August 19, 2022 | 13:24
Government Finances: Tide Change
Government Finances: Tide Change
The depth of summer usually brings a quiet period for government finances in Canada, but it’s also a good time to take stock of how things look heading into the busy fall fiscal update season. As it stands, both the federal and provincial governments are facing upside surprises to their near-term fiscal projections, thanks to higher-than-expected revenues. That should improve FY21/22 balances as final public accounts come in, and help drive positive revisions to FY22/23 projections for most jurisdictions. That said, we are now entering a much more challenging period for the economic outlook and, with built-in 2023 growth assumptions starting to look too high, peak upside fiscal surprises might be passing us by. Below we consider what this means for Ottawa and the provinces.
Federal finances coming in strong
Ottawa projected a $52.8 billion deficit in its FY22/23 budget, improved from $113.8 billion estimated for FY21/22 (ended in March)—there is likely some upside to both of those figures. For FY21/22, monthly budget tracking pegged the deficit at a more modest $95.6 billion. Revenues surged 14% in the year, while total spending fell sharply in the latter stages as pandemic-era support programs fully wound down (Chart 1). While these figures don’t always line up directly with official public accounts, and are still subject to adjustment, they highlight some room for improvement in the bottom line.
Meantime, a stronger handoff from last fiscal year will elevate the revenue base for FY22/23, while there are a number of other moving parts that will influence the budget balance. Ottawa assumed 3.9% real GDP growth for 2022, which now looks a touch high (BMO is at 3.4%)—that implies roughly $2.5 billion of downside risk. But, our GDP inflation forecast of 8.3% is now much stronger than Ottawa’s assumed 3.7% increase, which could add roughly $10 billion—this is one area where some extra inflation actually helps. Finally, interest rates are tracking higher, which could add around $5 billion to expenses. All in, there is modest upside to this fiscal year from economic developments since Budget 2022. Next year, however, the picture gets much cloudier, with net downside risk resulting from a weaker growth outlook and higher interest rates.
Provinces: It’s all relative
Downside risks to the growth forecast through 2023 are also going to permeate through provincial budget forecasts, with all provinces likely to revise down their 2023 real GDP growth assumptions, if our current view is any guide (Table 1). The downside ranges from less than 1 ppt in Saskatchewan and Nova Scotia, to as much as 2.5 ppts in Ontario. Similar to Ottawa, higher inflation will act as a cushion through nominal GDP, but the combination of higher interest rates and wider provincial spreads will add to expenses. The main takeaway is that most non oil-producing provinces will likely see upside to their FY21/22 results and some improvement to FY22/23 balances, but, their FY23/24 forecasts now face downside risk. Three key macro factors could shape relative performance:
Looking across the provincial landscape, we expect Alberta to outperform during the looming slowdown through 2023. While capital spending and job creation are not booming as they did during previous cycles, oil prices at current levels are highly supportive of cash flow, incomes and government revenues. For example, the Province assumed $70 for WTI this fiscal year, and a 79 US cent loonie (Chart 2). Based on recent levels, that implies as much as $10 billion of revenue upside versus the budget plan, all else equal. It’s a similar situation in Saskatchewan and Newfoundland & Labrador, but with less leverage to higher prices.
Housing is retrenching, and the most froth has accumulated in Ontario (Chart 3). Relative to long-run baseline growth in real home prices, smaller CMAs around the province are the most susceptible to a deep correction, and we are already seeing that on the ground. This will weigh relatively heavily on economic growth in Ontario through 2023 (where the share of GDP tied to residential investment is also relatively high). On the flip side, Alberta is an example where, after five years of declining prices leading into COVID, the market has just caught up to its long-term baseline. Other regions, such as B.C., Quebec and Atlantic Canada are frothy, but not to the extent of Ontario.
While the biggest impact of a prolonged housing correction would be through the broader economy, provinces also directly receive revenues from land transfer taxes. Ontario’s 2022 budget notes that a percentage point decline in the dollar volume of housing resales would cut $57 million in revenues from the $5.7 billion budgeted for FY22/23. The Province assumed a modest decline of roughly 2%, but the reality on the ground could leave the dollar volume down by as much as a third this year—that could have a direct fiscal impact in the $1-to-$2 billion range. B.C. budgeted $2.5 billion for property transfer tax revenues in FY22/23, and following a similar exercise suggests roughly $300 million of downside risk, a modest amount in part because of much more conservative assumptions for sales activity.
Movement of people among the provinces can highlight, and reinforce, relative economic strength, and right now there are some interesting trends in play (Chart 4). Ontario lost a record 37,000 people to other provinces in the year through 2022Q1, which is slicing 0.2 ppts from annual population growth—these are typically prime-age cohorts. Meantime, parts of Atlantic Canada are seeing record inflows, as families seek better affordability, adding almost a full percentage point to population growth across the region. Quebec is an interesting case too, where the province has stemmed decades of persistent outflows to other regions of Canada—flat readings there are actually a big win for the province.
Given the economic backdrop, it’s worth considering where relative stability and relative risk will be from a fiscal perspective. Chart 5 lays out the provincial fiscal landscape based on current budget deficit and net debt readings. It’s clear that, even before substantial incoming revenue upside, Alberta has made its way back to the best position in Canada based on these metrics. Given that the current slowdown will be characterized by an interest rate-led decline in housing and consumer spending activity, rather than a plunge in oil prices (as seen after 2014), Alberta should also be among the most insulated from downside risk.
At the other end of the spectrum, it’s clear that Ontario is most exposed to housing-related risk, and has also drifted to the weak end of the fiscal pack in recent years, with deficit and debt ratios now meaningfully higher than those in Quebec.
From a market perspective, Ontario remains the biggest and most liquid issuer, which always has value. But, Quebec (perhaps rightfully so) continues to trade through Ontario at the long end of the yield curve (Chart 6). In Alberta, much of the relative improvement has already been priced into spreads, but some value likely remains there. British Columbia is also notable at the wide end of its recent range, which reflects a pivot to more deficits and borrowing in that province.