In this global recovery dubbed by the IMF to be “too slow, too fragile” and where budgetary deficits are the norm, bond investors will definitively find some comfort in the improving fiscal situation observed in the Province of Nova Scotia.
To begin with, the deficits registered in the aftermath of the global financial crisis were relatively small in Nova Scotia, on average representing less than 1% of NGDP. Moreover, the $71M deficit registered in FY 2015-16 is lower than the $98M original estimate included in the 2015 budget; expenses came in significantly below expectations, more than offsetting lower-than-anticipated revenues. Consequently, the debt-to-NGDP ratio rose modestly in comparison to other Canadian provinces, budging from about 35% prior to the 2008-09 global financial crisis to a manageable peak of 38.5% at the end of FY 2014-15. Since nominal GDP growth in 2015 (2.1%) outpaced the $71M deficit representing 0.6% of NGDP, the debt burden declined to 37.9% at the end of FY 2015-16 (the lowest such figure east of Manitoba, with the exception of PEI).
The other good news is that deficits are on their way out. Excluding the one-time revenue windfall of $110M from the federal government and the Halifax Regional Municipality to partially finance the construction of the new Halifax Convention Centre, a tiny $17M surplus is projected for FY 2016-17 (0.3% of NGDP). Put simply, the Province of Nova Scotia is about to join the elite club of balanced budget jurisdictions in the country, British Columbia and Quebec. The budget also includes small surpluses for the remaining 3 of the four-year fiscal outlook presented by Finance Minister Randy Delorey.
The improvement in the Province’s fiscal fortunes is predominantly based on better economic conditions. After the near stagnation of real GDP between 2010 and 2014 - average annual growth rate of 0.05% was dragged down by slower extraction in existing natural gas fields and a shrinking labour force - the Nova Scotia economy began to show encouraging signs last year. Firstly, non-energy exports increased at a double-digit pace, thanks to the weak currency and robust demand from the US and Asia. Secondly, the $25B contract awarded by the federal government in 2011 to the Irving Shipbuilding company to build naval vessels has started to generate some economic activity. In turn, labour market conditions have stopped deteriorating: according to the latest LFS data available, total employment edged up by 0.3% or 1.4K on a year-over-year basis in March. Also, the economic downturn in oil-producing provinces, notably Alberta, has contributed to reduce Nova Scotia’s interprovincial labour outflows and slowed down the decline of the labour force primarily driven by the retirement of baby boomers.
In summary, business cycle conditions are improving but restrained by a slower potential growth due to demographic aging. As a consequence, the budget’s assumptions for real GDP growth in both 2016 (0.8%) and 2017 (0.9%) are soft. Yet, we think that the budget is built on cautious projections, as we forecast real GDP growth to surpass 1.0% in both years. This could potentially lead to positive surprises on the revenue side. Based on the Ministry of Finance’s economic assumptions, total revenues are projected to increase by 3.5% from FY 2015-16 to FY 2016-17. Most of this increase is based on the expectations of modest employment gains and moderate wage growth. Altogether, higher labour income gains are poised to bring an additional $215M in personal income tax (PIT) in FY 2016-17, a significant amount for the Province. PIT accounts for 26% of total revenues, the largest single source of revenue for the government while equalization payments and the PST follow with 18% each. Finally it is worth mentioning that this budget only contains one tax increase: a small tax hike on tobacco products projected to generate $16M annually in fiscal revenues.
Even though the government’s plan to return to a balanced budget principally rests on higher PIT revenues, tight spending control is also part of the equation. Total expenditures are projected to advance by only 1.2% in FY 2016-17, less than the 1.9% increase registered the previous year. The amount dedicated to health care, grabbing 41 cents of every dollar spent, is set to stay unchanged from FY 2015-16. Trying to flat line health care spending is a difficult task (health care spending rose by about 2% annually during the last five years, or about $80M annually). Potential cost overruns on that front may concern investors although upside surprises in tax revenues, as mentioned above, would offset them.
All in all, the small surpluses projected for the next 4 consecutive years will allow the debt-to-NGDP ratio to fall further from the peak of 38.5% observed in FY 2014-15 (note that this ratio was revised up by about 1.6 percentage points due to recent downward revisions to Nova Scotia’s NGDP by Statistics Canada). Specifically, this key financial metric is projected to reach the relatively comfortable level of 34% in FY 2019-20 (see chart below). The Department of Finance and Treasury Board pegs borrowing requirements at $810M for FY 2016-17, below last year’s borrowing activity ($1.055M in FY 2015-16 including a modest $200M in pre-financing made for FY 2016-17). Lastly, note that the Province is rated A high by DBRS, Aa2 by Moody’s and A+ by S&P, the same long-term credit ratings as Quebec and New Brunswick.
Bottom Line: This status quo budget containing no major tax hikes or new spending initiatives is likely to make the headlines for the good reasons as jurisdictions on track to balance the books are a rarity these days. Given the strong reliance of the budget on PIT revenues to restore Nova Scotia’s fiscal balance, monitoring the monthly provincial LFS data will be key for investors looking to determine if the plan presented by the government in this budget will remain on track.
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