Wednesday, July 8, 2015

Debt Levels on the Rise Provincially and Federally: First Ontario's Credit Downgrade, Then What?

Debt levels continue to increase in Canada's most populous province. Recently published reports by both Fitch and S&P, international bond/debt rating agencies, explain that Ontario's government debt will reach $289.9 billion in fiscal year 2015-2016. This figure alone doesn't tell us much unless we compare it to another measure, the provincial GDP, or gross domestic product.

Much like a home-owner compares their mortgage debt to how much their home is worth, known as a loan to value ratio, or LTV, a government compares their debt level to how much economic output the province achieves in a given year, known as GDP. For a home-owner, the maximum loan to value allowed, unless we buy CMHC mortgage loan insurance, is 80 percent. For a government, there is no easy rule of thumb, but for most developed economies 80 percent would be seen as reasonable.

Ontario has a relatively healthy GDP of $721 billion. At first glance, this would seem like Ontario is in fine shape compared with most other developed economies. So why are the rating agencies concerned about Ontario? Because Ontario's citizens are also responsible for the federal debt, kind of like being responsible for two somewhat related but distinct mortgage loans. We are heavily mortgaging future generations both federally AND provincially, and this will cost us dearly.

Canadian federal government net debt reached $688 billion in 2014, which is an increase of over $170 billion since 2008. Combined, Canada and the provinces now have over $1.2 trillion in debt! That is a staggering amount for a population of only 35 million people, many of whom are children, seniors, unemployed citizens, and students with poor job prospects. Sadly, this does not even include personal debts, such as mortgages, credit cards, car loans, et cetera, which are also rising to record levels for Canadians.

The only provinces showing signs of improvement since 2008 are Saskatchewan and Newfoundland, which managed to pay off a combined $3 billion dollars in debt by 2015. All of the other provinces are in worse shape. There are two broad solutions being proposed to improve the situation for Canadians. Firstly, to grow the economy, or GDP, through investments in infrastructure, new trade deals, and other ways of creating jobs and economic activity. Secondly, there is austerity, or cutting back spending to start paying down the debt.

The first solution is being attempted
 by the governing Liberal party in Ontario. They are proposing billions of dollars in transportation infrastructure that is being promised will improve economic activity in Ontario, and thus reduce the provinces debt / GDP ratio.

Austerity is being practised in many American states, such as Wisconsin, and within many government agencies at home as well. Austerity practices are evidenced by layoffs and wage freezes for many public sector workers, and cutbacks and outsourcing in many government departments. Essentially, the idea is to reduce the overall overhead and operating costs of government, and use any savings to pay down debt.

Why is this so important to think about? Interest rates are currently low, which means the cost for Canadians to finance their debt is relatively low by historical standards. A 5 year fixed rate mortgage can currently be obtained in Ontario by those with good credit at a rate of below 2.6 percent. The federal government can currently borrow for a 5 year period at a rate of below 1 percent. This means that interest costs are relatively low for both your average Canadian, and their governments. However, when interest rates rise so to will the expense to carry the debt, and we may find this crippling due to the high overall levels of debt that we have become addicted to in a low rate environment.

Rising interest costs will mean less money for health care, education, and other government programs. In addition, much like a typical borrower has a credit rating, so too does the government. Right now Ontario's credit rating is relatively high, at A+ according to Fitch, but should our debt situation get worse in Ontario the rating can decline, as it did this month. All else being equal, a rating downgrade means higher borrowing costs and more taxpayer dollars that need to be devoted to interest instead of social programs.

It is time for Canadians to start taking our debt seriously by encouraging governments to not only get spending under control, but also find new and inventive ways to increase revenue and GDP. The Ontario government is trying to boost GDP through infrastructure investment, but they are going to pay for that by selling part of Ontario's crown power assets, which will reduce our future revenues and ability to pay for public services. The federal government, for their part, is promising new international trade deals with European and Pacific countries to boost GDP, but it is notoriously difficult to measure their benefits to Canadians. We must do more, and Canadians themselves can practice this at home by borrowing less and living more within our means. Wages have stagnated in North America, but our spending has not.

Thanks for reading,