Moving From Debt to Growth

S&P

Published in the Telegraph-Journal 17th May 2013

The recent downgrade of New Brunswick to AA-minus from A-plus underscores the extent to which the global financial crisis continues to cast its shadow on local economies. Standard and Poor’s (S&P) outlook change took place in June 2011 when New Brunswick became the only province with a negative outlook rating.  According to the credit agency, even with the downgrading, New Brunswick maintained a very strong capacity to meet financial commitments.

At the time, S&P explained their downgrading this way: “Credit concerns include our view of the significant deterioration in the province’s budgetary performance since fiscal 2009 , which continued in fiscal 2011. In addition, New Brunswick’s relatively high net tax-supported debt burden, rose further in fiscal 2011 to about 33% of GDP from about 30.6% in the previous fiscal year. The province expects it to rise further to about 36% in fiscal 2012. The negative outlook reflects our expectation that New Brunswick’s budget plan will not be enough to return the province to a balanced budget position in the medium term.”

Although the downgrade has had no immediate impact on the province, the longer-term effects may be more profound, albeit manifested in subtle ways. Some of the effects of a ratings downgrade are straightforward and manageable. The underlying differences in fundamentals — the set of economic indicators, institutions and policy frameworks that shape the economic outlook — between an AA-minus and an A-plus bond arguably are only minor. Prudential regulations restrict some large institutional investors from holding any asset that is not rated A-plus but this is not an insuperable obstacle to investment.

A small change in fundamentals can result in a relatively large change in bond yields. If the change in yields is large enough and the stock of debt correspondingly high, there is the real possibility that the province could suffer a vicious circle of rising risk premiums and increased debt charges with the consequence of deteriorating economic performance.

There is an expectation that New Brunswick eventually will need greater access to capital to play a more active role in its economic renewal. To achieve this, the fundamentals will need to slant in the province’s favour. Government’s solution to the challenge to date has been to reduce government expenses to draw down its costs. It has been unable to engage in more aggressive austerity policies but additional reductions in health care costs will come with increased unemployment and slowed economic growth. The public policies that will support greater efficiencies — and which will provide real solutions to the growing constellation of health care challenges — will be more transformational than incremental. These policies will require budgets and long-term spending commitments, if they are to reduce costs over time.

To reduce the risk to the province, government would need to avoid introducing discontinuities in the set of policy choices in favour of smooth, orderly adjustments. This may require more time to achieve. Ratings agencies have confirmed their conditional confidence in the direction of the province’s finances. To some extent, the expected sequence of events that will eventually lead to the province’s financial health has already relieved some pressure on New Brunswick and delayed the implementation of greater austerity. The success of this strategy will depend in part on the ability of Finance Minister Blaine Higgs to gain traction on his deficit reduction plans. But success will additionally be predicated on economic growth.

This is where the province’s downgrade could have disproportionate and unexpected effects in the longer term. New Brunswick’s credit worthiness is a synthetic composite of risk and expectations about the future. The objective of government should be to move from current conditions characterized by concerns about the speculation of out-of-control deficits and growing debt, to a desirable equilibrium of improved public finances and a return to growth where government is a committed player.

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Filed under Austerity, Economic Growth, Fiscal Policy, New Brunswick

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