DBRS Comments on Alberta’s 2017 Budget: Large Deficits and Rising Debt Erode Flexibility

DBRS Limited (DBRS) has today noted that, in its 2017 budget released on March 16, 2017, the Province of Alberta (Alberta or the Province; rated AA (high) with a Stable trend by DBRS) continues to incur substantial deficits, resulting in rapid debt accumulation. Moreover, the Province has yet to provide a plan to restore balance. While DBRS takes comfort in Alberta’s currently low debt burden and expected economic recovery, the fiscal plan demonstrates a lack of willingness to contain debt growth, which may exhaust flexibility within the Province’s current ratings in the near to medium term.

This commentary reflects a preliminary assessment of the Alberta budget and will be followed by a formal in-depth review. DBRS will publish a full report on the credit following its annual review meeting with provincial officials later this spring.

With few new measures introduced, the medium-term outlook is similar to that presented last year. However, as spending pressures have outstripped modest revenue growth, key financial risk metrics have deteriorated relative to DBRS’s expectations at the time of its last review.

The Province forecasts real gross domestic product (GDP) growth of 2.6% in 2017 followed by 2.2% in 2018. These forecasts are roughly consistent with the private-sector consensus tracked by DBRS. The economy has been supported by the rebound in oil prices, which, along with major projects coming to completion, has contributed to a pickup in oil and gas activity. At the same time, government capital spending and the reconstruction of Fort McMurray following last year’s wildfires will further help to stimulate growth. Nevertheless, downside risks remain, including the uncertain outlook for global commodity prices, limited access to offshore energy markets, ongoing opposition to the construction of new pipelines and the threat of protectionist U.S. trade policies.

For 2017–18, the budget points to a deficit of $10.3 billion, or $13.6 billion on a DBRS-adjusted basis after recognizing capital expenditures as incurred (4.2% of GDP), followed by shortfalls of 3.5% and 2.6% of GDP in 2018–19 and 2019–20, respectively. Revenues are projected to grow by 6.2% in 2017–18 and by 5.8% and 8.7% in the last two years of the plan, respectively, driven largely by a recovery in resource revenues and growth in the tax base, including the carbon levy that went into effect on January 1, 2017. The Province has assumed a West Texas Intermediate oil price of USD 55/barrel (bbl) in 2017–18, and that forecast rises to USD 59/bbl in 2018–19 and USD 68/bbl in 2019–20. A USD 1/bbl change in the price of oil is estimated to affect revenues by $310 million, which leaves little flexibility given the current prices (near USD 50/bbl).

To control spending, the Province intends to hold the annual rate of expense growth below the rate of population growth and inflation (expected to average 3.3% over the coming three years). This will be a challenging task in light of past spending increases and the major labour agreements that are up for renewal, including those for teachers, nurses and general government employees. Public-sector compensation, which accounts for approximately 55% of total operating spending, is forecast to grow by 1.4% in 2017–18 without accounting for any wage increases that may result from upcoming negotiations. While a wage mandate has not been communicated, DBRS will be closely following labour negotiations to assess the government’s ability to adhere to its expenditure targets. This could be a challenge for a labour-friendly government.

For the fiscal year ending March 31, 2017, the deficit is estimated to be $10.8 billion. On a DBRS-adjusted basis, after recognizing capital expenditures as incurred and excluding the non-recurring impact of the wildfires, this equates to a shortfall of $13.2 billion, or a sizable 4.3% of GDP — somewhat better than expected on account of lower-than-anticipated capital spending. However, on a DBRS-adjusted basis, debt is estimated to have grown by more than 40% to $47.8 billion, or 15.5% of GDP, in part driven by coal phase-out liabilities of approximately $1.1 billion.

With continuing budget deficits and debt-financed capital investment, debt is set to rise steadily over the forecast horizon. On a DBRS-adjusted basis, debt is projected to approach 18.4% of GDP in 2017–18 and almost 24.0% by 2019–20. This erodes Alberta’s low debt advantage relative to provincial peers. In the absence of meaningful action to address the budget deficit and to slow debt growth, Alberta’s debt may exceed levels acceptable for the current ratings.

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

The principal methodology is Rating Canadian Provincial Governments, which can be found on dbrs.com under Methodologies.