Moody's report yet another warning sign for Ontario to act

A new report on provincial debts and deficits by Moody's, the international credit rating agency, is another piercing reminder of Ontario's serious fiscal challenges. Based on media accounts, the report warns that some provinces must take action to improve their public finances or face a possible credit downgrade. Ontario is the worst of the bunch.

No surprise here. Ontario's shaky government finances have generated a healthy dose of public scrutiny. But any time a prominent rating agency issues a warning sign about the state of provincial indebtedness, it's worth a closer look. A future downgrade could eventually lead to higher borrowing costs for government debt.

Moody's analyzes the ratio of provincial debt to revenue to gauge each province's capacity for managing debt. This is similar to how banks assess a family's ability to manage a mortgage. To know whether a household can safely make regular mortgage payments, the bank needs to know the family's annual income and its outstanding debt such as credit card bills, car loans, and lines of credit.

The results do not bode well for Ontario. Provincial debt amounts to 237.7 per cent of revenue - the highest ratio amongst the provinces. In other words, the total debt accumulated by the Ontario government represents almost two and a half years of revenues. Ontario's ratio is much higher than Quebec, the second most indebted province (189.5 per cent) on this metric.

Moody's conclusion about Ontario's fiscal troubles may sound familiar. The government's own commission (more commonly known as the Drummond report) sounded alarm bells back in 2012.

Even before the Drummond report, research published by the Fraser Institute highlighted the sorry state of Ontario's finances and the need for reform. A series of more recent studies has shown how badly Ontario's debt burden compares with other provinces and we've extended the analysis to include California, once the poster child for bad fiscal management. Compared to California, the situation in Ontario is worse on virtually any measure.

Of course, Ontario's high level of government indebtedness does not come without a cost. Governments like the rest of us need to make interest payments on their debt. The Ontario government currently spends 9.2 per cent of its revenues on interest payments.

According to the government's own estimates, this will rise to nearly 11 per cent in the next four years. But if interest rates rise faster than the government's projections, it would mean even more money going to interest payments and less to other priorities such as health care. The provincial budget suggests that a one-percentage point increase in the interest rate results in interest payments increasing by $400 million.

Ontarians have a sobering sense of where their province currently stands with respect to debts and deficits. But where is it headed in the future?

Towards more debt. The government expects deficits in each of the next three years, with recent projections set to mushroom. For instance, this year's deficit is now pegged at $12.5 billion or 25 per cent higher than previously expected.

Despite these setbacks, the government still claims it can balance the budget in 2017/18 although the details are slim. The lack of a credible plan is alarming especially since the Drummond report concluded the government needed to implement no less than 360 reforms to restrain the growth in government spending or it would risk running deficits and growing debt into the foreseeable future.

A recent Fraser Institute study projected that unless Ontario's spending patterns change, provincial debt will reach 66 per cent of the economy by 2019-20. This risk of continuous growth in government debt is precisely why Ontario must heed the warnings and better control government spending and reform its public programs.

Moody's report reinforces the fiscal challenges in Canada's largest province. Ontario's debt problem warrants swift and decisive action.