Canada’s governments brace for looming debt crunch

Canadian governments are bracing for rising debt-servicing costs, attempting to lock in low interest rates before the inevitable rise forces unpopular decisions on spending and taxes.

After years of deficit spending, Ottawa and some provinces are just starting to climb back into annual surpluses. Now, the country must grapple with hundreds of billions in accumulated government debt.

This year’s budget season revealed governments are taking steps to lock in current low interest rates. The question is whether they are doing enough.

Since the recession hit in 2008, Ottawa has added more than $150-billion to the national debt. Provinces piled on a further $217-billion.

The federal government is currently weighing whether to issue another round of 50-year bonds. It started that practice last year, raising $3.5-billion with yields below 3 per cent. Meanwhile Canada’s two most indebted provinces – Quebec and Ontario – are stretching out the average length of maturity of their debt. The average maturity of Ontario’s debt is now 14 years, up from eight years prior to the recession.

Nova Scotia now has more than half of its debt maturing in 15 years or more.

In dollar terms, the size of all of that post-recession debt is staggering. Some fear that when interest rates return to normal, governments will face crippling debt-servicing costs. But the scope of the problem is a matter of significant debate in policy circles.

Experts do agree that whether or not government debt is a serious problem depends on where you live. Government books in Western Canada are relatively healthy. East of Manitoba however, debt is already forcing hard choices.

The debt picture

Political debate over government finances is typically focused on the annual bottom line, which shows whether there is a annual surplus or a deficit. Economists say the often overlooked – but far more important figure – is the size of government debt in relation to the size of the economy.

As a percentage of gross domestic product, the net debt of all provinces and territories has grown to 28.6 per cent in 2013-14 from 20.5 per cent in 2007-08.

The federal debt grew to a peak of 33.3 per cent in 2012-13 from 29.2 per cent in 2007-08. That’s nowhere near the 67.1 per cent debt levels reached by Ottawa in 1995-96, when The Wall Street Journal warned that Canada was at risk of hitting the “debt wall.”

The size of the federal debt has already started to decline, reaching 32.3 per cent in 2013-14. The 2015 budget forecast that the federal debt-to-GDP ratio will reach prerecession levels by 2017 and decline further to 25 per cent by 2021.

The debt picture among the provinces varies dramatically. Alberta and Saskatchewan are currently facing hard times owing to low oil prices, but they are the darlings of Confederation when it comes to low debt. Alberta had no debt at all as of last year.

The real debt troubles can be found in Central and Atlantic Canada. Quebec’s net debt is the largest, at 50 per cent of GDP, followed by Ontario, at 38.4 per cent, and Nova Scotia at 37.7 per cent, using figures for 2013-14.

While Quebec announced a balanced budget this year, Ontario’s deficit was up slightly to $10.9-billion last year. Ontario insists the deficit will be erased by 2017-18.

Provincial governments are responsible for programs such as education and health care that can affect people more directly than federal programs. Spending restraint is easier said than done. The 2015 budget season has coincided with student protests in Quebec, New Brunswick and Nova Scotia, while Ontario is dealing with labour unrest from teachers’ unions.

Many provinces have also been negatively affected by a recent change to the federal health-transfers formula. The move to per-capita funding won out over arguments that the average age of provincial populations should be factored into the equation. Some of the most indebted provinces also face the most challenging demographics, with a shrinking ratio of younger workers to cover the costs of growing numbers of older citizens.

The Parliamentary Budget Officer has said that while federal finances are sustainable over the long term, the provinces are facing structural shortfalls that will demand spending cuts, higher taxes or both.

University of New Brunswick economics professor David Murrell said the return to surpluses in Ottawa will likely rekindle pressure from the provinces for more generous transfers.

Shrinking deficits, growing debt

Provincial finance ministers are quick to pat themselves on the back over shrinking deficits and balanced budgets, but economists urge Canadians to view these claims with a bit of skepticism. Accounting methods vary across the country, making comparisons difficult.

Unlike the federal government, provinces generally present two sets of books: an operational budget and a capital budget. Boasts of balanced budgets are in reference to operational spending. A province’s overall debt could still be rising on the capital side even though the government is in an operational surplus.

Supporters of this accounting method – including Calgary Mayor Naheed Nenshi – argue that it separates good debt from bad debt: Using debt to build public assets such as roads and bridges is better than slipping into the red to pay for public service salaries and other operational costs.

Critics such as tax-policy expert Jack Mintz have warned this approach allows provinces to play “hide the deficit.” Charles Lammam, director of fiscal studies with the Fraser Institute, a conservative think tank that regularly warns about the dangers of mounting government debt, agrees that claims of improving budget balances can be misleading.

“This is a real problem in places like British Columbia and Ontario,” he said. “It doesn’t seem like the growth in government debt will let up.”

Mr. Lammam’s research found that Canadian governments – including municipalities – spend more than $60-billion a year servicing debt, which is about the same as the entire cost of providing primary and secondary education across the country. Ontario’s recent budget said a one-point increase in interest rates would cost the government $400-million.

“There’s a real risk that provinces like Ontario, provinces like Quebec, can be subject to this very negative situation where they’re paying even more to service their outstanding debt,” he said.

The new debt debate

Rising urbanization is leading to increasing pressure on governments to spend big on infrastructure, especially during a federal election year. While borrowing to build transit and highways is generally considered good debt, it’s still debt.

The 2015 budget could have major implications for the debt debate. Ottawa announced a new public transit fund that will eventually be worth $1-billion a year, but it would be structured around helping municipalities fund debt-financed projects over a 20-to-30-year period.

But that raises questions as to which level of government is best positioned to take on the billions in debt required to address the country’s infrastructure deficit.

Ottawa Mayor Jim Watson noted that municipalities pay higher interest rates than the federal government.

“Ideally, it would be the federal government’s responsibility to provide the funding as opposed to the city going to the markets,” he said.

Former Bank of Canada governor David Dodge is among those who say the country’s more pressing deficit is on infrastructure and that it would be better to spend more now as long as current debt loads can remain stable as a share of the economy.

“I don’t think there’s a government debt problem in this country at all,” he said, suggesting Ottawa is better placed than provinces or municipalities to secure long-term financing at cheaper rates. “We maybe have built the debt in the wrong place.… This is a long-standing problem in this country. We delegate the borrowing for government capital to the least credit-worthy government, and we can solve that.”