Most of Canada’s provinces emerged from the pandemic with less debt and more revenue than expected, but the tailwinds they’ve seen in the last two years are about to shift, according to an RBC economist.
“The favourable fiscal environment may be coming to an end,” wrote Rachel Battaglia in an online economic report examining provincial debt levels.
“Weaker economic growth and the likelihood of a recession, rising operating costs including increasing wage pressures, and upward pressure on debt servicing costs, are poised to hold back further improvement in provinces’ fiscal position.”
The COVID-19 pandemic initially put a massive financial strain on provincial governments in Canada, with most provinces plunging into deep deficits that many experts predicted would take years to re-balance, said Battaglia.
But the Canadian economy rebounded faster than expected and inflation rose sharply, creating increased revenue for provinces and helping them repay their debts.
“Provincial balances emerged from deficit territory into surpluses (and in some cases hefty ones) which significantly eased government borrowing requirements,” Battaglia said.
Most provinces saw “exceptionally strong” nominal growth in the last two fiscal years, and seven of 10 were able to lower their net debt-to-GDP ratio compared to pre-pandemic levels, according to Battaglia.
PROVINCES CONTINUE TO SPEND
Battaglia said that even as pandemic support programs have mostly come to an end, provincial governments haven’t returned to pre-pandemic spending levels.
Battaglia added that Canadian provinces have actually seen expenditures grow by nearly $50 billion, or 10 per cent, since 2021, which is more than the $40 billion revenue windfall seen by provinces in the same period.
In 2022, provincial expenditures grew even faster than during the pandemic and more than two times faster than the average annual expenditure increase in the five years leading up to it, according to Battaglia.
However the period of elevated spending is now likely over, Battaglia said, with weak economic growth and rising costs expected to strain provincial budgets.
OUTLOOK FOR PROVINCES
Battaglia said that RBC predicts a “sharp slowdown” in nominal growth for all provinces in the coming year, which will “significantly curb growth in government revenues.”
“At the same time, an economic downturn would also impact expenditures. Governments typically step up to provide support and stimulate the economy during recessions,” Battaglia added.
“We see the expenditure side still feeling the heat of high inflation for some time. New contracts with public servants are bound to come with heftier price tags.”
Higher interest rates will also make debt servicing much more expensive for provinces, noted Battaglia, adding that debt charges were already on the rise, growing by 6.8 per cent in 2021 and another 5.4 per cent in 2022 – their fastest rate of increase in over a decade, according to RBC.
Battaglia said that post pandemic, debt servicing costs have been “manageable” for provinces, but that will soon change.
“Provincial governments spend an average of $5.70 for every $100 they take in in revenue to service their debt,” she said.
“That share is bound to increase in the coming years amid higher interest rates, taking spending room away from other items like healthcare.”
Higher interest rates, cooling economy will strain provincial budgets: RBC economist - BNN Bloomberg
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