Blogs & Comment

Ontario’s one weird trick to reducing the deficit: interest rates

By projecting improbably high interest rates, the Liberals have given themselves breathing room on the deficit

Ontario Finance Minister Charles Sousa delivers the provincial budget as Premier Kathleen Wynne looks on at Queen's Park in Toronto on Thursday, April 23, 2015.

Ontario Finance Minister Charles Sousa delivers the provincial budget as Premier Kathleen Wynne looks on at Queen’s Park in Toronto on Thursday, April 23, 2015. (Nathan Denette/CP)

With a lack of significant spending cuts or revenue increases in Ontario’s 2015 budget, questions remain on the ability of the government to close an $8.5 billion budgetary hole over two years. Instead of front-loading austere budgetary measures and cruising to a balanced budget, the government has chosen to stay the course on the plan mapped out in Budget 2014. With infrastructure spending priorities and upcoming negotiations with public-sector unions, improving the budgetary outlook by $4 billion per year for two consecutive years would seem a Herculean task. The struggle may not be as daunting as it appears, however, due to some relatively gloomy interest rate forecasts built into the budget.

Looking at past deficits is instructive in examining the ability of any government to meet their deficit projections. Ontario’s Budget 2014 projected a $12.5 billion deficit for fiscal year 2014-15. The government beat this projection by nearly $1.6 billion—by taking $1 billion from reserve, keeping spending levels $600 million less than projected, and through $335 million of savings from lower than anticipated interest rates on government debt.

The trend of improved budgetary balances through lower interest rates continues in Budget 2015. Relative to Budget 2014, the Ontario government has reduced deficit projections for 2015-16 and 2016-17 by between $400-500 million per year. More than 100 per cent of this improvement comes from Ontario revising their interest rate projections downward.

Despite a downward revision in interest rate projections, Ontario’s projected rates are still significantly above that of their federal counterparts, and vastly exceed that of some private sector forecasters, including BMO Capital Markets Economics. Conveniently, all three of these projections are for 10-year bonds issued by the federal government, allowing for an apples-to-apples comparison.

With over $300 billion in outstanding debt, even small changes in interest rates significantly alters Ontario’s bottom line. This year’s budget provides a sensitivity analysis for yields on 10-year bonds; should interest rates fall in line with the BMO projections, the Ontario government will see estimated gains of $400 million next year alone. An extra $400 million per year is not an insignificant sum relative to a projected deficit of $4.8 billion in fiscal year 2016-17. That $400 million is on top of the $800 million savings for that fiscal year from the change in interest rate projections between Budget 2014 and Budget 2015. These relatively conservative interest rate estimates will certainly be noticed by credit ratings agencies, which may help the province avoid further downgrades in ratings.

The two governments receive advice from a near-identical set of public sector forecasters, so the differences in projections is a deliberate choice. The federal government’s lower interest rate projections (though still well above BMO’s) allows for more optimistic budget forecasts for future years. Ontario has taken an opposing approach: projecting high debt financing costs, creating room for the province to under-promise and over-deliver on deficit reduction.