April 26, 2012 / 9:24 PM / in 6 years

Moody's downgrade threatens Ontario's fiscal plan

TORONTO (Reuters) - Credit rating agency Moody’s downgraded Ontario’s debt on Thursday, just a day after competitor Standard & Poor’s suggested it might do the same, the latest blow in the Canadian province’s battle to tame its climbing debt.

A Moody's sign on the 7 World Trade Center tower is photographed in New York August 2, 2011. REUTERS/Mike Segar

The negative action on one of the world’s largest non-sovereign issuers of debt is a warning signal to markets, and could make borrowing for the province even more expensive - threatening its recently improved plan to balance its budget.

“You see two back-to-back moves by very important credit rating agencies, I think markets are going to be concerned about the risks associated with Ontario debt but I don’t think it’s going to be a significantly higher risk premium than what we’ve been seeing,” said Sonya Gulati, economist at Toronto-Dominion Bank.

“Nothing has really changed from yesterday versus today but I think there’s a bit more concern out there for Ontario’s fiscal challenge.”

Moody’s dropped the issuer and debt ratings on Canada’s most populous province to Aa2 from Aa1, with a stable outlook, affecting approximately C$202 billion ($205 billion) in debt securities.

“The downgrade of Ontario’s rating reflects the growing debt burden and the risks surrounding the province achieving its medium-term fiscal plan given the subdued growth outlook, extended time frame back to balance and ambitious expenditure targets,” Jennifer Wong, Moody’s lead analyst on the province, said in a research report.

The move brought Moody’s score on the province more in line with the other two big rating agencies, S&P and DBRS. DBRS downgraded the province in the fall of 2009, after the global recession hit the province’s manufacturing base.

DBRS gave Ontario’s ambitious austerity budget the benefit of the doubt on Thursday, holding a “stable” outlook on its debt rating.

Ontario Finance Minister Dwight Duncan responded, pointing out that Moody’s new rating on Ontario is still higher than those of the two other major rating agencies.

“At the end of the day, these three agencies have a common message for us: They want the parties of this minority legislature to work together to hit the fiscal targets we’ve laid out,” he said in a statement.

Earlier this week, the minority Liberals overcame their first major challenge since being re-elected in October as they passed their 2012-13 budget with the help of a tax-the-rich deal with the left-leaning New Democratic Party that allowed them to stay in power.

Moody’s had some reassuring words for the province despite the downgrade. It noted that Ontario’s still high investment-grade rating “reflects high debt affordability and the high degree of fiscal flexibility.”

The credit action came a day after the government lowered its budget deficit forecasts to 2017-18, when it projects the province will run a C$500 million ($508 million) surplus.

Investors who ultimately decide how much of a pick-up in yield Ontario bonds should pay versus Canadian federal debt will have to weigh the province’s accelerated path to a balanced budget against the wake-up calls from the ratings agencies.

While still investment grade, Ontario’s credit rating - now Aa2 at Moody‘s, AA- at S&P, and AA low at DBRS - is two to three notches below the federal government’s top rating.

Ontario’s 10-year bond yield traded about 95 basis points above the Canadian government counterpart’s 2022 bonds, as the spread between the benchmark yields eased from the two-year high it hit earlier this month.

“Right now you take a look at the debt servicing costs ... and it already eased up quite a bit of the total spending pot,” added Gulati. “So with this downgrade you’re going to be facing increasing interest rates and that’s going to be crowding out the room for other really important priorities like health care and education.”

($1 = $0.98 Canadian dollars)

Reporting by Claire Sibonney; Editing by Jeffrey Hodgson and Dan Grebler

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