Thoughts

April 10, 2024 | 12:01

Provincial Finances: The Shine is Wearing Off

Economist

Robert Kavcic

Senior Economist and Director
Economics

Robert has been with BMO Capital Markets since 2006. He plays a key role... (Read more)

Robert Kavcic

Senior Economist and Director
Economics

Robert has been with BMO Capital Markets since 2006. He plays a key role... (Read more)

The FY24/25 provincial budget season is complete, and the group has begun to backslide after a few years of fiscal progress. The combined provincial budget deficit is on track to widen to $28 billion (0.9% of GDP) in FY24/25 from $10.6 billion in FY23/24, with the pressure coming on multiple fronts. Revenue growth, which has been robust thanks to the post-pandemic economic recovery and high inflation, has cooled notably amid sluggish growth. Meantime, program spending growth is strong, partly reflecting upward pressure on public-sector wages, while interest costs are on the rise. Not to be outdone, torrid population growth is stressing infrastructure, necessitating large capital spending programs.

Here are some quick takeaway themes:

Most balanced budgets are gone: Alberta and New Brunswick are the last remaining provinces in the black. Compare that to two years ago when eight of 10 reported positive balances. Most deficits are still relatively small at less than 1% of GDP, but a few (B.C. and Quebec) are pushing closer to 2%. Six of 10 provinces will see their budget balance weaken this fiscal year.

Cautious growth estimates: The provinces underestimated growth in 2022 and 2023, leading to persistent upside surprises, as the economy recovered faster than they thought, and then proved more resilient than they thought. But, 2024 estimates have now been scaled down, which has impacted revenue growth. Since nobody said economic assumptions were easy, a run of firm economic data now suggests that the provinces have gone too far to the downside with their outlooks—perhaps that’s a silver lining in a tough overall budget season.

Net debt ramping up: Total provincial net debt will jump more than $65 billion in FY24/25, a record annual increase and more than twice the underlying budget deficit. That will leave the net debt-to-GDP ratio at 30.6%, up a percentage point from a year ago, but right in line with pre-COVID (FY19/20) levels. Biggest increase? B.C., up 3.8 ppts year-over-year, although still relatively low. Biggest decline? New Brunswick, down 1.0 ppts year-over-year and a hefty 11 ppts from FY19/20.

Big borrowers: Total borrowing will likely rise to above $130 billion, the largest tally on record outside the COVID year (just over $160 billion). That speaks to large-scale capital spending beyond the operating budget, but also accounts for some provinces planning to pre-borrow ahead of some large 2025 maturities. Debt service costs, however, are still well contained at just over 6% of revenue.

Spending in the policy mix: There were few major policy initiatives on the tax front this year, with net tax changes/transfers at less than $2 billion. Recall that Quebec alone sent out roughly $3.5 billion in direct support payments in FY22/23. The majority of the action was in program spending and infrastructure in response to population growth. Total program spending growth looks to rise more than 4% this year, after a number of provinces backfilled FY23/24 with well above-budget spending levels.

Bottom Line: The provinces are still in good fiscal shape, but the lustre and steady positive momentum is wearing off. After a big post-COVID revenue boost, the group now faces the reality of a slower economy, public sector wage growth, higher interest rates and stress on infrastructure. Those issues were clear this budget season.