Even modest rate hike could derail Ontario budget

An unexpected rise in interest rates could jeopardize provincial government promises of balanced budgets, says the Fraser Institute.

“During this era of record low interest rates, governments in Canada have accumulated significant debt, which could pose serious risks to their budgets if interest rates begin to rise and return to normal levels, causing debt interest payments to increase,” says Jean Francois Wen, professor of economics at the University of Calgary and author of a report on the impact of interest rates on government debts.

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The study spotlights the interest rate risks faced by governments across the country using Ontario and Quebec—Canada’s two largest and most indebted provinces—as examples. It analyzes two scenarios: one where interest rates rise from a projected 3.8% in 2017/18 to 4.5%, and another with hikes to 5%.

In 2015/16, for example, Ontario expects to spend $11.4 billion on debt interest payments – equivalent to 9.2% of total revenues. If, however, interest rates rise by 4.5% to 5%, Ontario’s annual interest payments on government debt could increase by between $409 million and $857 million in 2017/18, putting Ontario’s plan to balance its budget in jeopardy.

Ontario’s interest payments on government debt as a percentage of revenues could rise to between 9.7% and 10.2% by 2019/20.

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“Higher than expected interest rates would not only put Ontario’s plan to balance its budget at risk, it would also result in a larger percentage of revenues going to service outstanding government debt rather than to public programs that Ontarians value,” Wen said.

The study notes that provincial governments have shifted the structure of their debt toward longer-term maturities to postpone refinancing at higher interest rates. But, this should not lull governments into a false sense of security—eventually, all public debt has the potential to be exposed to higher interest rates.

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The study also examines the effect of potential interest rate hikes for Quebec.

Unlike Ontario, the Quebec government is projecting budget surpluses in the near-term. But if interest rates were to rise, those surpluses would be lower than planned, requiring the province to devote a larger share of revenues to financing interest payments.

“Ultimately, governments and their citizens should not be complacent about the risks of interest rate hikes,” says Wen.