Ontario should be worried about its debt

The stage is set for Ontario’s debt to quickly become unsustainable

Livio-di-MatteoTHUNDER BAY, ON, Apr 21, 2014/ Troy Media/ – Ontario provincial net debt – estimated at $272 billion in 2013 – is the largest in Canada. If looked at in either per capita terms or as a share of GDP, Ontario’s debt is the second highest amongst the provinces. While Ontario accounts for just under 40 per cent of the country’s population, it accounts for almost 50 per cent of provincial net debt.

And given that Ontario’s net debt to GDP ratio is currently at about 39 per cent, one might argue that Ontario is just fine. After all, Ontario is nowhere near the 90 per cent net debt to GDP ratio that is sometimes remarked to be a crucial tipping point when it comes to the relationship between debt and growth. Moreover, if Ontario was a household, having a debt level just over one third of its income would be seen as quite sustainable given the levels of household debt many Canadians are carrying. As well, it can be argued that Ontario is a wealthy province in a wealthy country that has excellent credit ratings and is able to borrow at low interest rates, making its debt very manageable.

But . . .

While Ontario’s net debt to GDP ratio is below 40 per cent, it may continue to rise over the next few years given the projected continued slow growth of its economy. As well, there is the anticipated increase in spending in this spring’s budget that will delay balancing the books. While the provincial government maintains it will balance the budget by 2017, recently leaked documents suggest that there are plans to boost spending by over $5 billion in the May 1st budget, adding further to the debt pile.

Second, while Ontario’s net debt to GDP ratio appears low, the fact is that there are three levels of government in Canada but only one taxpayer. For Ontario, if one considers federal, provincial and municipal debt levels together, the net debt to GDP ratio Ontario taxpayers face is now well over 70 per cent. While this may not be a problem of Greek proportions, it suggests that, when it comes to debt, the whole picture for Ontarians may be more complicated than its separate parts.

Third, using the net debt to GDP ratio as an analogy to household debt income ratios may not be the best comparison. While GDP is the province’s income, unlike a household, not all of that income is available to the provincial government to spend as it pleases. The provincial government must impose taxes on provincial income and raise output to raise its revenue. Thus a more appropriate indicator is the provincial net debt to provincial government revenue ratio. In 2012-13, which stood at about 222 per cent. Compare this to the debt to income ratio of the average Canadian household, which has reached 160 per cent.

Fourth, as for the low interest rates that enable Ontario to finance its large appetite for debt, they cannot remain low forever. At some point, they will start to rise and growing debt service costs will crowd out other government spending. At present, debt service already costs Ontario taxpayers about $10.6 billion making it the fourth largest expenditure item after health, education and social services. A one-percentage point increase in interest rates could add billions of dollars in debt service costs by 2017.

Add to all this the intangible of investor perceptions of Ontario as a credit risk and the stage is set for the potential for Ontario’s debt to quickly become unsustainable. Ontario is being perceived as a more risky prospect compared to the federal government when it comes to the international bond market. Whereas in 2007 the spread on Ontario and Canada 10-year bonds was about one quarter of 1 per cent, the spread has grown to about a full percentage point. Even though interest rates are still low, the fact that the gap between what Ontario and Canada pays has grown since 2007 suggests some concern about Ontario’s fiscal future.

Ontario has built a large stock of public debt that to date has been manageable mainly because of the historic lows on the interest rates it has to pay. A return to either recession or higher interest rates may well push the province’s finances over the edge. Ontario should be more worried than it is.

Livio Di Matteo is Professor of Economics at Lakehead University.

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