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Ontario Premier Dalton McGuinty is photographed during a press conference at the provincial legislature, April 23, 2012. McGuinty was fresh out of a meeting with NDP leader Andrea Horwath where they discussed the upcoming provincial budget. (Fred Lum/Fred Lum/The Globe and Mail)
Ontario Premier Dalton McGuinty is photographed during a press conference at the provincial legislature, April 23, 2012. McGuinty was fresh out of a meeting with NDP leader Andrea Horwath where they discussed the upcoming provincial budget. (Fred Lum/Fred Lum/The Globe and Mail)

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Ontario's math: Why S&P and Moody's are so dubious Add to ...

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Ontario's math: Why Moody's, S&P are dubious Aside from the ups and downs of debt ratings - largely downs in this post-crisis environment - it's worth a closer look at why the U.S. agencies are questioning Ontario's math: With a bruised economy, an uncertain global outlook, and demographic and other pressures at home, can the Canadian province really meet its targets?

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First, though, how big a deal was yesterday's downgrade by Moody's and Wednesday's warning from Standard & Poor's?

It's certainly been a whirlwind week for Premier Dalton McGuinty's minority Liberal government, which struck a deal with the New Democratic Party to hit the wealthy with a temporary surtax in order to get its budget passed.

"Overall, we judge that the fallout on Ontario’s credit spreads from today’s downgrade should be relatively contained," Warren Lovely of CIBC World Markets said last night.

"With this week's Liberal-NDP deal removing near-term budget uncertainties and rating agency opinions now out in the open, Ontario can get on with funding its roughly $35-billion long-term borrowing program, and we expect to see a healthy pace of issuance over the balance of the spring."

Indeed, noted Mark Chandler, chief of fixed income and currency research at RBC Dominion Securities, "Ontario spreads are largely unchanged in the 10-year area in the wake of this week's announcements." Reaction in the bond market was modest.

And as Mr. Lovely reminded his clients in his research note, the Moody's downgrade catches up to hits several years ago by S&P and Canada's DBRS. And both agencies do cite some points in the province's favour.

"By way of background, note that S&P and DBRS both downgraded Ontario by one notch in the fall of 2009, given a significant erosion in the province’s fiscal position," he said. "In contrast, Moody’s had left Ontario’s rating and outlook unchanged through the worst of the global financial crisis and initial stages of recovery."

The Moody's downgrade - to Aa2 from Aa1 - affects more than $200-billion in provincial debt, as The Globe and Mail's Renata D'Aliesio reports. And its concerns are the same as those of its rival S&P, both seriously questioning whether Ontario can balance its books in the timeframe it laid down. by 2017-18.

For Moody's analyst Jennifer Wong, the sticking points are the "subdued" outlook for economic growth, the province's long timeline and its "ambitious" spending targets.

"Given a subdued growth outlook, the fiscal plan rests largely on significant expenditure restraint," Moody's said.

"Spending growth is expected to average 1.9 per cent per year over 2012-13 to 2014-15, then projected to decline to 1.1 per cent over 2015-16 to 2017-18. Expense growth targets appear particularly ambitious in light of growth in expenses averaging 7 per cent annually in the five years to 2011-12 and continued pressures on health expenses, the province's largest expense item, due to demographic pressures."

That all amounts to "significant" risks in meeting the targets.

Consider the weak outlook: Keeping in mind the province's conservative projections, it forecasts economic growth of 1.7 per cent this year, followed by three years of expansion at 2.5 per cent or under. It also projects that unemployment, expected to be 7.7 per cent this year, won't dip below 7 per cent until 2015.

Given the deterioration in the global economy in the latter half of 2011, the government has been forced to rely more heavily on spending measures in this budget to counteract potentially softer revenue growth," S&P said on Wednesday, when it cut the outlook for Ontario to "negative" from "stable."

"The cornerstones are a two-year public sector salary freeze to manage current and future compensation, pension plan cost containment, some job reductions, and a number of cost avoidance measures," the S&P report said.

"In our view, the government will need to be successful in implementing these measures in order for it to hold program spending growth to a 1-per-cent average annual rate in fiscal 2012-2015. In our opinion, it is a challenge for any province to sustain this low growth rate in spending, due to the substantial cost pressures in health care delivery alone."

U.S. growth slows The U.S. economy lost a bit of steam at the beginning of the year as governments cut back and inventories built up. But at least shoppers were still out at the malls.

The economy expanded at an annual rate of 2.2 per cent in the first quarter, the U.S. Commerce Department said today. That's below the 2.6 per cent forecast by economists, and also below the 3 per cent in the last quarter of 2011.

As expected, spending by governments fell, but consumers were still spending, to the tune of 2.9 per cent more.

"U.S. GDP was a tad disappointing, with the Q1 growth rate only slightly below expectations, but a bit too much of the growth coming from inventory rebuilding for the second straight quarter," said chief economist Avery Shenfeld of CIBC World Markets.

"A lot of the bounce in GDP is simply coming from restoring auto inventories and meeting better demand there, as GDP excluding autos was up only 1.1 per cent," he added. "All of this hints that Q2 might come in a bit softer, consistent with some of the downside surprises in recent monthly and weekly data."

Spending by governments continued to slip, by 3 per cent in the quarter, though consumers pushed ahead by 2.4 per cent.

"Undoubtedly the brightest spot in this report was the resurgence in consumer spending," said deputy chief economist Beata Caranci of Toronto-Dominion Bank.

" A good chunk of the gain was in auto sales, which was already well telegraphed within retail sales data. Smaller gains were seen in nondurable goods and services, but we’ll take what we can get when it comes to consumer spending. Looking forward, we don’t expect to see a repeat performance in the strength of spending to this degree in Q2. The second quarter won’t have the advantage of unseasonably warm weather that likely goosed auto sales. Likewise, large savings in utility bills won’t line the pockets of consumers."

Iamgold strikes Trelawney deal Canada's Iamgold Corp. is paying almost $600-million to acquire Trelawney Mining and Exploration Inc., a junior miner whose focus is in northern Ontario.

Under a deal unveiled by the two companies today, Iamgold is offering $3.30 a share for Trelawney and its Cote Lake Deposit project.

"The acquisition of Trelawney creates a larger and more geographically balanced portfolio of long-life gold assets for Iamgold," said chief executive officer Stephen Letwin.

"This transaction provides an accretive return on invested capital as we are effectively redeploying the cash proceeds from the sale of non-core assets last year into a Canadian gold project that significantly strengthens our future gold production profile."

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