Outlook for provincial bond market ‘stable, if not favourable’

For governments, the pandemic has resulted in severe revenue declines as well as increased spending. Despite that combination fuelling provincial deficits, the outlook for the provincial debt market remains stable, said a Scotiabank Economics report on Thursday.

The provinces’ revenues from their own sources are expected to fall by about 11% in the current fiscal year (2021) in the face of job losses and reduced employment earnings, the report said.

“Corporate income tax receipts are widely expected to plunge as business profits nosedive,” it said. “Mirroring the economic growth outlook, the net oil-producing provinces will take a further hit as natural resources revenues plummet.”

At the same time, Scotiabank forecast total expenditures for the provinces to rise by about $51 billion, or 2.4% of GDP — an 11.3% year-over-year increase mostly related to Covid-19.

Federal support will help offset the damage. Still, Scotiabank projected the average provincial deficit to be 4.5% of nominal GDP in fiscal 2021, or $100 billion, based on provincial fiscal updates.

That may compare favourably to the federal government’s projected shortfall of 18% of nominal GDP, but with six more months to go in the fiscal year and second waves of Covid-19 emerging, “[provincial] balance sheet shocks are expected to reverberate into next year even in a best-case scenario,” Scotiabank said.

Despite an economic rebound being part of Scotiabank’s forecast for next year, it said it expects economic activity to remain below pre-pandemic levels until 2022.

Further, pandemic-related spending is expected to remain high into next year.

The report thus estimated that provincial deficits could start at $60 billion next year before accounting for additional Covid-19 spending or new federal transfers. (Provincial deficits in the current fiscal year have been projected at $96 billion.)

The report also included a warning: “With an increasing likelihood of further increases to spending pressures related to second waves, the total could reasonably be expected to be higher.”

Further federal transfers could provide an offset, it added.

As things stand, the markets are taking the projected deficits in stride.

“Provincial debt issuance has been relatively well-received so far,” the report said.

The provinces have raised more than two-thirds of their financing requirements already — about $154 billion — at a point only about halfway through the fiscal year.

Spreads have also remained in normal ranges, largely as a result of the Bank of Canada purchasing provincial bonds.

“With spreads durably back in normal ranges, the Bank of Canada has recently scaled down its purchase programs while continuing to signal it stands ready to scale up liquidity support if needed,” the report said.

The “relative attractiveness” of provincial bonds has also been a driving factor in bond market liquidity.

“Overall, provincial debt markets should remain stable, if not favourable, over the course of the recovery (and second-waves),” the report said.