Fitch Affirms Province of Ontario, Canada's IDR at 'AA-'; Outlook Stable
OREANDA-NEWS. Fitch Ratings has affirmed the following ratings for the Province of Ontario, Canada (the province):
--Long-Term Issuer Default Rating (IDR) at 'AA-';
--Long-Term Local Currency IDR at 'AA-';
--Short-Term IDR rating at 'F1+'.
The Rating Outlook is Stable.
The bonds are senior unsecured obligations of the province to which the province's full faith and credit is pledged. Commercial paper notes are promissory notes ranking equally with Ontario's other unsubordinated and unsecured indebtedness.
KEY RATING DRIVERS
FISCAL CONSOLIDATION CONTINUES: The tabled budget for fiscal 2017 follows the province's plan to eliminate its annual budget deficits by fiscal 2018. Despite an uptick in the annual deficit in fiscal 2014, the province has recorded two successive years of declines since then and Fitch believes it remains on track to achieve its target assuming continued economic growth.
STRONG FINANCIAL MANAGEMENT: The province has demonstrated the ability to exert considerable expenditure restraint while instituting revenue changes as necessary to achieve its deficit reduction objectives. Nevertheless, the province will be challenged to maintain expenditure restraint once the consolidation target has been reached, in Fitch's view, in the absence of continued revenue advances, including those gained through the sale of provincial assets.
SIGNIFICANT FINANCIAL IMBALANCE: The province estimates an accumulated deficit equal to 153% of operating revenues in fiscal 2016 (26% of gross domestic product [GDP]) fueled by a long-term misalignment between annual revenues and expenditures. Growth in the accumulated deficit is expected to taper once the budget is structurally balanced.
SIZABLE, DIVERSE ECONOMY: The province's diverse economy includes Canada's largest business and financial hub and accounts for 38% of the country's population. Growth in trade, financial services, and education and health care services has diversified the economic base from a prior manufacturing concentration. The provincial economy remains heavily linked to that of the U. S.
LARGE AND GROWING DEBT BURDEN: The province has a high debt burden measured by net direct debt to GDP, equal to 39.6% in fiscal 2016, although debt service consumes a manageable 9% of annual revenues. Fitch expects net debt to remain level in fiscal years 2017 and 2018. Pensions are well funded.
SUCCESS IN ELIMINATING THE DEFICIT: The rating is sensitive to the province's commitment and success in achieving deficit elimination targets and restoring fiscal balance. Failure to table budgets and achieve results that follow a path toward deficit elimination would result in negative rating pressure.
Ontario's 'AA-' rating is supported by its wealthy, diversified economy and generally sound financial management. The province continues to make steady progress in its multi-year fiscal consolidation plan from the last recession that subdued its economic growth and slowed its tax revenues, leaving a peak operating deficit of C$19.3 billion (20% of revenue) in fiscal 2010. Fiscal 2018 remains the target for fiscal consolidation.
The province has made progress reducing its operating deficit, which was C$5.7 billion as of fiscal 2016, aided by modest tax revenue increases, slow economic growth, and recently, the sale of provincial assets that have provided funds to the capital improvement plan (CIP). The most significant asset sales have occurred over the past eight months, with approximately 30% of provincial ownership in Hydro One, the province's electricity transmission and distribution utility, sold through public offerings. The asset optimization program is currently on track to net the province C$5.7 billion over time.
LARGE, DIVERSE ECONOMIC BASE
The province is Canada's largest by population, and its diverse economy generates 38% of Canada's GDP. Provincial GDP gains have been steady since the recession. Following the downturn in crude oil markets in late 2014 and its impact on oil-producing Canadian provinces, growth in Ontario now exceeds national averages; GDP growth of 2.7% compared to Canada's 2.5% in 2014 and provincial employment recorded 1.1% year over year growth in May 2016 compared to Canada at 0.6%. Unemployment rates also currently best national averages at 6.6% in May 2016 compared to the nation at 6.9%.
Manufacturing, which was severely affected in the recession, has become a much less significant driver of the province's economy, contributing 12.3% to GDP in 2015 compared to 20.4% in 2000. Other sectors have seen robust growth, including in trade and transportation, financial activities, and education and health services. Economic growth is forecast by the province to continue at a steady pace over the medium term and is expected to be ahead of national growth rates. The forecast is currently supported by a favorable export position, strong housing market, and federal government stimulus, although downside risks remain; slower economic growth in the U. S., pressured housing markets, and financial sector exposure to the resource provinces.
FINANCIAL BALANCE IS NEARING
Ontario's fiscal 2010 ended with a C$19.3 billion operating deficit (20% of revenues) and an accumulated financial deficit of almost C$131 billion (136% of revenues). The province subsequently enacted a multiyear fiscal consolidation plan with the goal of reaching a balanced budget by fiscal 2018. Despite a setback in fiscal 2014, through fiscal 2016 the province is exceeding its targets as expressed in the plan although enacting additional revenue and expenditure measures have been necessary to achieve its goals. At the close of fiscal 2016, the annual operating deficit is estimated to have declined to C$5.7 billion while the accumulated deficit reached C$193.4 billion.
The fiscal 2016 deficit was a C$2.2 billion improvement from the fiscal plan articulated in the 2010 budget, incorporating better than expected results from the sale of shares in Hydro One and strong performance in the housing market and government enterprises, offset by slightly under-forecast economic growth that dampened the collections of certain tax revenues. Absent the sale of shares in Hydro One, Fitch estimates the annual deficit would approximate C$6.8 billion.
The tabled budget for fiscal 2017 continues the province's tight expenditure controls supported by forecast solid growth in revenue sources. To the extent that revenues do not perform as forecast, the province will be required to implement expenditure reductions on already streamlined operations to achieve its target of a C$4.3 billion deficit at year-end. Non-recurring measures in the budget include a continued provincial asset optimization program whereby assets are sold and net revenue gains are directed toward transit and transportation and other priority infrastructure and capital improvement projects. Asset sales that affect fiscal 2017 include sales of shares in Hydro One as well as the sale of office space that houses the provincial liquor control board.
New recurring revenue measures enacted with the budget include a cap and trade program, estimated to bring in annual revenue approximating C$1.9 billion beginning in fiscal 2018 (C$478 million estimated for fiscal 2017), to fund initiatives that lower greenhouse gas emissions. Proceeds from the program can be used for eligible projects included in the CIP, such as the development of mass transit or transportation infrastructure, or to fund new green initiatives.
The province continues to forecast steady economic growth in support of its financial plans with continued growth in economically sensitive revenues, such as personal income taxes (PIT) and sales tax. Overall, revenues are forecast to grow 3.2% from fiscal 2016, inclusive of the sale of shares in Hydro One, other provincial asset sales, and cap and trade proceeds. Expenditures are budgeted to increase by a modest 1.4%, incorporating a significant decline of expenditures related to hosting the Pan-American/Parapan games in 2015 and includes modest increases in most areas of government offset by an expectation of C$800 million in programmatic savings. Fitch believes expenditure targets will continue to be challenging but achievable.
SIGNIFICANT DEBT BURDEN AND ACCUMULATED DEFICIT
Even as the province moves closer to achieving its fiscal balance goal by fiscal 2018, Fitch expects the province to be left with a sizable accumulated deficit, peaking at C$198 billion in fiscal 2017, and a debt burden that will have reached a substantial 39.6% of GDP. The province's debt burden has expanded greatly in recent years both from financing its fiscal imbalances and a robust CIP.
The provincial goal is to bring the debt burden to 27% of GDP; given the current level of almost 40%, Fitch believes this goal is likely to prove challenging. Total borrowing in fiscal 2017 is forecast at approximately C$24.4 billion, of which C$11.2 billion is for capital purposes and the remainder largely for repaying debt maturities and funding the annual deficit. Interest on outstanding debt remains manageable, at 9% of expenditures in fiscal 2015.