With Ontario tabling its 2016 budget on Thursday, it’s important to keep in mind there are risks to the provincial government’s promise of balancing its budget by 2017/18. One risk that does not receive much attention, but could jeopardize the plan to eliminate the deficit, comes from a higher-than-expected rise in interest rates (which affect the cost of government borrowing).

During this era of record low interest rates, governments in Canada have accumulated significant debt, which could pose serious risks to their fiscal plans if interest rates begin to rise and return to normal levels, causing debt interest payments to increase.
    
It’s true that the government has shifted the structure of its debt toward longer term maturities as a means to postpone the need to refinance their debts at higher interest rates, if rates were to rise. But, this should not lull the government into a false sense of security—eventually, all debt has the potential to be exposed to higher interest rates.

A recent study by University of Calgary economics professor Jean-Francois Wen examines the interest rate risks facing the Ontario government, one of Canada’s most indebted provinces. It analyzes two scenarios: one where interest rates rise from a projected 3.8 per cent in 2017/18 to 4.5 per cent and another with hikes to 5.0 per cent.

In 2015/16, Ontario expects to spend $11.4 billion on debt interest payments—equivalent to 9.2 per cent of total revenues. If, however, interest rates rise faster than expected, Ontario’s annual interest payments on government debt could increase by between $409 million and $857 million in 2017/18.

This additional expenditure would make it more difficult for the government to meet its target of balancing the books by 2017/18. Given that the government’s plan is already precarious, and faces substantial risks on both the revenue and expenditure side of the ledger, the prospect of higher interest rates represents yet another reason Ontario’s plan to balance its budget may be in jeopardy.  

Aside from possibly sinking Ontario’s plan to balance its budget by 2017/18, higher interest rates would bring other costs to Ontario taxpayers. Specifically, it would result in a larger percentage of revenues going to service outstanding government debt rather than to important public programs, or perhaps even tax relief. In fact, Ontario’s “interest bite” (interest payments on debt as a percentage of revenues) could climb to between 9.7 per cent and 10.2 per cent by 2019/20.

Despite historically low interest rates, the province’s large public debt is already creating significant costs for Ontario taxpayers, who pay almost a billion dollars every month in debt interest payments. If interest rates go up, this burden could grow larger still.

The prospect of higher interest rates is one more reason the budget should take meaningful steps to balance the books and lay out a clear plan to rein in Ontario’s mountain of public debt.