DBRS Comments on Alberta’s October 2015 Budget: Rising Debt Exhausting Flexibility

DBRS Limited (DBRS) today notes that the Province of Alberta (the Province or Alberta; rated AAA and R-1 (high) with Stable trends) introduced a new budget on October 27, 2015 — the first budget under the newly elected New Democratic Party government. The Province now plans to return to fiscal balance by 2019–20, two years later than planned by the previous government in its March 2015 budget (see DBRS Comments on 2015 Alberta Budget: Confronting Fiscal Reality; Ambitious Plan; March 27, 2015). As presented, the plan exhausts flexibility within the current ratings. As was first noted by DBRS in 2013, continued worsening of the debt outlook to the point where the debt-to-gross domestic product (GDP) ratio could remain above 15% for an extended period would put downward pressure on the ratings. The current plan is based on a recovery in oil prices and containing spending, which has yet to be proven.

For 2015–16, the budget points to a deficit of $6.1 billion compared to $5.0 billion at the time of the March budget. On a DBRS-adjusted basis, after recognizing capital costs as incurred rather than as amortized, this equates to a shortfall of approximately $10.0 billion, or 3.0% of GDP — the second largest fiscal gap among all provinces. Over the medium term, the deficit is projected to decline to $5.4 billion in 2016–17, $4.4 billion in 2017–18, $2.1 billion in 2018–19 before returning to a small surplus in 2019–20. This translates into DBRS-adjusted deficits of roughly 2.8% to 0.8% of GDP.

In the plan, revenue is projected to grow in the mid-single digits year over year with contributions from non-renewable resource revenues, income tax receipts and other sources. Revenue projections are now based on USD 50/barrel WTI in 2015–16, rising to USD 61/barrel in 2016–17 and USD 68/barrel in 2017–18. A USD 1/barrel change in WTI is estimated to impact the fiscal plan by approximately $170 million. As oil prices have remained weak, a significant decline in non-renewable resource revenues will contribute to a more than 11% decline in total revenues in 2015–16 from the prior year, while corporate income tax receipts and investment income will also see declines.

As was first announced in June 2015, the Province is moving forward with new revenue measures to offset the decline in resource royalties. These include: (1) raising the general corporate income tax rate to 12%, from 10%, beginning July 1, 2015; (2) replacing the flat personal income tax regime with a more progressive structure comprised of five tax brackets beginning October 1, 2015; and (3) raising tobacco taxes and alcohol mark-ups. In total, new revenue measures are projected to generate $1.5 billion in additional revenues in 2015–16 and $2.3 billion on a full-year basis. Despite the increases, Alberta’s tax regime remains very competitive and the Province has considerable capacity to raise taxes further, if willing.

As part of the plan, the Province aims to contain consolidated expenditure growth to just over 2% although the majority of effort appears to be deferred until the outer years. This includes bringing the annual growth rate in health-care expenditures down to just 2% by 2018–19. Achieving these targets will be highly dependent on containing the growth rate in public sector compensation, which the Province has budgeted to grow by an average 2.5%. DBRS believes this to be an ambitious target when viewed in relation to the combined rate of population growth and inflation, historical DBRS-adjusted average spending increases of 6% to 7% over the past ten years and the more recent steps to reverse cuts to health and education funding that had been announced by the previous government.

Real GDP is budgeted to contract by 1.0% in 2015 followed by a modest recovery to 0.9% in 2016, which compares to the current private sector consensus tracked by DBRS of -1.2% and 1.0% for 2015 and 2016, respectively. This marks a significant reversal from past years as Alberta’s real GDP growth is now expected to trail the national average. To help partially insulate the provincial economy from slowing investment in the energy sector, the Province plans to increase its five-year capital program by $4.5 billion, or approximately 15%, relative to the prior plan.

Based on budget estimates, DBRS-adjusted debt — defined as tax-supported debt plus unfunded pension liabilities, net of heritage fund liquid assets — is forecast to rise by almost 25% in 2015–16, pushing the debt-to-GDP ratio to 10.0%, up from 7.3% in 2014–15. Ongoing fiscal deficits and an elevated capital plan will continue to pressure debt needs over the medium term. As a result, the debt-to-GDP ratio is projected to reach approximately 14.0% by 2017–18 and peak at just under 15% in the outer two years of the fiscal plan based on our preliminary views. The above-noted projections are based on high-level estimates, but will be refined as part of DBRS’s detailed annual review in the coming weeks.

As was first noted by DBRS in 2013, continued worsening of the debt outlook to the point where the debt-to-GDP ratio could remain above 15% for an extended period would put downward pressure on the ratings. This could arise from a combination of factors including: oil prices remaining near their current level without any offsetting fiscal measures, difficulty in achieving slower expenditure growth, unforeseen economic shocks or a combination of any of the above.

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.

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