The Ontario budget shows no sign the provincial government is worried about its debt load. And by one major benchmark, it has no reason to be: fixed-income investors aren't worried either.
Despite a net debt load totaling $284-billion, amounting to 39.4 per cent of its gross domestic product, the Ontario government will continue to borrow heavily over the next fiscal year, tapping investors for another $35.9-billion.
Yet there is every expectation that investors will snap up these bonds, the same way they clamoured for the $40-billion worth of debt sold last year.
Blame it on perverted markets: in an era of rock-bottom interest rates, the slight step up Ontario provides on its annual coupon, relative to federal bonds, is appealing to investors who are thirsty for yield. Lately, the 10-year Government of Canada bond yield has hovered around 1.5 per cent, and more than a trillion dollars worth of European government debt now pays negative yields.
"While the debt dynamics are not ideal, they're manageable," said Ed Devlin, an executive vice-president and head of Canadian portfolio management at PIMCO, one of the world's largest fixed-income managers. adding "this isn't a bad place to be."
"I don't see this being a real market-moving budget."
Susan Rimmer, who heads Canadian Imperial Bank of Commerce's debt capital markets group, which helps to underwrite the province's debt sales, echoed the sentiment. "Investors crave bonds in this market and are happy to buy Ontario credit," she said, adding that the province's credit spreads over Ottawa's bonds are at multi-year lows. When investors are worried, they widen these spreads, forcing Ontario to pay much more in interest than its federal counterpart.
Because there is such high demand for yield, Ontario has been able to sell more debt that matures farther out in the future – longer-term debt pays higher yields. In the last five years, the province sold $45-billion worth of debt that comes due in 30 years or longer – meaning it has locked in ultra-low rates for many decades.
The province's total debt load is undoubtedly alarming, but when factored into investors' decisions to buy the bonds, it's not so scary.
The last time Ontario was in dire financial straits in the 1990s – when its net debt to GDP jumped to 32.3 per cent by 1999, up from 13.4 per cent at the start of the decade – the annual interest the province paid on its debt amounted to 15.5 per cent of its revenues. The equivalent figure today is a fraction of that, only 9 per cent – though it has climbed slightly since the financial crisis.
And in the 90s, the average effective interest rate on the province's debt amounted to 9.5 per cent. Last year, it fell to 3.8 per cent.
Better yet, the province's economic growth is encouraging. Around the world, the United States is often seen as the current engine of the global economy, saving us from anemic GDP expansion in Europe and a cooling China.
But U.S. economic expansion this year is expected to clock in at 3.1 per cent. Ontario's, according to the budget, is expected to hit 2.7 – not far off. While that is only a projection, Ontario's GDP grew 2.2 per cent last year, just shy of the U.S. economy at 2.4 per cent.
However, such figures can't mask the total debt burden, which has worried debt rating agencies. Although Ontario's fiscal deficit last year totaled $10.9-billion, which was smaller than the $12.5-billion estimate, the province had boosted its deficit projections in the 2013 budget. Before that, Ontario expected to be short only $10.1-billion last year.
Lately, rating agency Moody's Investor Service has also warned that Ontario is starting to look troubled relative to Quebec, which was once viewed to be in dire straits.
"Ontario is in a more challenged position than Quebec because its debt burden has been rising since 2009, it faces larger ongoing deficits and also because there is a risk that all the cost controls designed to return Ontario to a balanced budget may not be carried out," Moody's noted in February.
The province is also susceptible to higher rates, and laid out in the budget that a 1 per cent rise in debt yields this year would cost it $400-million more in interest.
Concerns such as these have prompted Ontario debt downgrades by multiple rating agencies in the past few years. Investors, though, haven't seemed to mind.