Low Interest Rate Era Ending?

THUNDER BAY – ECONOMICS – The era of low interest rates may be coming to an end.

While interest rates have remained at historic lows since the 2008-09 economic crisis and subsequent slow world economic growth, recent dissent at both the Bank of England and the U.S. Federal Reserve over whether to continue a policy of low interest rates suggests that interest rates may rise sooner rather than later. Indeed, RBC apparently expects that Government of Canada bond yields will double to about 3.3 per cent by the end of 2015.

The end of low interest rates should spark concern, given the accumulation of net debt particularly at the provincial level in Canada. Whereas 20 years ago, the preoccupation was a federal debt crisis, we may very well be on the verge of a provincial one given the changes in the fiscal and debt positions of the federal and provincial governments.
In 2001 federal government net public debt was $565 billion, declining to $516 billion in 2007 on the eve of the financial crisis. As a result of the Great Recession’s revenue impact and fiscal stimulus programs, the federal net debt grew to reach $671 billion by 2012. Ottawa has since managed to balance the budget and it can be expected that its net debt will once again edge downwards.

The case of the provinces is more disturbing. In 2001, the total net provincial public debt in Canada was $290 billion. Unlike the federal government, this total debt has risen relentlessly, reaching $321 billion in 2007. With the onset of the Great Recession, the provinces also incurred large deficits and their net debt soared to $510 billion by 2012. It should be noted that 80 per cent of this net debt is for Ontario and Quebec.

Between 2001 and 2012, the federal net debt grew 19 per cent. However, as a result of the long-term decline in interest rates, debt service charges fell from $39.7 billion in 2001 to $29.2 billion in 2012 enabling the federal government to reap an enormous fiscal dividend that allowed it spend more and reduce tax rates.

Between 2001 and 2012, provincial net debt rose by 76 per cent. While the provinces also reaped a fiscal dividend from the fall in interest rates, they were prone to taking on relatively more debt given the attractiveness of cheap borrowing. As a result, debt service costs for the provinces went up slightly during this period whereas they declined 26 per cent for the federal government. Provincial debt charges were $24.4 billion in 2001 and grew to $24.8 billion by 2012.

The provinces, however, are not all equally debt afflicted. Between 2001 and 2012, net debt growth ranged from an increase of 91 per cent for both Ontario and Quebec to a large drop in Alberta. After Ontario and Quebec, the largest increases in net debt over this period were for Prince Edward Island at 87 per cent, New Brunswick at 64 per cent, Manitoba at 61 per cent and British Columbia at 54 per cent. Down at the bottom with Alberta is Saskatchewan, which saw a 45 per cent decrease in its net debt, Newfoundland with a 4 per cent decrease, and Nova Scotia, which experienced only a 15 per cent increase.

With a combined federal provincial net debt in 2012 of $1.2 trillion and a combined debt to GDP ratio pushing 70 per cent, this mass of debt is generating combined debt service charges of $54 billion annually. While any interest rate increases will gradually affect debt charges as debt rolls over to be refinanced, it remains that debt service costs will grow. Moreover, this will cause greater fiscal damage at the provincial level and particularly in Ontario and Quebec, which have the highest total and per capita provincial net public debts.

While Quebec has embarked on the path to balancing its budget, Ontario is still lagging in its commitment towards budget balance and, in the meantime, both provinces will add billions of dollars more to their net debts. Rising interest rates combined with rising debt will increase debt service costs and crowd out important public spending on health, education and infrastructure. The resulting fiscal fire will be extremely unpleasant.

Livio Di Matteo is Professor of Economics at Lakehead University in Thunder Bay.
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