Ontario debt weighs heavily on budget
Even small rate hike will have huge impact, economist says
• The Ontario budget lands Thursday, but a new report warns that the $ 315- billion provincial debt could derail the finance minister’s best fiscal plans.
Ontario spends $ 11.4 billion a year just to service its debt — more than it spends on all social services for adults or to run its universities and colleges. It’s the third- largest single item in the budget after health care and public education, and that’s in a historically low-interest- rate environment. So what happens when interest rates rise?
The government’s debt payments go up.
If you think of the province’s $ 315- billion debt as several massive public mortgages, then it mostly holds fixed-term debt. That means, just like a mortgage, pay- ments are set for a number of years before a term comes up and, depending on what interest rates are, they are then renegotiated.
Finance Minister Charles Sousa and t he t eams of bureaucrats who work away in the Frost Building at Queen’s Park have taken advantage of historically low interest rates. They’ve locked in much of the province’s debt at current rates, but 40 per cent of it will come due within the next five years. Although the fiscal plan accounts for modest interest rate hikes, a new study from the Fraser Institute finds that, by 2020, Ontario could be paying $ 1.2 billion more than expected just to maintain its debt if drastic increases occur.
“We should not take it for granted that the government can rely on low interest rates for a long time in financing its borrowing,” said JeanFronçiu Wen, a professor of economics at the University of Calgary. “Interest rates are historically low, they could rise.”
He credits the government for long-term planning, saying when he first started cal- culating the impact of a larger- than- expected increase in interest rates on Ontario’s books, it was smaller than expected. However, he also found the province could pay hundreds of millions more a year if interest rates went up higher than expected.
If in 2017-18 — when the province promises to balance its books — interest rates are just 0.7 per cent higher than the 2.7- per- cent forecast, the province would have to spend $409 million more to maintain its debt. If it’s 1.2 per cent higher, that climbs to $ 857 million, or about $ 100 million more than the Ministry of Natural Resources’ $720-million budget.
Wen’s projections are based only on the 40 per cent of the debt that will come due by 2020.
“It’s not a prediction that interest rates will go up, it’s really a stress test,” he said of the report, titled The Impact of Higher Interest Rates on the Cost of Servicing Government Debt, released Wednesday by the Fraser Institute. He said it’s not so much about the likelihood of a spike, but to highlight the costs of government borrowing.
Ontario’s debt is expected to grow after Thursday’s budget as Premier Kathleen Wynne and Sousa implement a plan to spend $ 130 billion over 10 years on infrastructure — all while ostensibly balancing the books by 2017-18 as promised on the 2014 campaign trail.
“It may be confusing to the public that it shows up as a balanced budget … but it doesn’t take into account the full amount of borrowing,” Wen said. “The higher the debt, the more money that needs to be spent on interest payments. That money could be spent on health education, social services … instead it gets eaten up servicing debt payments.”
RBC senior economist Robert Hogue says banks and markets won’t just be watching t he budget to make clear how the $7.5-billion deficit will be eliminated by the end of March 2018. They will also look for Sousa’s plans to tackle the net- debt- to- GDP ratio — essentially the amount a province or country owes versus the total size of its economy. Ontario’s rate was expected to hit 39.8 per cent this year.
“The whole idea of balancing the books is to make sure the whole debt situation comes under control,” Hogue said. “To me the best of all worlds would be to set a hard target the way Quebec has done.”
Quebec’s 50.1-per-cent net debt- to- GDP ratio makes Ontario’s look paltry, but in 2015 its government released a detailed plan to tackle that burden.
Hogue said such a plan would serve Ontario well with credit- rating agencies and big banks alike. And, there’s a chance the budget may do just that.
“We are taking the next steps in our plan, including reducing Ontario’s net-debtto- GDP ratio to its pre-recession level of 27 per cent,” a spokesperson for Sousa said Tuesday.