This report does not constitute a rating action.
Key Takeaways
- Current macroeconomic hurdles and increased operating spending will thwart the gains made on operating surpluses and Canadian provincial debt levels in fiscal years 2022 and 2023 (ended March 31).
- With improving fiscal performance and a return of operating surpluses, borrowing will primarily fund the refinancing of maturing debt and capital investment.
- In the medium term, higher operating and capital spending of provincial utilities, coupled with hydrological variability affecting revenue performance, could increase provincial borrowing beyond our forecast.
- S&P Global Ratings expects that total provincial and municipal debt will rise by 2.5%-3.0% annually in the next two years, reaching C$1.2 trillion by the end of fiscal 2026.
- Debt issuance will remain bond based, dominated by fixed-rate provincial bonds issued in the domestic market.
We expect the Canadian economy will continue to slow in 2024, at the beginning of a drawn-out, sluggish growth path for the next several quarters as the cumulative lagged effect of higher interest rates and a slowdown in global demand work through the economy. S&P Global Ratings Economics forecasts growth of 0.8% in 2024 and 1.4% in 2025 (see "Economic Outlook Canada Q1 2024: Growth Is Set To Continue Slowing," published Nov. 27, 2023, on RatingsDirect). We expect that the economic recovery for most provinces will converge toward the national level. With the relatively robust price of oil and natural gas, provinces with a concentration in these and other commodities, in particular, will see stronger economic growth than peers.
Borrowing Will Keep Climbing Before It Plateaus In 2026
After factoring in recent economic hindrances, S&P Global Ratings expects gross borrowing and total debt will rise through fiscal 2026 as Canadian local and regional governments (LRGs) contend with higher operating costs, such as wages and cost of goods, and larger capital investment plans, in conjunction with lower tax revenues (for provinces, in particular). We still expect debt burdens will moderate back to historical levels, climbing below nominal GDP since 2021 (chart 1). This is particularly true for Canadian provinces, which remain among the largest issuers globally. We project that total LRG debt will represent about 40% of Canada's GDP in 2024, which is significantly higher than that of other federal nations, such as Australia or Germany.
Chart 1
As of calendar year-end 2023, all Canadian provinces had provided their midyear updates to budgets they released last spring. The updates incorporated the impact of inflation, recent monetary policy decisions, and expected near-term economic difficulties through a slight downward revision to real GDP growth forecasts. A relatively modest decline in consolidated provincial operating revenues and a more notable increase in year-to-date operating expenses have led to fiscal results that have underperformed forecast expectations, leading to downward revisions in current year estimates for operating and after-capital balances. As a result, based on midyear fiscal 2024 provincial updates, we expect that gross borrowings for Canadian LRGs in fiscal 2024 will total about C$130 billion, about C$7 billion more than initially expected when provincial budgets were first released in spring 2023.
Conversely, municipal finances remained relatively stable in the past year. In the next 12-18 months, we expect that, generally, local governments will raise property taxes to offset the impact of high inflation on wages and the cost of goods. We also expect that municipalities will face higher capital spending on maintenance and on growth to support the needs of an expanding population (chart 2). If affordability constraints start to limit municipalities' practical revenue-raising flexibility in this higher-cost environment, we could also see a moderate draw on resources or the use of debt without a commensurate rise in taxes or fees.
Chart 2
On a net basis, we expect total net new borrowings of about C$40 billion in fiscal 2024 compared with more than C$1.5 billion in consolidated debt repayments recorded in fiscal 2023. In the next two fiscal years, we project that total provincial and municipal debt will rise by 2.5%-3.5% annually, to reach about C$1.2 trillion by the end of fiscal 2026. Revenues will continue to moderately increase at a slower rate in fiscal 2025 (at less than 2%) and will outpace growth in tax-supported debt in fiscal 2026. As a result, we project that relative to operating revenues, tax-supported debt will remain stable in the next two years (chart 3).
Chart 3
Debt Composition Will Be Unchanged, And Structural Factors Will Drive Borrowing Needs
The overwhelming majority of Canadian LRG borrowing is through public bond markets, largely domestic, and mostly at fixed rates. Private-placement financing is typically only a small and infrequent component of total bond market financing and bank lending is minimal. We do not expect any meaningful change in the sources of funding in the next two years. Of note, even given climbing debt levels and interest rates, we expect interest expense will rise modestly but remain relatively stable at about 5% of operating revenues, given that about 11% of provincial debt, on average, is exposed to variable interest rates, and about 10%-12% of provincial debt stock is refinanced annually.
At more than 90% of total LRG debt, provincial debt dominates. Canadian provinces are not bound to any fiscal framework by the federal government. In addition, provincial service-delivery responsibilities, such as health care and education, are significantly more onerous than those of municipalities and, as a result, total provincial debt is larger and has risen faster than that of the municipalities.
Multiple economic and fiscal shocks, such as the 2008 financial crisis and the fall in the price of oil in 2014-2015, have pushed up most provincial debt burdens over the long term. For some provincial governments with electric utilities, historically large investments in new generation capacity have also further increased their debt burdens. More recently, since the COVID-19 pandemic, provinces have significantly increased spending on health care delivery and health-related capital investment, contributing to the rise in debt burdens (chart 4).
Chart 4
Despite the provinces' relatively high debt burdens, in our view, a solid institutional framework, healthy regional economies, robust financial management, and strong access to external liquidity support our ratings on the provinces. We expect that, in contrast to previous expectations, the provinces' borrowing requirements will rise in the current fiscal year while the economy faces near-term hurdles and then level off as real GDP growth improves, budgetary performance strengthens, and financial management remains focused on fiscal sustainability. On a net basis, we project most provinces will borrow less than they did before the pandemic, with Ontario and Alberta showing the largest drops in new borrowings compared with 2016 levels. As a result, we expect debt burdens for these two will remain stable or rise modestly. Conversely, the growth in new debt for Quebec and British Columbia is the most pronounced of the provinces, accounting for nearly all of total new borrowings in the next two fiscal years (chart 5).
Chart 5
Municipalities' Budgets Are On Steadier Ground
Municipal operating results are more insulated from economic shocks. We expect that municipal budgetary performances will, generally, remain strong in the next two years and that any increase in municipal borrowing requirements and debt burdens will be moderate and related to funding capital investment.
Provinces impose fiscal frameworks on municipalities through their respective Municipal Acts. Legislation requires that municipalities balance their operations and issue debt only for capital purposes, the bulk of which is allocated to infrastructure. In addition, debt issued by municipalities is typically amortizing. As a result, Canadian municipalities' debt burdens compared against operating revenues are generally materially lower than those of the provinces. Some fast-growing municipalities, however, have substantial capital-intensive local infrastructure responsibilities, such as water, sewer, and transit networks. Only one municipality, Montreal, is among the top 10 most indebted Canadian LRGs.
We assess the institutional framework of Canadian provinces as very predictable and well balanced, which reflects some of these structural challenges while acknowledging the institutional strengths of the system. This is somewhat weaker than our view of the framework for municipalities, which we assess as extremely predictable and supportive due to their lower spending needs, higher taxing flexibility, and generally strong and predictable support from higher tiers of government (see "Institutional Framework Assessment: Canadian Provinces," March 14, 2022, and "Institutional Framework Assessment: Canadian Municipalities," June 1, 2022).
Despite the provinces' relatively high debt burdens, in our view, provincial ratings are supported by a solid institutional framework, healthy regional economies, sound financial management, and strong access to external liquidity. We expect that, compared with previous levels, the borrowing requirements of the provinces will moderately rise in the current fiscal year while the economy faces near-term hurdles and then level off as real GDP growth improves, budgetary performance strengthens, and financial management remains focused on fiscal sustainability. In the medium term, we will continue to monitor the evolution of capital investment programs at provincial electric utilities, as recent announcements would suggest higher borrowing needs that will need to be either debt financed provincially and on-lent to the utility company or guaranteed by provinces. In the next two years, we expect that the borrowing needs of the three largest provinces, British Columbia, Ontario, and Quebec, will continue to dominate Canadian LRG borrowing.
Related Research
- Subnational Debt 2024: Fiscal Policy Differences Influence Borrowing In Developed Markets, March 4, 2024
- Subnational Debt 2024: France, Adaptability Will Remain Key Amid Sluggish Growth, March 4, 2024
- Subnational Debt 2024: Spain (Debt Absorption Scenarios): All could benefit, with some more than others, March 4, 2024
- Subnational Debt 2024: Australian States' Debt Rift Deepens, Feb. 29, 2024
- Subnational Debt 2024: Chinese Governments Reach Their Limits; Other Emerging Markets Taper Borrowing, Feb. 29, 2024
- Subnational Debt 2024: Global LRGs Can Handle Rising Interest Expenses, Feb. 29, 2024
- Subnational Debt 2024: Focus on debt sustainability, Feb. 29, 2024
- Subnational Debt 2024: Germany, Subdued Fiscal Performance Suggests Borrowing Will Rebound, Feb. 29, 2024
- Subnational Debt 2024: Infrastructure Spending Succumbs To Economic Slowdown, Feb. 29, 2024
- Subnational Debt 2024: Spain: Lower borrowings, but bond issuances recover, Feb. 29, 2024
- Subnational Debt 2024: Switzerland, Resilient Budget Surpluses Should Enable Further Deleveraging, Feb. 29, 2024
- China City Governments Risk Falling Into A Debt Trap, Feb. 20, 2024.
| Primary Credit Analyst: | Bhavini Patel, CFA, Toronto + 1 (416) 507 2558; bhavini.patel@spglobal.com |
| Secondary Contacts: | Adam J Gillespie, Toronto + 1 (416) 507 2565; adam.gillespie@spglobal.com |
| Dina Shillis, CFA, Toronto + 1 (416) 507 3214; dina.shillis@spglobal.com | |
| Sarah Sullivant, Austin + 1 (415) 371 5051; sarah.sullivant@spglobal.com | |
| Research Contributor: | Ekta Bhayani, CRISIL Global Analytical Center, an S&P affiliate, Mumbai |
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