Along with the leadership of Canada’s largest province and the keys to its 120 year-old pink-sandstone legislature, the winner of Ontario’s election tomorrow will claim the largest pile of debt of any province, state or local government in the world.
Ontario’s C$250 billion ($229 billion) of bonds rated by Moody’s Investors Service is the most of any sub-sovereign borrower tracked by the New York-based ratings company. Its debt-to-revenue ratio, which measures its ability to pay back the bonds, is at 237.7 percent, among the worst of the sub-sovereigns, according to Moody’s.
With economists forecasting Canadian borrowing costs to be pulled higher this year by a recovering global economy, Ontario’s debt will start to become more expensive after years of falling average interest rates. That will slowly increase the amount of cash Ontario, whose government building is nicknamed the Pink Palace for its rose tinge, must divert from serving people toward servicing debt.
“The cost of carrying that debt is going to rise,” said Craig Wright, chief economist in Toronto at Royal Bank of Canada. “A higher share of revenues is going to have to go to servicing debt in the debtor provinces, so that’s money that won’t be available for spending increases, debt reduction, tax reduction or a combination of the three.”
Ontario’s election has largely come down to a debate between the two front-runners over how to deal with the debt and the deficit, now in its seventh year, that’s making it bigger. Tim Hudak, leader of the opposition Progressive Conservative party is pitching a combination of austerity and tax-cuts to slay the deficit in two years, bolster confidence and win business investment.
“That’s the biggest load we have on our backs that’s holding back job creation -- we need to balance the books,” the Progressive Conservative party leader said at a televised debate last week. “Nobody’s investing in Greece these days, nobody’s investing in Detroit.”
Liberal Premier Kathleen Wynne is taking the opposite tack, seeking to stoke economic growth with stimulus spending to ensure the increased revenue needed to balance the books and pay down debt in years to come.
Ontario is carrying more debt than California yet has a higher Aa2 credit rating from Moody’s, thanks to the broad powers it enjoys over its own revenue. Standard & Poor’s has a negative outlook on its AA- rating for Ontario, raising the possibility of a cut and the higher borrowing costs that go with it.
Investors who lend to the province don’t seem worried.
“If the bond market is worrying about it, it’s not sending yellow signals just yet,” said Aubrey Basdeo, head of Canadian fixed-income in Toronto at BlackRock Inc., the world’s biggest money manager. “Would you rather be in Greece or Ontario? Definitely Ontario.”
Ontario has sold C$5.7 billion in bonds since the election was called May 2, almost half of the total its sold all year, according to data compiled by Bloomberg. At its latest sale of 30-year notes, the province locked in lower borrowing costs than neighboring Quebec.
Last year, the province’s effective interest rate on all its debt was 3.9 percent, the lowest in at least 23 years as it replaced old bonds with new ones with lower interest rate payments, according to budget documents.
“I’m not worried because Ontario is big in the Canada index, plenty of buyers, and if they get in trouble they would get federal support,” said Scott DiMaggio, director of Canadian fixed income at AllianceBernstein LP in New York, by e-mail June 9. “I would guess as long as they have a plan to stabilize or decrease the debt path, the market and rating agencies would give them time.”
The province’s borrowing advantage over Quebec has narrowed over the course of the election, with investors asking for only six basis points more in yield to hold Quebec’s most recent 10-year bond compared with Ontario’s yesterday. The difference was 19 basis points as recently as March 12, according to data compiled by Bloomberg.
The most important factor for leaders to keep the debt from becoming a problem will be growth, and whether Ontario gets it will largely depend on factors outside the province’s control, BlackRock’s Basdeo said.
Ontario’s economy is tilted towards manufacturing and U.S. exports, so if economists’ forecasts for a weaker Canadian dollar and a pickup in U.S. growth come to pass,then Ontario should get a revenue boost that will make closing the deficit and paying down debt easier, Basdeo said.
Government debt’s ability to soak up revenue is a familiar story to Canadians who remember the early 1990s, when a lofty national debt load prompted S&P to downgrade the country.
Ontario went through a downgrade of its own in 2012 by Moody’s. The province’s net debt per capita of C$19,881 last year, according to budget documents, is comparable to Canada’s C$19,956 per person figure in 1995, the year then Finance Minister Paul Martin began tackling the deficit, according to International Monetary Fund data.
The province’s ability to pay off its debt is better today than Canada’s in 1995. The province estimated its ratio of net debt to gross domestic product at 39 percent last year. Canada’s was 71 percent when it peaked in 1995, the IMF data shows.
AllianceBernstein’s DiMaggio said he wouldn’t be concerned about Ontario until the debt-to-GDP ratio topped 60 percent.
“Even if the absolute number is big the ratio is reasonable,” said Jonathan Lemco, senior sovereign-debt analyst at Valley Forge, Pennsylvania-based Vanguard Group Inc., the biggest U.S. mutual fund company, who says his funds own Ontario bonds and if given a choice he’d still favor it over Quebec. “It’s one of the strongest economies in the world. Priority one is improving economic growth in the province. Debt matters, but growth is more important.”
Since the great recession global central banks have kept interest rates low to stimulate economic growth and signs are emerging it is starting to pay off, causing market interest rates, and yields to rise.
Yields on Canada’s 10-year benchmark bond, which Ontario uses to price its own 10-year securities, are expected to rise to 3.01 percent by the end of the year from 2.35 percent now, according to the weighted average of 20 economists surveyed by Bloomberg.
That’s still relatively low compared to the 5.3 percent average yield over the last 50 years, data compiled by Bloomberg show.
“If everything was due in the next two years, then I’d be a lot more worried about an interest rate increase,” said Michael Yake, the Moody’s analyst covering Ontario. “An interest rate increase today is not going to have a direct, 100 percent impact on what Ontario has to pay. It will take some time to work its way in.”