With budget season across Canada now over, it's a good time for a regular debt check-up for all governments. The prognosis: Canada's debt is still manageable, but we're in poorer health than a decade ago, and some of the provinces have flashing warning signs.
Economic history teaches that countries and jurisdictions face increased health risks when their debt-to-GDP ratio rises beyond 80 per cent of GDP. Debt service payments eat up a significant share of the national budget, pushing governments to undertake fiscal austerity through budget cuts and tax increases. Financial markets become nervous about the capacity and willingness to pay. Credit ratings get marked down and the cost of carrying the debt rises due in part to higher bond risk spreads.
Today, several industrial countries – notably Japan and many across Europe – have debt ratios that far exceed 80 per cent of gross domestic product (GDP). The fiscal room to manoeuvre for these countries is sharply limited. The United States joined the 80 per cent public debt club after the 2008-09 financial crisis, and the Trump administration's tax and fiscal policies are likely to take the U.S. debt ratio higher – either inadvertently or by design.
How does Canada stack up today?
At the federal level, Canada has no material concerns, especially with debt financed at low nominal interest rates. A fiscal policy that maintains the debt-GDP ratio stable in the mid-30s is acceptable for now, if considered on its own. Ideally, the Conference Board would prefer to see a federal debt-GDP ratio of around 30 per cent and declining, as was the case in the mid-2000s. A lower and falling federal debt ratio creates room to add significant federal stimulus in a deep recession without concerns about managing future debt, as happened in response to the 2008-09 recession.
It's worth emphasizing that continuing federal debt accumulation and rising debt service have a material opportunity cost. Annual interest payments on federal debt represent real money that is not available for other national priorities. The recent federal budget projected debt service of $25-billion in 2017-18, rising to $33-billion over five years. That amount is roughly half the annual federal health and social transfers to the provinces, or comparable with the annual defence budget.
In Canada, provinces can borrow in their own name, so taxpayers get to pay for both federal and provincial/territorial debt. Thus, the relevant debt burden here is best determined by assessing the combined federal and provincial debt ratio for each province.
Among the provinces, there are three noteworthy trends.
First, the debt ratio has risen for nearly every province over the past decade, in some cases by up to 20 per cent of provincial GDP. Recurring provincial deficit spending was understandable during and just after the 2008-09 recession, but those years are far behind us. Yet, some provinces have taken a long time to stabilize their debt position, and at a higher level.
Second, there is sharp variation in provincial public debt burdens today. Stronger performance in the west weakens progressively on the journey east. The fiscal management story varies by province. British Columbia is arguably the top overall performer in public debt management. By making a conscious effort to balance provincial budgets in recent years without using significant energy royalties, B.C. has stabilized its debt ratio at 15 per cent of provincial GDP.
Alberta decided decades ago to keep taxes low by spending most of its non-renewable energy royalties on current programs, and not to accumulate significant assets. It saved some of the royalties and had net assets until recently. Because of a two-year recession caused by the collapse in oil prices, Alberta has now become a net debtor like everyone else.
At the other end of the spectrum, Newfoundland and Labrador is once again experiencing large fiscal deficits and a sharp rise in public debt, rising to a projected 47.5 per cent of provincial GDP in 2017-18. This change in fortune is because of the shock to oil and other commodity prices, but also to many generous fiscal decisions taken during the boom years. Painful policy decisions will be required to keep public debt levels under control in Newfoundland and Labrador.
Third, every province is caught in a structural fiscal squeeze between slowing economic growth potential and unrelenting spending pressures, notably on health care. Growth of 2 per cent or less is the new normal for Canada, which constrains growth in revenues for governments. The challenge to balance budgets and manage public debt burdens will only get harder in the years ahead, particularly for Quebec and the Atlantic provinces that have higher public debt levels and slower growth potential.
What is the outcome of Canada's debt health check-up? Most provinces and the country as a whole are in better shape that many other industrial economies. However, debt levels have risen federally and in all provinces over the past decade, and things are not going to get any easier in a slow-growth economy.
Glen Hodgson is senior fellow at the Conference Board of Canada.
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Glen Hodgson