Analysis: Ontario deficit targets at risk as outlook dims

A worsening economy will hurt Ontario's chances of meeting already long-term plans to balance its budget as it prepares for a fiscal update on Wednesday.

The government has said its fall economic statement will show a C$16 billion ($15.5 billion) deficit for 2011-12, but warned that revenue projections and growth targets will fall to reflect recent private sector downgrades.

Ontario plans to balance the budget by 2017-18, later than any other Canadian province.

But reaching that goal means cutting costs, a daunting challenge for a minority Liberal government committed to protecting healthcare and education, and not raising taxes.

Unfortunately you may see larger deficits than what was expected in the budget of 2011, said Sebastien Lavoie, assistant chief economist at Laurentian Bank Securities in Montreal.

Ontario, which relies heavily on the manufacturing and export of autos and parts to the United States, accounts for about 40 percent of Canada's gross domestic product.

The risk of slowing U.S. and global growth was highlighted by Canadian Finance Minister Jim Flaherty's decision earlier this month to push back Ottawa's promised date to balance the federal budget.

Don Drummond, a former Toronto-Dominion Bank chief economist now advising Ontario on spending, has already said the province will not meet its deficit targets unless it cuts program expense growth to 1 percent a year for the next six years.

Ontario's auditor general also says the province's spending projections are too ambitious. But that was before the government promised a 7 percent reduction of the public service by 2014.

We'll see how much resolve they have in terms of implementing that, said Eric Beauchemin, director of public finance at credit rating agency DBRS.

Labor costs generally make up 60-65 percent of government budgets, so job cuts would have more of an impact than previous attempts to cap wages - which were thwarted by some public service unions.

I really think they're trying to manage expectations and I would say the environment is quite convenient for that because conditions are difficult out there, said Beauchemin.

He doesn't foresee any adverse changes to Ontario's credit rating at this stage, but a major deviation from its fiscal recovery plan would definitely be a source of concern.

LESSONS FROM EUROPE

Ontario, hit hard by the 2008 recession, was the only Canadian province downgraded by DBRS during the slowdown. The province's long-term credit rating is investment-grade AA low at DBRS, AA- at Standard & Poor's and AA1 at Moody's.

That's between one and three notches below the top rating that the federal government enjoys and makes it more costly for the province to borrow, especially when markets become volatile.

Some people compare us (to highly indebted European countries) in terms of our debt to GDP ratios and demographics in Ontario, that they don't see any balanced budget in the foreseeable future, said Hosen Marjaee, senior managing director at Manulife Asset Management, describing Ontario's 2017-18 balanced budget deadline as very doubtful.

If that doesn't happen, and debt continues to grow and debt to GDP grows, we will be painted with the same brush as some European countries right now that are in deep trouble and the cost of financing will definitely go up, he said.

Ontario's net debt-to-GDP ratio was 34.9 percent in 2010-11. In its last budget, the province said it should peak at around 41 percent in 2014-15.

Most analysts agree some austerity measures are necessary and they want to see specifics, but they say slashing spending too deeply could hit growth.

Marjaee said the belt-tightening should not be implemented for another two to three years, until growth picks up again.

Laurentian's Lavoie pointed to similar lessons from Europe.

You cannot shave spending growth and still have strong decent economic growth overall. (Christine) Lagarde from the International Monetary Fund has been talking about this and I still look forward to seeing what sort of rabbit she can pull out of the hat because honestly I don't know that recipe. It just doesn't work that way, he said.

($1=$1.03 Canadian)