TORONTO (Reuters) - A minority government will make it harder for Ontario's Liberals to make tough decisions to rein in a C$16 billion ($15.4 billion) deficit, which may require tax hikes and painful spending cuts.
The Liberals have said they will work with opposition parties to meet their goal of wiping out the deficit by 2017-18, but their rivals may tire of cooperation if the economy slows and the action needed gets harder.
"The minority government has the potential to complicate fiscal management over the years to come, especially if further actions are required in response to another economic slowdown, as the Liberals are no longer alone in the driver seat," said Eric Beauchemin, managing director of public finance at credit rating agency DBRS.
He said bigger deficits, or a slower track to a balanced budget, would put pressure on Ontario's credit rating, although the province has some flexibility because it has so far exceeded deficit cutting targets.
Ontario's long-term credit rating is investment-grade AA low at DBRS, AA- at Standard & Poor's and AA1 at Moody's, all between one and three notches below the top rating that the federal government enjoys.
The province is Canada's economic powerhouse, accounting for some 40 percent of gross domestic product. The Liberals won a third straight term in Thursday's election, but were one seat shy of a majority and will need support from opposition legislators to stay in power.
But it won't be easy for the party to keep its promises of balancing the budget without raising taxes, or to rein in the growth in healthcare costs, the biggest line item in a C$114 billion spending program.
Ontario's manufacturing and export-reliant economy was hit hard in the last recession and recovery is slow. Its debt levels are among the highest in the country and Ontario lags other provinces in growth projections that private sector economists recently downgraded further.
Derek Burleton, deputy-chief economist at TD Bank Financial Group, raised the possibility of tax hikes if the Liberals fail to achieve their targets of keeping the growth in spending to just over 1 percent a year.
"It is going to take some pretty tough decisions. If you look back at history I don't think we've seen a period since the post-war where spending growth has been held down to less than the rate of inflation for a period of five years, so this would represent the most prolonged period of restraint that we've had in decades," said Burleton.
Canadian inflation was 3.1 percent in August.
Premier Dalton McGuinty has promised to not raise taxes, but he has broken his word before, most notably by introducing the province's harmonized sales tax last year, which raised some costs for consumers but helped business.
Even before financial markets turned sharply lower in August, Ontario's auditor general warned that the Liberals' spending plans were too optimistic. Healthcare is government's biggest cost by far, and Ontario wants to halve health care spending growth despite a rapidly aging population.
Labor costs are another major question mark, and unions have largely ignored McGuinty's call in 2010 for a two-year wage freeze for public-sector workers.
The government also put great store on a program to boost green energy production, and the renewable energy industry breathed a sigh of relief after the election as the Liberal victory keeps that plan alive.
Nelson Wiseman, a politics professor at the University of Toronto, predicted another election in the next two or three years, well before the scheduled date in October 2015, as the "honeymoon effect" wears off.
The two opposition parties can join forces to bring the Liberals down, either by rejecting major legislation or by passing a vote of no confidence.
I can see the government becoming very unpopular in a couple years because of very tough economic times. Even if the economy picks up some, the fiscal situation is bad," he said.
Editing by Janet Guttsman and Jeffrey Hodgson