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A Moody's sign on the 7 World Trade Center tower is photographed in New York August 2, 2011.MIKE SEGAR

Just two days after the McGuinty Liberals' first minority government budget passed a crucial vote, one of the world's major credit rating agencies downgraded Ontario, citing the province's swollen debt burden and tough economic times ahead.

Moody's Investors Service's decision Thursday to downgrade Ontario followed a stern warning and dimmer outlook issued one day earlier from Standard & Poor, another influential credit rating agency.

Finance Minister Dwight Duncan acknowledged that the move by Moody's was serious but he also attempted to play down the sour financial news. Moody's downgrade could make Ontario's government bonds less attractive to investors and could also make it more expensive to borrow money at a time when the province's debt is mounting.

Progressive Conservative finance critic Peter Shurman suggested the rating drop was "catastrophic for Ontario," but Mr. Duncan said he expects the effect will be minimal.

"We're still in the top echelons of credit ratings," Mr. Duncan noted. "It [the downgrade]reminds us that it's important that we continue to meet our targets or we risk paying more money to bond holders instead of for schools and for health care."

Moody's downgrade of the province's debt rating to Aa2 with a stable outlook from Aa1 with a negative outlook brings the agency's score more in line with S&P and DBRS, which both downgraded Ontario by one notch in the fall of 2009. DBRS, which also weighed in Thursday on Ontario's fiscal state, decided to maintain its "stable" outlook on its debt rating for Canada's largest province, saying the government's increased focus on controlling spending was "an encouraging step in the right direction."

But DBRS, too, struck a note of caution. Limiting debt growth will be very challenging and require a "significant pickup in fiscal resolve," DBRS analysts Travis Shaw and Eric Beauchemin said in a report to clients.

The Ontario government is in a deep financial hole, as the province's economy struggles to shake off the economic downturn that has battered its vital manufacturing sector. The Liberal minority government had faced the prospect of losing a confidence vote on its budget until it struck a deal this week with the New Democratic Party. The agreement included a new 2 percentage point surtax for those earning more than $500,000 a year, which will bring in an estimated $470-million in additional revenue a year.

Still, the government's timeline for balancing the budget remains unchanged: Ontario doesn't expect that to happen until 2017-18, when, at the moment, a modest surplus of $500-million is projected. The deficit forecast for 2012-13 is $14.8-billion.

In its decision to downgrade Ontario, Moody's noted the province's subdued growth outlook and ambitious expenditure targets pose risks to the government's plan to return to balanced budgets. Indeed, Ontario's economic prospects in the coming years are weak and fiscal pressures on its health system are rising as the population ages.

The government forecasts economic growth at 1.7 per cent for 2012, and 2.2 per cent, 2.4 per cent and 2.5 per cent in the following three years, respectively. At the same time, unemployment is expected to remain high, hovering at 7 per cent or higher until 2015.

Ontario's Finance Minister used the rating agencies' fiscal warnings to reinforce the province's tough stand on wages with doctors, teachers and other public-sector workers. The government is calling on unionized public sector workers to freeze their pay for two years.

For now, the outlook on Ontario's credit rating is stable, Warren Lovely of CIBC World Markets noted in a written comment on Moody's downgrade. But the pressure isn't over, he added. The province's rating could be knocked down further if it fails to stabilize its debt burden or if it sees an unexpected deterioration in debt affordability.

"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," Mr. Lovely said.

With a report from Reuters

Editor's note: An earlier version of this story incorrectly stated that the agreement between the Ontario Liberals and NDP included a 2 per cent surtax. The agreement included a 2 percentage point surtax. This version has been corrected.

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