In a world in which the level of financial stress has ramped up in recent months, investors can find some comfort in British Columbia's solid economic and fiscal performance. Supported by sound real GDP growth above the national average, a modest $377M budgetary surplus (0.2% of NGDP; see chart below) is estimated for FY 2015-16; above the Second Quarterly Report estimate of $265M and the 2015 Budget estimate of $264M. In a nutshell, strong momentum in consumer spending and housing activity, thanks to steady employment gains, increased tourism and a more favourable net interprovincial migration flow, led to higher-than-expected tax revenues for FY 2015-16.
The balanced budgets achieved by the BC government during the past four years have put key financial metrics, such as the debt/NGDP ratio, on a downward path (see chart above). This contrasts with most other provinces which continue to deal with a growing debt burden. In turn, the S&P credit agency sees the Province of British Columbia as the only stable AAA subnational jurisdiction in the country (Alberta’s long-term credit was downgraded to AA+ last December, while Saskatchewan’s outlook was revised to AAA negative from stable last October). Also, most (94%) of BC’s debt accumulation over time was contracted to finance infrastructure spending, contributing to improve longterm productivity in the province, rather than direct operating costs. Having already completed its $5.5B borrowing program for FY 2015-16, the Province of BC now projects to reduce its funding needs significantly to $4.7B in FY 2016-17; another contrast with some of the other provinces looking to tap into capital markets more often in the coming years.
A $100M amount will be dedicated to the new BC Prosperity Fund in order to preserve a portion of today's revenue for tomorrow's expenses and to pay down the debt. Additional amounts could be transferred to the new fund if LNG projects are eventually launched in the province. Similarly to previous budgets, the 2016 Budget does not include any anticipated revenues from the LNG industry. Earlier in February, Royal Dutch Shell (L:RDSa) decided to postpone a US$40B LNG project given that global energy prices are currently depressed. Also, Petronas, which leads the consortium of another front-running project (Pacific NorthWest LNG), is awaiting final regulatory and environmental conditions from the federal government in March before making its final investment decision. Meanwhile, the Province continues its consultations with various stakeholders, as the long-term outlook for global LNG demand remains positive.
All in all, the economic and fiscal outlook is excellent at this time. Moreover, the strong track record of the BC government in managing its budget adds credibility to its forecast that it will balance the books for the next three years. Yet, persistent downside risks that could affect this outlook led the Ministry of Finance to build its fiscal plan on prudent assumptions. Notably, slower-than-expected economic conditions in China could result in lower demand for BC’s exports (17% of BC's exports go to China). As such, the 2016 budget includes a respectable $350M annual forecast allowance; moreover, the assumption for real GDP growth is 0.3pp lower in 2016 (2.4%) and 2017 (2.3%) than that of the private sector.
Finally, the BC Finance Minister announced in his speech the establishment of a Commission on Tax Competitiveness. In our view, given that consumption patterns are rapidly evolving and that new companies are shaking up legacy industries, it is important to optimize the fiscal framework in order to optimize revenues. Notably, the Provincial Sales Tax, accounting for 13% of total revenue in the Province, was originally introduced in 1948. The commission’s terms of reference will explicitly exclude a potential return to the harmonized sales tax (the referendum of 2011 led to the reinstatement of the PST as voters strongly voted against the HST). Our view is that this Commission could potentially end up with recommendations similar to the one made by the Godbout Commission in Quebec in March 2015, such as reduced taxation on labour and investment and consumption tax increases.
New Measures to Address the Housing Affordability Issue
Beyond the fiscal outlook, the focus of the 2016 BC budget is about addressing the housing affordability issue. The BC government announced specific measures aimed at boosting the construction of new homes and reducing the cost of acquiring a property for residents of the province. First, newly built properties priced up to $750K are now exempted from the property transfer tax, allowing buyers to save up to $13K. This new exemption is available to Canadian citizens and permanent residents who intend to use the property as their principal residence. The government estimates that, in 2016, 22K new housing units will be subject to this new property tax exemption. Given that we forecast total housing starts to reach 31K in 2016 (a number that could be higher given the new measures), a sizeable proportion of new home transactions will be impacted. Moreover, as a single-detached unit in the Greater Vancouver area sells for $1.1M on average and an apartment unit (including condos) sells for $406K, this exemption will be mostly felt in the condo market. The fiscal cost of this measure is estimated to be offset by an increase in the property transfer tax rate for expensive single-detached homes; from 2% to 3% for the portion above $2M (see table).
Increasing the housing stock of relatively affordable units is one factor that could contribute to taper off the surge in BC’s housing prices. The good news is that the BC government made a first step towards addressing the issue of the unclear effect of foreign funds on housing prices by announcing that it will resume collecting data on purchasers’ nationality (citizenship disclosure was required with land transfers until 1998). With reliable data, the government will be able to eventually consider measures to curb foreign demand on housing, if deemed necessary. Finally, BC Finance Minister Michael de Jong has vowed to look at the apparent use of deceptive tactics (e.g. multiple contract assignments and dubious marketing techniques) in the Vancouver housing market which were recently exposed in the media and which contributed to increase housing prices further (see charts).
