The post-Brexit financial stress is unambiguously front and center these days (we will nonetheless take a look at Friday’s jobs reports in North America; we expect a net addition of 210K jobs in the U.S., 5K in Canada). The Brexit brings risks to the global economic outlook further to the downside. Although the end game is unknown, it is important for bond investors to keep in mind that the Province of Quebec is in relatively good position to cope with global headwinds.
While Québec’s population was submerged by the P.K. Subban trade last Thursday afternoon, the Quebec Ministry of Finance released at the same time on its website the Monthly Report on Financial Transactions. The report indicated that the budgetary balance was in surplus of $1.65B for the fiscal year (FY) 2015-16. The surplus stands at $1.8B once we add the $150M unused contingency reserve. Even though it will take some time before we get the final budgetary transactions numbers of the health and social services and education networks, we can say, with a high degree of confidence, that this is the largest surplus ever registered by the Province of Quebec (see chart). Given the $1.5B transfer to the Generations Fund, the difference between total revenues and total expenses was actually $3.3B for FY 2015-16. This greater-than-expected result reflects a healthy pace of growth in own-sources revenues (up 4.0% from FY 2014-15, led by personal and corporate income taxes) and virtually no change in program spending (up by only 0.4% from FY 2014-15).
The mid-year fiscal update to be released next fall, as well as the 2017 budget, will allow investors to find out exactly what the Quebec government intends to do with the $1.8B surplus. According to the Balanced Budget Act, any surplus left after the amount paid into the Generations Fund is appropriated to the stabilization reserve fund. This stabilization reserve fund was established to facilitate the government’s multi-year budget planning. In practice, the balance of the stabilization reserve fund can be used by the Quebec government for multiple purposes. Three of them are more likely in our view:
The money could turn out to be a useful cushion, allowing the Quebec government to maintain a balanced budget in coming fiscal years if economic developments post-Brexit disappoint and lead to lower-than-expected fiscal revenues.
If the global recovery stays on the same slow path despite Brexit, some of the money could eventually be used to finance personal income tax cuts (let’s say, before the October 2018 election). The Quebec Finance Minister Carlos Leitao mentioned that possibility to the media yesterday before attending a Members of Cabinet’s meeting. In our view, it will be difficult to finance permanent tax cuts with this $1.8B surplus, unless the Quebec government is confident to generate recurrent budgetary surpluses of that magnitude.
A safer option for the Quebec government, and a preferable one for bondholders, would be to make additional payments to the Generations Fund (in other words, to ultimately pay down the debt further).
As promised by the Quebec government when it took office in June 2014, the Province of Quebec’s gross debt-to-GDP ratio is definitively going to be on the downtrend; but investors will have to wait some time before finding out by how much exactly. This constructive development is in line with the decision taken a month ago by the S&P credit agency to revise from stable to positive the Province of Quebec’s outlook. Put simply, the Province of Quebec maintains its A+ rating and moves a notch closer to a AA- rating, which was lost in 1993 after the early 1990s recession. In its report, the S&P credit agency noted that the positive revision to the outlook was notably based on the expectation of further improvement in the budgetary performance.
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