THUNDER BAY – Moody’s Investors Service has revised the outlook on the Province of Ontario’s Aa1 issuer and debt ratings to negative from stable, affecting approximately CAD190 billion in debt securities. “The negative outlook on the province reflects the softening economic outlook, Ontario’s growing debt burden, and the extended timeframe to achieving a balanced budget,” said Moody’s Assistant Vice President Jennifer Wong, lead analyst for the Province of Ontario. Moody’s states, “The change in the outlook reflects Moody’s assessment of risks surrounding the province’s ability to meet its medium term fiscal targets given the recent slowdown in provincial economic growth and the resulting risks to the province’s ability to stabilize the recent accumulation in debt”.
The province’s Fall 2011 statement, released in November, revised its forecasts down for provincial growth in 2011 and 2012 to 1.8% and 1.8% from 2.4% and 2.7%, respectively. The provincial economy is particularly affected by the moderation in US growth, given its higher export share relative to other Canadian provinces and the high proportion of international exports (roughly 80%) destined for the US.
The province set out in its 2011-12 budget a plan to return to fiscal balance in 2017-18. Moody’s has highlighted that the extended period of fiscal consolidation presents an element of risk in achieving the planned consolidation path, and a risk to stabilizing and reversing the recent deterioration in the province’s financial position. At March 31, 2011, Ontario’s net direct and indirect debt, at roughly 200% of consolidated revenues, was at the high end of the spectrum for Canadian provinces, whose ratings remain in the narrow range of Aaa to Aa2.
The slowdown in provincial economic growth presents a challenge to the already lengthy planned consolidation path, particularly given the strong expense growth seen in recent years. Expense growth leading up to the recent downturn was relatively robust, highlighting the challenge ahead. Indeed, expense growth averaged 7% annually in the five years to 2007-08, with health expenses having grown at an average of 8%. The fiscal plan presented in the 2011-12 budget assumed expense growth of roughly 2% annually for the duration of the plan.
Nevertheless, Moody’s reports that Ontario’s high investment-grade rating reflects high debt affordability and the high degree of fiscal flexibility inherent in the institutional framework governing the way Canadian provinces operate. The current low interest rate environment has enabled the province to issue long-term debt bearing historically low coupons. While the proportion of revenues consumed by interest payments has increased with the recent accumulation in debt, this remains manageable given the province’s fiscal flexibility. Moreover, the province’s large and diversified economy and growing population provides access to a broad and productive tax base and, as such, remains a source of credit strength.
While Ontario retains sufficient fiscal flexibility inherent in the institutional framework to adjust its fiscal outcomes, thereby improving its financial position, difficult policy decisions are required.
“We believe that increased fiscal discipline will be required to sustain debt affordability,” said Ms. Wong. “If a credible plan to address the fiscal imbalance and stabilize the debt burden is not implemented in the next provincial budget, expected in March 2012, downward pressure on the province’s Aa1 rating would emerge.”
Moody’s P-1 rating on Ontario’s commercial paper program remains unchanged.
The Province of Ontario is Canada’s largest province, representing approximately 40% of national GDP. The province’s population measured approximately 13.2 million in 2010.
WHAT COULD CHANGE THE RATING UP/DOWN
A rating upgrade is unlikely in the near term given the current context of continued consolidated deficits and debt accumulation.
An inability to address continued consolidated deficits and to stabilize the debt burden over the medium term would put downward pressure on the rating. Further downward revisions to growth would also place pressure on the province’s ability to achieve medium term fiscal targets and would place negative pressure on the rating. Finally, if debt affordability were to deteriorate due to higher-than-expected increases in debt levels or a significant rise in interest rates, the province’s fiscal flexibility would be reduced, exerting downward pressure on the rating.
The methodologies used in this rating were “Regional and Local Governments Outside the US”, published in May 2008, and “The Application of Joint-Default Analysis for Regional and Local Governments”, published in December 2008.