Bond investors and rating agencies have given a conditional endorsement of Ontario's austerity budget, but both groups are closely monitoring the fallout, fearful that Premier Dalton McGuinty doesn't have the political muster to pass his proposals.
For now, the government can take heart that the investment community is on board with the plan to find $17.7-billion in cost savings over the next three years. Ontario bond yields ticked lower on Wednesday, signalling that investors aren't looking to abandon their debt holdings. And rating agency DBRS Ltd. also expressed relief, describing the fiscal plan as "encouraging but ambitious."
The early support is key because both groups have the power to influence the interest rate that Ontario pays to borrow funds.
The province has already announced plans for $35.6-billion of new debt this year, and even small movements in interest rates have a big impact on financing costs. A rate increase of just 0.5 percentage points would add another $178-million in annual interest costs.
Yet investors and credit raters remain on edge. To achieve the budget's far-reaching goals, Mr. McGuinty will have to wrestle wage concessions from powerful unions and steer his budget through a legislature he controls with only a minority government.
Provincial NDP Leader Andrea Horwath has described the budget's attempt to restrain executive pay as a "half measure."
"The key issue now, whether you're a rating agency or a bond investor, is: Can the government actually get its plan implemented?" said Warren Lovely, a government debt strategist at CIBC World Markets.
And if it does pass, DBRS noted that "the plan continues to rely on some bold assumptions, especially with respect to future growth in public sector compensation and health care costs."
Ontario is desperate to avoid a downgrade of its credit rating. Moody's Investors Service, the rating agency that slapped a "negative" outlook on Ontario's debt in December, remains concerned about economic growth, the main driver of the government's tax revenues. Jennifer Wong, assistant vice-president and lead analyst for Ontario at Moody's, said Wednesday that a downgrade is still a possibility. DBRS plans to release its next Ontario rating in about one month.
Debt rating agencies will now spend the next few weeks meeting with the Ontario government to get more details on how the government plans to execute the budget, and achieve the fiscal austerity measures it has set out.
"We wanted to make sure the province had some measures highlighted to especially slow down expenditure growth because that's the primary measure that they will be pursuing to restore fiscal balance," said Eric Beauchemin, managing director of public finance at DBRS.
Still, Mr. Lovely said the market is clearly giving Ontario the benefit of the doubt – at least for now. "They're batting 2-for-2," he said of the government's past two budgets, which both beat their targets. "So far they have stuck to their plan," he said.
Despite the current optimism, investors were much more skeptical just a few days ago. Heading into the budget release, some had even shorted Ontario bonds, a manoeuvre that would have made money if the budget failed to show a plan to slash the deficit sharply. After the budget was released, the short bets were unwound and Ontario bonds were purchased to cover the positions, helping to send yields lower. (Bond prices and yields move in opposite directions, so when investors started buying, sending prices higher, the corresponding yields dropped.)
Even though bond yields fell slightly Wednesday, the amount by which they dropped – 0.02 percentage points – was modest. Ontario five-year bonds now yield 2.23 per cent, 10-year bonds 3.10 per cent and 30-year bonds 3.59.
Past budgets didn't offer much clarity on how the province planned to meet austerity targets. "This year's budget is very different from the previous in terms of the extent of details it provides regarding the return to fiscal balance," Mr. Beauchemin said.
However, the details only go so far out. "They've shown quite a bit for the next three years," said Mark Chandler, fixed-income strategist at RBC Dominion Securities "There are still question marks beyond that."