Kathleen Wynne’s reality: Ontario’s massive debt cannot be ignored
Now that voters have returned Kathleen Wynne to power, the premier will need to find a way to manage a debt load that is larger than California’s while continuing to keep the credit rating agencies mollified long enough to avoid a dreaded downgrade.
With a net debt of $267.5-billion that is growing at a faster rate than the economy, the challenge is just beginning for the party that emerged victorious from the provincial election. “They are still going to be facing pressures from the credit agencies to get the province’s fiscal finances in order,” said Mazen Issa, senior Canada macro strategist at TD Securities in Toronto. “There’s no way to avoid it. The reality is there and it can’t be wished away.”
Put simply, Ontario is increasingly dependent on tapping lines of credit because it spends more than it collects. Currently, the province pays $11-billion annually in interest payments to finance its debt — money that is not going toward paving roads, building public transit, hiring more teachers and shortening wait times in hospitals.
During the 40-day election campaign, which focused predominantly on the economy, the three main parties offered a stark choice: Conservative leader Tim Hudak vowed to cut 100,000 public-sector jobs over four years and lower corporate taxes to kick-start the creation of one million jobs in eight years while balancing the budget in two.
The New Democrat and Liberal parties both promised to loosen the provincial purse strings further and increase spending for at least two years by borrowing more money and increasing taxes. NDP leader Andrea Horwath promised to offer wage subsidies to businesses to hire new workers, slash auto insurance rates and cut government spending by $600-million annually although she wouldn’t say how she would balance the books in three years.
Liberal leader Wynne also promised to balance the budget by 2017 and she too was vague on details of cost cutting, prompting critics to accuse both parties of pinning their hopes on unusually robust economic growth in the range of 2.8% to 4.7% to pump up government coffers.
“It’s a bit of a Hail Mary to hope the economy will recover so much that it will take care of the problem,” said Candice Malcolm, Ontario director of the Canadian Taxpayers Association. “It’s a huge hole to come out of and it’s going to require tough measures, including looking seriously at the spending side.”
Ms. Malcolm believes that the premier will not be given much time to make drastic spending cuts before credit rating agencies and bond markets begin to force her hand. Finn Poschmann, vice-president of policy at the C.D. Howe Institute, concurs: “Certainly the pressure is there for a downgrade. To balance the budget in two or three years will take sharp measures and that is a difficult task.”
Next year, the province’s net debt is forecast to jump by 7.7%, faster than the 4% economic growth rate anticipated during the same time. Still, while Ontario may be carrying more debt than California, long considered the poster child for poor fiscal management, Moody’s Investor Services Inc. has nonetheless applied a slightly higher — and more favourable — credit rating of Aa2 (the third-highest investment grade rating) to Canada’s largest province. Meanwhile, Standard & Poor’s has slapped a lower AA-rating with a negative outlook for Ontario.
Meanwhile, there are signs of pressure that a downgrade is inevitable. For one, Ontario has $250-billion worth of bonds rated by Moody’s, the most of any sub-sovereign borrower tracked by the New York-based ratings company, according to Bloomberg. The province’s ability to pay back those bonds, known as the debt-to-revenue ratio, is 237.7% — the worst among all Canadian provinces, including Quebec, according to a Moody’s report. Alberta ranked lowest — and the best — with a debt-to-revenue ratio of 31.9%.
Michael Yake, assistant vice-president at Moody’s Toronto, explained the rating agency’s concerns in an interview: “We see deficits narrowing at a lower pace but in Ontario, they are growing from previous forecasts. That’s not an ideal situation from our point of view.”
And that is worrisome for a province that borrows as much as Ontario. A future downgrade would result in higher borrowing costs, adding billions more to the debt-to-revenue ratio. Ontario currently spends 9.2% of its revenues on interest payments and provincial government estimates predict that figure will rise to almost 11% in the next four years. Keep in mind that interest rates have been at 20-year low levels and will inevitably rise if the economy grows at a faster clip.
The cost of carrying that debt will also skyrocket, as much as $3-billion in annual interest costs for every point increase in interest rates, according to Jack Mintz, the Palmer chair and director of the School of Policy at the University of Calgary. The bottom line: more money will be earmarked for servicing the debt and less spending for vital services.
“It’s been an issue that has been lingering for several years,” said TD’s Mr. Issa. “Some very tough decisions are going to have to be made to get the books in order.”