Fitch Affirms Province of Quebec at 'AA-'; Outlook Stable

Fitch Ratings-New York-June 08: Fitch Ratings has affirmed the province of Quebec, Canada and Financement-Quebec's (FQ) Long-Term Foreign and Local Issuer-Default Ratings (IDR) at 'AA-'. Fitch has also affirmed the Short-term IDRs on the province and FQ at 'F1+'. In addition, Fitch has affirmed the 'AA-' ratings on debt linked to the province and FQ's IDRs. A complete list of ratings follows at the end of this release. The Rating Outlook is Stable. SECURITY Quebec's senior unsecured obligations are direct and unconditional obligations of the province to which its full faith and credit is pledged. Commercial paper notes are promissory notes ranking equally with Quebec's other unsubordinated and unsecured indebtedness. Payment of debt service for Financement-Quebec is unconditionally guaranteed by the province from the consolidated revenue fund. KEY RATING DRIVERS CONTINUED BALANCED OPERATIONS: Quebec's Long-term 'AA-' IDR and Stable Outlook reflect its maintenance of fiscal equilibrium in recent years and the likely continuation of balanced operations through the forecast horizon, allowing the province to make additional progress on lowering the burden of debt. HIGH DEBT: Debt burden metrics are expected to continue falling, although in the near term the province's debt is likely to remain high relative to resources, capping the rating at the current level. Debt management is strong and centralized, debt service is manageable and the province maintains ample access to liquidity for both operating and debt service requirements, supporting the Short-term 'F1+' rating. BROAD FISCAL POWERS: Independent control of tax rates and the ability to determine spending are the basis for the province's broad, though not unlimited, fiscal flexibility. The province demonstrated a willingness to curb spending growth through much of the fiscal consolidation period. DIVERSE ECONOMY: The economy is large and diverse but historically slower growing and less wealthy than the Canadian average. Recent strong economic performance, combined with favorable exchange rates and improving U.S. economic conditions continue to support fiscal balance. Vulnerabilities include the uncertainty posed by cross-border trade relations and the ongoing competitiveness of certain key sectors. FINANCEMENT-QUEBEC'S RATING EQUALIZED TO PROVINCE IDR: The rating for Financement-Quebec reflects the IDR of the province given its unconditional guarantee of Financement-Quebec's debt. RATING SENSITIVITIES FISCAL UNDERPERFORMANCE: Unexpected near-term fiscal deterioration or the inability to attain currently forecast operating targets could result in a rating downgrade. REDUCED DEBT BURDEN: The Stable Outlook at the current rating level assumes the province retains its focus on lowering the burden of debt. The resumption of significant borrowing to support operating deficits would result in a downgrade. CREDIT PROFILE Quebec's 'AA-' IDR and Stable Outlook continue to reflect the strong fiscal performance it has experienced since its return to fiscal balance in recent years, following a multi-year, post-recession consolidation program. Economic and revenue trends were well above forecast over the past year and are likely to remain positive in the near future, giving the province a wider margin of flexibility to maintain budget balance, address targeted spending needs, and accelerate progress on debt reduction. Since the province's debt burden peaked as a percentage of GDP in fiscal 2015, it has fallen more rapidly than forecast, and Fitch expects it to continue falling absent a material slowdown in economic and revenue momentum. Progress on reducing consolidated debt will be assisted by C$2 billion annual draws from the Generations Fund over the fiscal 2019-2023 period, announced with the tabled fiscal 2019 budget. The province now expects to reach its longstanding debt burden objective of 45% of GDP in fiscal 2023, three years before the statutory target. Fitch views Quebec's debt burden as remaining elevated for the current rating category. However, the continuation of recent favorable trends could, in Fitch's view, strengthen the province's ability to absorb a moderate economic and revenue shock and a corresponding short-term reversal of debt burden metrics without affecting its credit standing. As with other Canadian provinces, Fitch expects Quebec to rely on deficit borrowing to support countercyclical operating and capital needs during economic downturns, returning to surplus operations and lowering debt during periods of economic expansion. DEBT BURDEN ELEVATED BUT FALLING Quebec's debt burden has been falling in recent years and Fitch expects it to continue falling, although it is likely to remain elevated relative to its resources and to most Canadian provincial peers. As of fiscal 2018, outstanding gross debt, a measure which includes borrowing of consolidated entities and pension liabilities, stood at almost C$205 billion (49.6% of GDP). Total public sector debt measures C$273 billion (66.3% of GDP). Gross and total public debt figures are net of the Generations Fund balance, a reserve for debt reduction, which held C$12.8 billion in fiscal 2018. Much of the current debt burden stems from accumulated deficits built up in past decades and during the recently concluded period of fiscal consolidation. As of the fiscal 2017 public accounts, accumulated deficits totaled C$112.8 billion (29% of GDP). EARLY ACHIEVEMENT OF DEBT TARGET Longstanding statutory targets for gross debt-to-GDP at 45% and accumulated deficit-to-GDP at 17% as of fiscal 2026 have guided the province's focus on debt reduction for more than a decade. Although the province relied on borrowing during the fiscal consolidation period, the gross debt-to-GDP ratio peaked in fiscal 2015 at 54.3% of GDP and has fallen since. Forecast ratios continue to decline, supported by fiscal balance; the province now expects to reach the gross debt-to-GDP target three years early, in fiscal 2023. With the fiscal 2019 tabled budget, the government has also announced C$2 billion in annual draws from the Generations Fund during the fiscal 2019-2023 period for debt repayment. Despite planned draws from the Generations Fund, deposits of water-power royalties, alcohol taxes, other revenues and investment earnings are expected to drive the fund's balance higher over the forecast period. The province is a sophisticated debt manager and has demonstrated broad market access for liquidity needs, new borrowing and debt refunding. Liquidity is ample, and the province has established a reserve intended to cover a share of annual refinancing requirements in the event of market disruption. About 23% of total public sector debt is self-supporting, mainly for the province's large water power utility, Hydro-Quebec (AA-/Stable). Debt service relative to resources has been manageable, assisted by a historically low interest rate environment. In fiscal 2018, debt service of C$9.2 billion consumed about 9% of consolidated revenues, a lower share than in recent years. ECONOMIC GROWTH SUPPORTING FISCAL GOALS Quebec's economy is diverse, mature and generally more slow-growing than Canadian averages. Similar to other Canadian provinces, it has significant exposure to U.S. economic performance, the primary destination for many of its exports, including from its important manufacturing sector. A globally important transportation equipment sector is one of the province's key economic anchors. Economic performance during most of the current expansion has generally been less robust than past expansions, although over the last three years growth in Quebec has accelerated. Quebec's real GDP rose 1.4% and 3.1% in 2016 and 2017, respectively, in line with overall GDP growth in Canada. Consistently solid consumer spending, favorable exchange rates and growth in business and public investment are continuing to support robust performance. Fitch views the province's economic forecast as reasonable, although the risk of disruption to the NAFTA trade framework has grown given possible U.S. trade policy changes. Quebec's forecast assumes real GDP rising 2.1% in 2018, again matching the Canadian average, with growth slowing to a more typical range between 1.7% and 1.3% during the 2019-2022 forecast period. The province estimates that if Canada reverts to most favored nation trade status with the U.S., in place of NAFTA, it could ultimately shave 0.5% off baseline GDP. Labor market conditions in Quebec historically were weaker than Canadian averages but have largely converged over time; average annual employment growth in the province was 1% during 2005 - 2015, just below the 1.1% Canadian rate, while average unemployment during the same period was 7.8%, compared to 7% for Canada as a whole. Recent trends have shown further improvement; Quebec's unemployment fell to 6.1% in 2017, compared to 6.3% for Canada. The province's economic forecast assumes unemployment at a historically low 5.4% for 2018 and 5.3% in 2019. BUDGET CONTINUES NEAR-TERM SURPLUSES Quebec only recently completed a multi-year fiscal consolidation program in response to the last recession, reporting a small fiscal 2015 surplus on a consolidated basis, before deposits to the Generations Fund. Measured on the same basis, surpluses since then have been much larger, at C$4.4 billion in fiscal 2017 and an estimated C$3.1 billion in fiscal 2018. Much of these surpluses have been deposited to the Generations Fund, with the remaining budgetary surpluses of C$2.4 billion in fiscal 2017 and an estimated C$850 million in fiscal 2018 diverted to its stabilization reserve. A key part of Quebec's successful fiscal consolidation was its ability to hold program spending growth below the level of revenue growth through most of the period. Policy actions to curb growth affected a wide range of spending, including employee remuneration, health care delivery and education. Health care and education consume two-thirds of program spending in Quebec and remain persistent sources of fiscal pressure. Given revenue over-performance and continued balanced operations, the government opted in both the fall 2017 update and in the tabled fiscal 2019 budget to increase spending, largely in health care and education. Despite these actions, it forecasts a surplus of C$850 million in fiscal 2018, after a C2.3 billion deposit to the Generations Fund, and budgetary equilibrium going forward, an outlook that Fitch views as reasonable assuming economic and revenue performance remains on track. Consolidated spending is estimated to have risen 5.6% in fiscal 2018 and will rise 4.5% in fiscal 2019, driven by growth in health and education, and reflecting recent labor agreements. Although the tabled budget for fiscal 2019 contains no formal contingency allowance, several sources of fiscal flexibility remain. These include a contingency fund of C$718 million to cover unexpected spending needs, a debt service reserve of C$50 million, and the stabilization reserve itself, which represents recent surpluses in excess of Generations Fund deposits, measuring C$5.4 billion as of fiscal 2018. Nearly C$1.6 billion of the latter is budgeted to be applied in fiscal 2019 to maintain balance, including deposits to the Generations Fund. Own-source revenues rise an estimated 2.2% in fiscal 2018 and 1.7% in fiscal 2019. The province also estimates a 12.3% gain in federal transfers in fiscal 2018, driven primarily by the growth of the federal equalization envelope, and projects 4.4% growth in fiscal 2019. RELATED RATINGS Fitch has affirmed the following ratings: Province of Quebec: --Senior unsecured debt at 'AA-'; --Long-Term Foreign- and Local-Currency IDR at 'AA-'; --Short-Term IDR at 'F1+'; --Commercial Paper Rating at 'F1+'. Financement-Quebec: --Senior unsecured debt at 'AA-'; --Long-Term Foreign- and Local-Currency IDR at 'AA-'; --Short-Term IDR at 'F1+'. The Rating Outlook is Stable. Contact: Primary Analyst Douglas Offerman Senior Director +1-212-908-0889 Fitch Ratings, Inc. 33 Whitehall St. New York, NY 10004 Secondary Analyst Karen Krop Senior Director +1-212-908-0661 Committee Chairperson Laura Porter Managing Director +1-212-908-0575 Media Relations: Sandro Scenga, New York, Tel: +1 212-908-0278, Email: sandro.scenga@fitchratings.com. 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