THUNDER BAY – Standard and Poor’s has downgraded Ontario’s economic outlook to negative. Standard & Poor’s Ratings Services said it revised its outlook on the Province of Ontario to negative from stable. At the same time, Standard & Poor’s affirmed its ratings, including its ‘AA-‘ long-term and ‘A-1+’ short-term issuer credit ratings on the province. The move came at the end of the day on Wednesday and after the Ontario Budget passed in the Legislature as the New Democrats abstained from the vote as a result of an agreement reached by Premier Dalton McGuinty and Andrea Horwath.
“The outlook revision reflects our view regarding the minority legislature’s ability to meet challenging cost-containment targets in the next one-to-two years necessary for the debt burden to peak in fiscal 2015 as planned,” said Standard & Poor’s credit analyst Mario Angastiniotis.
“Supporting the ratings are what we view as Ontario’s large, wealthy, and well-diversified economy, which continues to recover, albeit unevenly, from the recession; ongoing support from the federal government; and positive
liquidity. The provincial government estimates that real GDP slowed to 1.8% in 2011 from a 3.0% gain in 2010. The government is forecasting real GDP growth to advance a further 1.7% in 2012. While recognizing that the tenuous recovery in the U.S. and the European sovereign debt crisis pose risks to Ontario’s economic outlook, we believe that the government’s forecast for real GDP growth underpinning its fiscal plan is reasonably cautious”.
“In our view, another credit strength is the ongoing support from the federal government. The federal government provides significant and predictable transfers to the provinces through the key Equalization, Canada Health
Transfer, and Canada Social Transfer programs. In Ontario, transfers represented more than 19% of total revenues in fiscal 2012 (year ended March 31), up from the 15% share recorded in 2007, prior to the onset of the global
economic recession. This increase mainly reflects higher federal equalization payments and capital grants to support stimulus spending in Ontario, where the manufacturing sector had substantial job losses during the recession”.
The problem for Ontario is this move will make borrowing money more expensive and likely cause greater difficulty in reaching budget targets to lower the debt.
We believe the province’s main credit challenges include its continuing weak budgetary and debt metrics and its challenging cost-containment plan required to achieve budgetary balance by fiscal 2018. In fiscal 2012, it recorded an operating deficit of about 12% of operating revenues (Standard & Poor’s adjusted) and an after-capital deficit of more than 22% of total revenues (Standard & Poor’s adjusted), which bettered the government’s forecast for a third consecutive year, but which remains stubbornly high, in our view.
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. 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.
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% 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.
The negative outlook reflects our view that there is at least a one-in-three likelihood that we could lower the long-term rating one notch within two years. Although we believe that the government’s fiscal plan is based on
cautious near-term economic assumptions, its success is tied to significant savings measures that could prove challenging to achieve. A downgrade could occur should we come to believe that the debt burden were to start trending materially above our current base-case scenario projections for a peak in the tax-supported debt burden of about 250% as a share of consolidated operating revenues. For example, this could occur as a result of rising economic or fiscal pressures due to lower-than-anticipated economic growth or the government’s inability to rein in spending. Conversely, we could revise the outlook to stable if we saw that the government was able to meet or exceed its targets for its budgetary and debt burden metrics in the next two fiscal years, and remain on course to attain its goal of budgetary balance by fiscal 2018.