Morningstar DBRS' Takeaways From the Canada in Transition Event: Canada and Its Provinces Draw Closer Amid Uncertainty

As part of its takeaways series, Morningstar DBRS is publishing write-ups about "Canada in Transition: Bank Resilience, TSX Strategy, Policy Shifts," an industry event looking at Canada's financial institutions and key economic policies at both the federal and provincial levels to provide a comprehensive outlook for H2 2025.

In the session "Equity Markets & Policy Outlook," Travis Shaw, Senior Vice President and Sector Lead of Global Sovereign Ratings at Morningstar DBRS, answered a wide range of questions posed by Christine Dobby, Canadian Finance Reporter for Bloomberg News.

Q: After the G-7 summit, Canada and the U.S. agreed to work toward some form of trade agreement within the next 30 days. And the Trump administration's 90-day pause on tariffs is set to expire on July 9. Against this backdrop, what do you see as the potential implications for the Canadian economy in the near term?

A: "We've lived in this uncertain world long enough now to know that until we have a new Canada - U.S. trade agreement, we really don't have any certainty," Shaw said. "The dialogue between Prime Minister Carney and President Trump has been generally co-operative for the most part, so I do find that encouraging."

Canada hasn't yet been broadly affected by tariffs aside from targeted sectors, Shaw noted. Tariffs aside, the uncertainty about the trade agreement has been the biggest drag on economic activity, weighing on business investments and holding back growth. If that uncertainty is removed, it's generally positive for Canada's domestic outlook.

Q: Prime Minister Carney is taking steps to set his administration apart from the Trudeau government, including introducing legislation to fast track nation-building projects and remove internal barriers to trade. Will these policy shifts create opportunities or barriers for business?

A. "I think the Carney government is moving back toward the middle compared with the Trudeau government that had been drifting more toward the left," Shaw said. Prime Minister Carney is trying to unlock some domestic economic potential by removing internal trade barriers. This is important for both the flow of goods across Canadian provincial borders and labour mobility. Progress is being made as the federal government has an initiative underway and several provinces have signed agreements with neighbouring provinces to remove some of these trade impediments.

A 2022 paper from the Macdonald-Laurier Institute has suggested that nominal GDP could be boosted by about $200 billion upon the removal of interprovincial trade barriers. "It's not clear if we'll get those gains or how significant they will be, but it's definitely positive," Shaw said.

Speeding up the development of major projects is important for Canada as a nation and to reduce our dependence on the North-South trade with the U.S. and provide more East-West trading corridors. It's also important in domestic politics. Alberta has been quite vocal about its frustrations with federal policy but early signals suggest that we're in a bit of a honeymoon phase between Ottawa and Alberta. "This is where I think the Carney administration is really going to have to thread the needle," Shaw said. "Can it make changes to support energy and resource developments without having to abandon all of their environmental standards?"

Q: We hear so much about not letting a good crisis go to waste. Do you think that major changes will be put in place to really turn the direction of the Canadian economy around?

A: Looking at the domestic political environment now compared with a year ago, Shaw sees a wholesale change despite the same party being in power federally. "I think we'll see some positive developments domestically but, ultimately, Canada is a large, open, trade-dependent economy. We're still going to be quite dependent on the U.S. outlook for growth and we're still quite vulnerable to the global environment."

Q: We're waiting for a federal budget and clear fiscal direction from the Carney government although it does seem like we're heading toward larger deficits and rising debt. How does this affect Morningstar DBRS' view of Canada's credit profile? Is its credit rating at risk?

A: Morningstar DBRS confirmed its credit rating on the Government of Canada at AAA with a Stable trend on February 28, 2025. At that time, Canada was already under the threat of meaningful tariffs, Prime Minister Trudeau had resigned, and the outcome of the federal election was months away. "Now we have some clarity on the political front, I don't have any immediate concerns about the AAA rating," said Shaw. "We're comfortable there, the trend is Stable, and I don't see that changing in the near term."

From the global perspective, Canada is entering this period of turmoil from a relatively good starting point, despite the domestic criticism about fiscal and debt dynamics. The deficit was less than 2% of GDP and debt was on a declining track. "Clearly, that is changing, and it would have changed regardless of who became the prime minister," Shaw said. "We are expecting larger deficits. We've got all the signals now: increased defense spending, increased infrastructure spending, and the tax cut coming into effect in another week or so."

"We will probably have to wait until the fall budget to get more details on what the infrastructure program looks like, but more spending on capital and restraint on operations suggests larger deficits and rising debt in the near term," Shaw said. "But in our eyes, within the current AAA rating, there is still a lot of flexibility."

Q: The provinces are spending in response to the tariff situation. Do you have any concerns there?

A: Morningstar DBRS has taken action on only one province, Shaw explained. The trend on British Columbia, currently rated at AA (high), changed to Negative from Stable. That is still the highest provincial credit rating. "This trend change shouldn't be perceived as being entirely in response to the current economic environment or the tariff threat," Shaw said. "This came after successive years of deterioration in fiscal performance and fiscal management by the current governing party and that's really what's precipitated the trend change."

"When we look across the other nine provinces, certainly we are seeing deterioration in fiscal and debt metrics almost across the board," said Shaw. "Nonetheless, we don't expect to see widespread rating changes at this point and we do have a degree of flexibility within our existing ratings."

Written by Deirdre Maclean

Notes:
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