Key Points

• Ontario’s debt is rated by four major international credit rating agencies,[1] based on their assessment of the province’s economic and financial outlook and future risks.[2] These credit ratings represent the agencies’ opinions on the ability of Ontario to meet its debt-related financial obligations.
• Since the FAO’s last Update on Ontario’s Credit Rating, Moody’s downgraded its credit rating from AA to AA- and revised its outlook from negative to stable. Fitch maintained its AA- rating but also revised its outlook from negative to stable. The other two agencies did not change their rating or the outlook on their rating.
• On average, Ontario’s credit rating is now lower than the ratings for Quebec, Nova Scotia, Alberta, Saskatchewan and British Columbia, but still higher than Manitoba, New Brunswick, Prince Edward Island and Newfoundland and Labrador.
• While Ontario benefits from a strong, investment-grade credit rating,[3] the four agencies cite several concerns regarding Ontario’s credit outlook, including the Province’s elevated debt burden, the prolonged and on-going period of budget deficits, and an outlook for relatively moderate economic growth compounded by heightened risks.

Ontario’s Credit Rating Modestly Weaker

Based on a standardized scale[4], Ontario’s debt is currently rated AA- (4^th highest rating) by three of the four credit rating agencies and A+ (5^th highest) by S&P. In general, the agencies continue to rate Ontario as an ‘extremely strong’, investment-grade borrower. Since the FAO’s last Update on Ontario’s Credit Rating,[5] Moody’s lowered its Ontario rating by one notch, from AA to AA-, while also revising its outlook from negative to stable. Fitch maintained its AA- rating for Ontario but revised its outlook for the Province from negative to stable.

Over the past year, the yield on 10-year Ontario government bonds fell by 100 basis points to 2.1 per cent, in line with a similar decline in Government of Canada 10-year bond yields.[6] As a result, the spread between Ontario and Government of Canada 10-year bond yields has remained relatively stable, suggesting that the risk profile of Ontario debt relative to Canadian government debt has not shifted significantly.

The four agencies note that Ontario’s strong credit rating is supported by the Province’s large and diversified economy, a high degree of fiscal flexibility and an effective borrowing and debt management program. However, the agencies also identify several challenges for Ontario’s credit rating including an elevated debt burden, a prolonged and on-going period of budget deficits and an outlook for relatively moderate economic growth compounded by heightened risks.

Elevated Debt Burden

With net debt at $338 billion in 2018-19, Ontario continues to be the most indebted Canadian province and the most indebted sub-sovereign borrower.[7] Consistent with the FAO’s fiscal projections[8], the agencies expect Ontario’s debt-to-revenue ratio (and other related measures of the Province’s debt burden) to peak in the next year before gradually declining over the extended outlook. However, Ontario’s net debt-to-GDP ratio will remain well above historical levels prior to the 2008-2009 recession due to the borrowing required to finance budget deficits until 2022-23.

Some of the agencies acknowledge that the current period of low interest rates has partially eased the pressure on the Province’s borrowing program and interest expense.[9] However, there is the risk that large borrowing requirements in the next few years combined with a steeper-than-expected increase in interest rates could accelerate the accumulation in debt and put downward pressure on the Province’s credit rating.

Prolonged Period of Deficits and the Challenge of Spending Restraint

Ontario has recorded on-going budget deficits each year since 2008-09, with continued projected deficits until 2022-23. The agencies noted that this prolonged period of deficit financing has made the path to a balanced budget more challenging by increasing the accumulated deficit and debt burden. The agencies view the lower capital spending plan[10] in the 2019 budget and a planned return to balance by 2023-24 as a positive direction for the province’s credit health. However, population growth, aging and previous fiscal constraint will make it challenging for the government to meet its current spending targets, particularly in the context of slower economic growth.

Weaker Economic Outlook and Heightened Risks

Ontario’s economic outlook has weakened over the past year, leading to lower expectations for revenue growth. The agencies stress that the province’s credit rating would face downward pressure if economic growth was weaker than expected.

Ontario faces heightened risks that could contribute to a potential economic downturn occurring in the near term.[11] The agencies point to structural barriers to Ontario’s revenue growth, including heavily indebted households and an uncertain trade and investment environment which could limit the government’s flexibility on tax policies. Since the government’s budget plan depends heavily on sustained economic growth and success in limiting spending, the agencies agree that an economic downturn or a significant departure from current spending plans could lead to a deterioration in Ontario’s credit health.

Ontario’s Rating Slips Behind Quebec and Nova Scotia

Ontario’s rating remains in the middle of the pack compared to other Canadian provinces, all of which have very strong, investment-grade credit ratings. However, over the past year, Ontario’s average rating has slipped below that of Quebec and Nova Scotia due to the downgrade of Ontario’s rating by Moody’s and an improvement in Nova Scotia’s rating.

Average Credit Rating by Province as of October 2019[12]

Jay Park           
Economist        
jpark@fao-on.org

Zohra Jamasi                
Senior Economist                       
zjamasi@fao-on.org

Paul Lewis
Director
plewis@fao-on.org

Financial Accountability Office of Ontario
2 Bloor Street West, Suite 900
Toronto, Ontario M4W 3E2

Media queries, contact: Victoria Coste, 647.519.5161 or email vcoste@fao-on.org.

About the FAO

Established by the Financial Accountability Officer Act, 2013, the Financial Accountability Office (FAO) provides independent analysis on the state of the Province’s finances, trends in the provincial economy and related matters important to the Legislative Assembly of Ontario. Visit our website at http://www.fao-on.org/en/ and follow us on Twitter at https://twitter.com/InfoFAO.

Appendix

Background on Credit Rating Agencies

Credit rating agencies are private, for-profit companies which assign a credit rating to the debt of governments or corporations. The credit rating is an assessment of the borrower’s credit risk and reflects the borrower’s ability to make interest payments as well as repay the original debt. A credit rating is a relative measure of the likelihood of default by a borrower, based on economic and financial forecasts and an assessment of future developments and risks. The factors that go into a government’s credit rating can be divided into five broad categories^[13]:

1. economic conditions;
2. fiscal performance;
3. financial and debt position;
4. management quality and institutional strengths; and
5. influence of intergovernmental relationships and fiscal arrangements.

Rating agencies also typically assign “outlooks” to credit ratings.  The outlook of a credit rating indicates the likely direction of a borrower’s credit rating over the next two years. An outlook can either be stable, negative or positive. A stable outlook indicates that the borrower’s rating, all else equal, is unlikely to change in the short-term, while a negative or positive outlook indicates that the rating is likely to be lowered or raised over the same period. A change in a credit rating outlook does not necessarily indicate a change in the current credit rating.

Debt issuers (governments and corporations) are charged a fee by credit rating agencies to issue a credit rating, while investors (purchasers of debt) also pay a fee to access credit reports.  The critical importance of an agency’s reputation ensures that credit rating agencies strive to provide an unbiased and accurate assessment of credit risk.

The main motivation for a debt issuer to acquire a credit rating is that the rating helps the issuer raise funds in capital markets. Receiving an investment-grade credit rating is valuable as it attracts and expands the number of investors willing to lend to the issuer in addition to substantially lowering the cost of borrowing.