of Canada (the Government or Canada) at AAA as well as its Short-Term Local and Foreign Currency Issuer Ratings at R-1 (high). The trend on all ratings is Stable.

The Stable trend reflects DBRS’s view that the challenges facing Canada are manageable. A severe downturn in commodity prices has negatively affected economic growth projections and is contributing to a notable slowdown in business investment. Prolonged weakness in energy prices may represent a more structural downturn in global energy markets and could pose challenges for Canada’s longer-term growth prospects. If this environment persists, it is likely to have a more lasting negative impact on the resource-intensive regions, but will also have spillover effects on the broader economy; however, this is partly mitigated by an improving economic outlook for Canada’s biggest trading partner, the United States, and a notable depreciation of the Canadian dollar versus the U.S. dollar. Furthermore, at the general government level, Canada’s fiscal balance has shown improvement for four consecutive years, and general government debt peaked at 88% of gross domestic product (GDP) in 2012 and appears to be headed on a gradual downward path. For the central government, a small fiscal surplus was recently reported for the year ended March 31, 2015, and central government gross debt has also begun to moderate. As such, this provides Canada with ample flexibility to address unforeseen fiscal challenges without causing a significant deterioration in its credit profile.

Canada’s credit profile could come under pressure should weak energy prices result in a prolonged period of lower economic growth that leads to a material deterioration in fiscal performance and rising debt. Furthermore, if financial-sector vulnerabilities were to increase significantly, triggered by imbalances in the housing market caused by a combination of increased unemployment, higher interest rates and a severe downturn in housing prices, this could also negatively affect the credit profile.

At 87% of GDP in 2014, Canada’s general government gross debt is high. Nevertheless, a prudent fiscal policy and good debt management have placed the debt ratio on a gradual 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. This buffer has been reduced from previous years, however. Furthermore, Canada’s general government gross debt burden compares favourably with G7 peers, and on a net debt basis, is the lowest among the group. The Government actively pursues a predetermined debt structure and well-distributed maturity profile 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 prudential liquidity plan aimed at maintaining liquidity at levels sufficient to cover at least one month of projected cash flows, including debt service requirements.

The ratings are also supported by Canada’s resilient financial system, which continues to be recognized by the World Economic Forum as the soundest in the world. As a result, this allowed the Government to focus more on precautionary measures to preserve confidence during the 2008-09 financial crisis rather than directly intervening to bail out financial institutions as was required in other countries.

However, the rapid decline in commodity prices, particularly oil, poses challenges for the Canadian economy and has led to a notable decline in investment across the oil and gas sector. This, in turn, has led to a reduction in growth expectations and has put pressure on other sectors to support growth, notably in the service sector.

A long period of accommodative monetary policy has induced Canadian households to assume a steadily increasing debt burden as measured by household debt-to-disposable income. This has only been amplified by recent reductions in borrowing costs and slowing income growth. This has contributed to an increase in average house prices, which are up by almost 80% since 2005. 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. This is somewhat mitigated by the high level of household assets as household net worth represents 768% of disposable income.

Over the past two decades, Canada’s productivity growth has underperformed both the United States and many other Organization for Economic Co-operation and Development 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 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.

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

The applicable methodology is Rating Sovereign Governments (October 2014), which can be found on our website under Methodologies.

The full report providing additional analytical detail is available by clicking on the link under Related Research at the right of the screen or by contacting us at info@dbrs.com.

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