The 2016 Ontario budget contains plenty of good news for investors. To begin with, the government is projecting a modest $5.7B deficit in FY 2015-16, an improvement of $2.8B compared to the 2015 Budget forecast. Higher-than-expected revenues generated by the sales tax ($0.6B), the land transfer tax ($0.3B) and crown corporations ($0.4B) were the main positive surprises, reflecting strong household demand. As previously announced in the Fall Update, part of the bump in fiscal revenues comes from the $1.1B net gain related to the Hydro One IPO (this money will be used to fund infrastructure projects in the future). When we exclude the impact of Hydro One’s IPO, the main take is that the Ontario government did beat its short-term target in FY 2015-16.
In fact, smaller-than-projected deficits have been registered during the last seven years. Furthermore, the positive economic momentum is expected to remain steady. Lower energy prices, the past depreciation of the Canadian dollar and respectable growth in U.S. private demand will maintain Ontario’s real GDP growth above 2% in 2016 for a third consecutive year. Due to increasing global economic uncertainty, the Ontario Ministry of Finance prudently decided to forecast real GDP growth at 2.2% in 2016; below the private sector average of 2.4%. In contrast to what appears to us as a potential upside surprise in 2016, there is no margin for error in 2017 as the Ministry of Finance expects 2.4% real GDP growth despite a potentially stronger loonie and likely higher oil prices. In terms of fiscal implications, the 3.2% increase in total revenue for 2016-17 appears soft while the 5.4% increase for 2017-18 seems on the high side. Indeed, revenues growth averaged 2.5% between 2011 and 2015.
Combined to a modest pace of increase in spending, the deficit is projected to shrink to $4.3B in FY 2016-17 (0.6% of NGDP). The beating of the deficit target in FY 2015-16 and the narrowing of the deficit in FY 2016-17 will translate into lower borrowing requirements in FY 2016-17 ($26.4B) and FY 2017-18 ($23B) following relatively high issuance in FY 2015-16 ($30.1B, $1B lower than budgeted).
If we look in the rearview mirror, the $4.3B deficit penciled for FY 2016-17 will likely mark the last of nine consecutive shortfalls. During that period, the net debt almost doubled from $157B in FY 2007-08 to $296B in FY 2015-16 while the key financial debt-to-NGDP ratio increased significantly from 26% to 39.6%. This ultimately led the S&P credit agency to downgrade the Province of Ontario from AA- to A+ in July 2015. This is very unlikely to occur again, as the debt-to-NGDP ratio is projected to stay about the same in FY 2016-17 before starting to decline gently and reach 38.5% in FY 2018-19. Going forward, one specific line of the budget document states that “the government continues to maintain a target of reducing the net debt-to-GDP ratio to its pre-recession level of 27%.”
In comparison to other jurisdictions, the current fiscal performance of the Province of Ontario is in the middle of the pack. For example, Alberta is on track to register a massive $10B deficit this year and appears unlikely to balance its books during the current decade. At the other end of the spectrum, Quebec and BC are the two only provinces that balanced their books in FY 2015-16.
Besides the fiscal outlook, the 2016 budget is about facilitating the structural transformation of the Ontario economy by (1) investing in infrastructure, (2) embracing a low-carbon economy, (3) improving access to postsecondary education and (4) helping Ontarians to achieve a more secure retirement.
- On the topic of infrastructure, there is nothing new to report. As a reminder, the government continues the largest investment in public infrastructure in the history of the Province: $137B in capital spending is projected over the next 10 years. This being said, it is expected that the Province of Ontario will get the lion’s share of the $125B federal program for public infrastructures. It remains to be seen if this eventual money windfall from Ottawa will be used to finance new projects or some of the shovel-ready projects. The latter would ease financial pressures on the Province.
- Regarding the transition to a low-carbon economy, the new cap-and-trade program proposes to reduce the cap of GHG emissions by about 4% each year between 2017 and 2020 (there is a break for large industrial polluters who face stiff international competition; they will benefit from free allowances until 2020). Fighting climate change also implies modest tax hikes aiming at changing the habits of energy consumers. For example, the 2016 budget includes a levy of 4.3 cents per litre on gasoline and a $5 hike on the average monthly natural gas bill. Investors will take note that cap-and-trade revenues, projected to be $1.9B in FY 2017-18, will not be used to reduce the deficit. Instead, the money will be reinvested for initiatives such as clean tech, home energy efficiency and green infrastructure projects. The need to decarbonize the economy has implication for financial markets: the Province of Ontario made its second issuance of Green Bonds last January, successfully raising $750M that will fund eight environmental projects. Overall, the Province of Ontario’s strategy is very similar to the one already in place in the Province of Quebec.
- One surprise in this budget is the complete overhaul of the student financial assistance program. The goal is to make postsecondary education more affordable for middle-class families by notably providing more grant funding to ultimately reduce tuition fees. In turn, Ontario’s workforce will ultimately be better prepared to deal with a fast-changing economic environment in which a growing number of positions are high-skilled jobs.
- There is nothing new in the report regarding the government’s objective to reduce the retirement income gap, besides the already known fact that the Ontario government will give an additional one-year delay to large companies to enroll in the Ontario Retirement Pension Plan (ORPP). Although the Ontario government remains open to the alternative idea of having a nation-wide enhancement of the Canada Pension Plan, the most likely option, as of today, remains the gradual implementation of the ORPP. In order to ease the increasing cost of the initiative – related to the companies’ contributions to the ORPP and the reduction of workers disposable income – the ORPP mandatory enrolment process will gradually take place from 2017 to 2020 for small, medium and large businesses that do not already offer a private pension plan to their employees.
Bottom Line: Several years ago, former Finance Minister Dwight Duncan projected the return to a balanced budget in FY 2017-18. Of course, no one knew at that time that the Canadian dollar and oil prices would fall significantly. These timely macroeconomic developments turned out to be favorable to Ontario in making its final push toward the zero-deficit finish line. With such a positive momentum, a balanced budget within reach should please credit agencies and market participants. Barring a global economic disaster, this budget almost marks the end of the deficits era. More importantly, it moves the Ontario economy toward a brighter future by embracing the low-carbon economy, investing in key infrastructure, making tuitions more affordable and improving the retirement income of Ontario residents.
