DBRS Comments on Ontario’s 2017 Budget: Back in Black and Spending to Wynne

DBRS Limited (DBRS) has today commented on the Province of Ontario’s (Ontario or the Province; rated AA (low) with a Stable trend by DBRS) 2017 budget, released on April 27, 2017. The budget is consistent with DBRS’s expectations and sets the tone and agenda for the remainder of the government’s term in office. While Ontario has fulfilled its long-stated commitment to balance the budget in 2017-18, the real focus is spending on new initiatives. The Province is allocating all incremental revenue to program priorities and foregoing debt reduction, despite the significant increase in debt since the financial crisis. Nevertheless, growth in the Province’s debt stock has slowed considerably, the debt burden as a share of the economy is declining, albeit gradually, and the outlook for the economy is positive. The credit profile is stable, but will remain vulnerable to an economic shock in the absence of a more concerted effort to reduce debt.

Ontario first introduced its plan to restore balance by 2017-18 in the 2010 budget; at that time, many commentators, including DBRS, cast doubt on the government’s ability and willingness to do so. The government has, to its credit, outperformed its targets each year. Efforts to constrain wages and limit spending growth in key program areas kept the plan on track initially while the Province has benefited from strong economic growth and, more recently, some one-off measures. Had expenditure restraint been sustained as initially planned, fiscal balance would have been achieved sooner. Nevertheless, DBRS-adjusted debt peaked at 44.0% in 2015-16, below original expectations when the return-to-balance plan was introduced. Preliminary estimates now indicate that the debt burden is falling, having reached an estimated 43% of gross domestic product (GDP) in 2016-17.

The government pre-announced many of the headline initiatives, including electricity and housing cost measures, funding for new child-care spaces and a significant increase in health-care spending. The DBRS-adjusted deficit, which recognizes capital spending on a pay-as-you-go basis, is estimated to be about $6.4 billion in 2017-18, or 0.8% of GDP, down from $24.4 billion, or 4.1% of GDP, in 2009-10.

Total revenue is projected to rise notably (+6.3%) with growth across most revenue sources, driven largely by a strong underlying economy. The Province has not proposed any significant tax increases, but will benefit from proceeds of the carbon emission cap-and-trade program. Federal transfers will rise modestly with growth in health, social and infrastructure-related transfers, more than offsetting the declines in equalization.

The Province has budgeted for total expenses to rise 4.8%. Health care (+3.0%) was a focal point of this budget as the government announced a 3.0% increase in hospital funding and the introduction of pharmacare for children and youth. Other program areas are seeing similar growth with funding increases or new program funding in education (+3.0%), post-secondary and training (+7.7%) as well as children’s and social services (+4.3%). Interest costs are rising more modestly (+2.9%) as the net increase in debt is partially offset by a lower effective interest rate on the debt stock. Capital investment is planned to rise to $13.1 billion in 2017-18 and steadily higher in subsequent years.

The Ontario economy continues to post relatively strong growth. In recent years, growth has varied between 2.5% and 2.7% annually. Economic growth is being driven by the private sector with business investment, household spending and exports contributing strongly to the outlook. Consistent with the private-sector consensus, the Province is projecting growth of 2.3% in 2017 and for growth to track somewhat lower in subsequent years. Nevertheless, uncertainty regarding the potential renegotiation of NAFTA and U.S. tax policy as well as political integration in Europe present downside risks to the outlook. Furthermore, elevated household debt and housing market dynamics leave Ontario particularly vulnerable in the event of an unforeseen shock that results in significant job losses or a rapid increase in interest rates.

The multi-year fiscal outlook remains unchanged with balanced budgets projected through 2019-20. The Province intends to raise spending in lockstep with revenue, which stands in contrast with the more deliberate efforts by some other provinces to reduce debt that accumulated since the onset of the financial crisis. The Province will continue borrowing to fund its capital needs, but the debt burden as a share of the economy is projected to track lower over the medium term with economic growth outpacing debt growth. Preliminary estimates suggest that the DBRS-adjusted debt burden fell to about 43% of GDP in 2016-17 and could decline to about 40.0% of GDP by 2019-20 based on budget estimates.

The return to balance is encouraging and suggests that there will likely be some modest improvement in the Province’s credit metrics over the medium term, which will slowly rebuild flexibility within the rating. Nevertheless, Ontario’s debt burden will remain elevated over the medium term and the credit profile will continue to have limited flexibility to address any unexpected shocks. If a material economic shock occurs, the Province’s credit profile may come under stress.

This commentary reflects a preliminary assessment of the Province’s budget. DBRS will conduct a formal in-depth review of the Province in the coming months and will publish a report at the conclusion.

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.

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