In a review of Ontario and Quebec finances published Monday, Moody’s Investors Service has given the “okay” to the provinces with a stable rating of double-A-2, similar to the eastern provinces but below that of the western provinces. With direct and indirect debt now exceeding 200 per cent of revenues for both provinces, one cannot help but scratch the pointy forehead as to how Moody’s could come to a stable outlook.
Moody’s does have some good justifications for its argument. Despite direct and indirect debt totalling $247-billion in Ontario and $166-billion in Quebec, each of the provinces does have some important strengths to help withstand a financial downturn. Both have large, diverse economies, reliant on many different industries ranging from resources to finance. They have good fiscal flexibility with a diverse range of taxes and levies that are controlled by the provinces. Both have professionally well-managed debt practices (I know that personally, as I served on the Ontario Financing Authority for six years).
Nonetheless, one should be careful not to get too caught up with existing figures. It is not clear that debt, as a share of revenues, is the only measure to rely on, although certainly better than looking at debt as a share of GDP. Interest rates are bound to rise, and the ability of a province to finance debt obligations will be critical in the future. For that reason, corporate financial assessment looks at a number of ratios such as debt financing costs relative to earnings, not just debt leverage ratios.
What is more important to understand is whether both private and public debt can be supported in a jurisdiction. An example would be to look at whether gross savings can support both public and private debt in the province (a point recently made in a paper by Bruce Ramsay delivered at the University of Calgary’s School of Public Policy).
Even then, debt obligations for a province are more than what is held officially on the books. As Moody’s points out, debt calculators rarely include public pension plan obligations – Ontario’s are fully funded, but not Quebec’s. Further, there are large unfunded liabilities in health spending, long-term care and home care due to an aging population. In the past three years, the provinces, especially Ontario and New Brunswick, have done a better job controlling these costs, but certainly demographic pressures will increase health spending in the future.
And, of course, provincial revenues depend in part on revenues derived from selling oil, gas, mining and forest assets owned by governments. (For this reason, Newfoundland and Labrador’s net debt obligations potentially take off like a rocket after 2030.)
Forecasting the future is a quite difficult in determining whether a jurisdiction can cope with its debt obligations. No one really knows future growth rates, inflation rates, commodity prices, interest rates and exchange rates. We also don’t know if provinces will even balance their budgets, since it will depend on political decisions over time and the ability of the federal government to back up provinces with transfers. The best an analyst can do is assess the potential risk of downturns on a province’s state of financing.
My gut feeling is that Moody’s has it right when it comes to Ontario, whose current net debt as a share of GDP is below 40 percent and will be on a downward trend, so long as it truly balances its budget after 2017 (as planned) and holds health care cost increases to their historical average.
Quebec is a different matter, with higher debt at more than 50 per cent of GDP, greater unfunded liabilities and the most onerous tax load in the country. I’m not sure I would buy Quebec debt at Moody’s current ranking.
Jack M. Mintz is the Palmer Chair of Public Policy, School of Public Policy, University of Calgary.