DBRS Comments on Canada’s 2016 Budget: Deficits are Here to Stay!

DBRS Limited (DBRS) notes today that the Government of Canada (rated AAA and R-1 (high), with Stable trends) presented its much-anticipated 2016 budget on March 22, 2016, marking the first budget of the newly elected Liberal government. With an economy challenged by low commodity prices and the government’s efforts to implement campaign promises, the fiscal outlook has softened notably from the time of the last federal budget. As a result, Canada’s debt burden is no longer on an improving trend. However, projected deficits are modest and Canada’s credit profile remains sound, given the government’s history of responsible macroeconomic and fiscal management, Canada’s manageable debt burden and a resilient economy that is slowly adjusting to lower commodity prices and a weaker currency.

Following a small surplus in 2014–15, the government projects a small deficit of $5.4 billion, or 0.3% of GDP, in 2015–16. However, the outlook for 2016–17 and subsequent years has deteriorated sharply from the small surpluses previously forecast at the time of the last federal budget. For 2016–17, the government is now projecting a budgetary deficit of $29.4 billion, or 1.4% of GDP. DBRS notes that this remains manageable in relation to G7 peers, but nevertheless represents a sizeable year-over-year deterioration in fiscal balance. Over the medium term, deficits are projected to fall from 1.4% of GDP to 0.6% of GDP by 2020–21. The budget includes a contingency of approximately $6 billion annually built into the revenue projections and, if not used, could help to improve the bottom line. This represents a doubling of the contingency typically used in previous years.

DBRS notes that the deficits in this plan are modest relative to the size of the Canadian economy, and well below the peak realized in 2009–10 (3.5% of GDP). What is concerning, however, is that the plan does not provide a timeline for returning to balance and, as this is the first budget in the government’s mandate, further growth in program spending is probable. Persistent deficit spending will somewhat reduce flexibility within Canada’s credit profile to weather another severe economic shock over the medium term.

Total revenues are expected to decline by 1.2% in 2016–17 due to sluggish growth and a number of one-time revenue gains recorded in the prior year; however, the revenue outlook in subsequent years is expected to be much stronger, averaging 4.6% growth annually between 2017–18 and 2020–21. The budget does not contain any major revenue initiatives, aside from the previously announced tax changes, which include the introduction of a new tax bracket for incomes above $200,000, a lower rate for a middle-income tax bracket, and the elimination of income splitting for families with children.

The budget outlines a number of key spending initiatives for the coming year which include the introduction of the Canada Child Benefit, reforms to the Employment Insurance program and training programs, a variety of initiatives to spur business innovation and growth, increased funding to support Indigenous peoples, new funding and subsidies for the transition to the “low-carbon economy,” and enhancements to retirement security programs. Overall, program spending growth is expected to average 3.6% over the forecast horizon.

The budget also provides further clarity on the anticipated ramp-up in infrastructure spending. The government is announcing the first phase of its additional $120 billion, ten-year infrastructure plan. It includes $11.9 billion over five years for public transit, water, wastewater and waste management, and social infrastructure. The government will provide further information on the second phase of the plan within the next year. The second phase, which will begin in two years’ time and overlap with the first phase, will include larger, more ambitious projects.

The debt-to-GDP ratio, as measured by gross market debt, is expected to increase marginally to 35% in 2016–17. This represents a reversal of the downward trend of recent years. Nonetheless, the ratio remains well below levels reached in the 1990s and continues to provide meaningful flexibility to the credit profile. Furthermore, Canada’s debt burden continues to compare favourably with most G7 peers.

Canada’s export-oriented economy, supported by a flexible exchange rate and accommodative monetary policy, is undergoing structural change in realization of the view that low oil prices will persist. This is leading to a reallocation of capital and labour across sectors and a shift toward growth led by export-oriented manufacturing-intensive provinces. Real GDP is forecast to grow by 1.4% in 2016, followed by 2.2% in 2017, largely consistent with the latest IMF forecast, though somewhat weaker than anticipated at the time of the last budget. However, there continues to be some uncertainty, given volatility in financial markets and potential for renewed weakness in commodity prices or underperformance of the U.S. economy.

Notes:
All figures are in Canadian dollars unless otherwise noted.

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

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