DBRS Comments on 2016 Ontario Budget: Economic Momentum Keeps Fiscal Plan on Track

DBRS Limited (DBRS) today notes that, in its 2016 budget released on February 25, 2016, the Province of Ontario (the Province of Ontario; rated AA (low) and R-1 (middle) with Stable trends by DBRS) maintains its plan to restore fiscal balance by 2017-18. The plan is largely consistent with last year’s, although it includes a number of modifications to both revenues and expenditures. As a result, debt metrics remain manageable for the existing credit profile; however, DBRS continues to believe that, because of the notable run-up in debt since the onset of the Great Recession, the Province has yet to restore sufficient flexibility to withstand another economic downturn without negatively affecting the credit profile.

For 2015-16, the Province is anticipating a deficit of $5.7 billion compared with a shortfall of $8.5 billion expected in the 2015 budget. After making adjustments to recognize capital expenditures as incurred rather than as amortized, this equates to a DBRS-adjusted shortfall of approximately $9.1 billion, or 1.2% of gross domestic product (GDP). The stronger performance is largely a result of a one-time gain recognized on the partial sale of Hydro One and a combination of higher-than-planned tax receipts and earnings at government business enterprises. Spending projections are relatively unchanged, although DBRS notes that the capital program is expected to be underspent, slowing the increase in provincial debt.

The fiscal plan is based on the expectation that Ontario’s economy will be one of the provincial growth leaders, with real GDP projected to rise by 2.2% and 2.4% in 2016 and 2017, respectively. This forecast is just slightly below the current private sector consensus tracked by DBRS, which points to real growth of 2.3% and 2.5% in 2016 and 2017, respectively. Economic growth in Ontario is expected to be driven by higher exports and business investment, supported in large part by an improving U.S. economy and weaker Canadian dollar; however, heightened financial market volatility and uncertainty regarding the pace of global growth present downside risks.

Consequently, revenue growth is expected to average 3.9% annually over the coming three years, outpacing planned average total spending growth of 2.1%. This includes the Province’s efforts to introduce a cap-and-trade program to limit carbon emissions, which is estimated to generate $1.9 billion in new revenues by 2017-18, and will be offset by an equal amount of new spending on emission-reduction efforts. While a number of other small spending initiatives were undertaken, including modest increases in health-care programs, children and social services as well as reforms to post-secondary financial aid programs, DBRS believes that the increased spending profile made possible by stronger revenue projections is more realistic relative to last year’s plan, which called for no growth in program spending over the forecast horizon.

The medium-term fiscal plan now points to a fiscal shortfall of $4.3 billion in 2016-17 – a modest improvement from last year – followed by a balanced position in both 2017-18 and 2018-19. The goal to restore fiscal balance by 2017-18 is consistent with the Province’s commitment first introduced in 2010. On a DBRS-adjusted basis, this points to a deficit of approximately 1.2% of GDP in 2016-17 and declining thereafter which, if achieved, will be sufficient to gradually reduce Ontario’s debt burden. As anticipated at the time of last year’s review, Ontario’s debt burden appears to have peaked around 44% of GDP (DBRS-adjusted) in 2015-16. Provided that the economy performs as expected and that fiscal targets are adhered to, the debt burden should trend gradually downward to approximately 42% of GDP by 2018-19.

While this will begin to rebuild flexibility in the credit profile, the ability to withstand a material economic shock without an adverse impact to the credit profile will require greater effort on the government’s part to meaningfully reduce debt from current levels.

These 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.

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