Quebec Fiscal Prudence Beats Ontario Spending for Bond Investors
(Bloomberg) -- Quebec’s dogged effort to get its fiscal house in order is rewarding the Canadian province with consistently lower borrowing costs than Ontario, a dramatic departure from the norm that’s prevailed for decades.
Quebec government bonds are outperforming their provincial peers, with relative yields trading largely below Ontario’s since the end of last year. It’s a trend that’s likely to continue as the provinces release dramatically different budgets this week.
“No way, no how did I ever think we would ever see Quebec trading through Ontario on a persistent basis,” said Brian Calder, senior bond trader at Franklin Bissett Investment Management in Calgary, which has about C$20 billion ($15 billion) in stocks and bonds and owns the debt of both provinces. “A decade ago that was simply unimaginable, yet today the market has validated that.”
For bond investors, the reasons for Quebec’s outperformance are clear.
Once the poster child for Canadian fiscal mismanagement, the French-speaking province will once again target a balanced budget for 2018-19 when it unveils its plans on March 27, its fourth in a row, and will even put C$10 billion toward its debt. The next day, Ontario is expected to present its first balanced budget in a decade -- then immediately go back into the red for 2018-19 to fund pre-election spending.
The budgets will offer both finance ministers -- Carlos Leitao for Quebec and Charles Sousa for Ontario -- a final chance to set out priorities ahead of elections. Ontario votes by June 7 and Quebec on Oct. 1. Both governing Liberal parties are trailing in opinion polls.
Years of spending restraint have helped propel Quebec 10-year debt to a 2.95 percent return in the 12-months ended March 22, topping a 2.29 percent gain for the ICE BofAML Canadian Provincial & Municipal Index. Bonds issued by Ontario, the country’s most populous province, returned 2.69 percent in the period, the data show.
Average Quebec government bond yields narrowed 17 basis points in the past year to 55 basis points, while Ontario has compressed by 14 basis points to 57 basis points. On Friday, Quebec’s benchmark 10-year bond yielded 2.758 percent compared with 2.796 percent for Ontario.
“Simply put, Quebec has been better behaved,” said Calder at Franklin Bissett. “They are firmly focused on fiscal prudence and targeting overall debt reduction for the long term. You look at Ontario, and they don’t have that.”
Ontario continues to have excellent access to the market, Orli Giroux Namian, a spokeswoman for Sousa, said Friday via email. “Strong demand for Ontario bonds allowed the province to prefund C$8.1 billion of next year’s borrowing requirement.” Leitao is unavailable for comment until after the Quebec budget, according to a finance ministry spokesman.
In June, S&P Global Ratings upgraded Quebec to AA-, its fourth-highest level, from A+. This marked the first time the province has enjoyed a better standing than neighboring Ontario, whose debt is rated A+.
“Quebec stands out,” Paul Judson, a credit analyst at S&P, said in a telephone interview from Toronto. “Their financial management has been among the best across Canada for the past several years now. They’ve been successful at bending the cost curve.”
The upcoming fiscal plans are likely to reinforce the trend. Quebec’s plans to pay down debt over five years may allow the province to save a combined C$1.1 billion in interest costs, the government has said. The province has been aided by an economy firing on all cylinders, with the 5.6 percent unemployment rate in February hovering near a record low.
Still, Quebec remains Canada’s most indebted province relative to gross domestic product. Its net debt -- or difference between its liabilities and financial assets -- will be about 46 percent of GDP at the end of March, according to a 2017 projection from the finance ministry. That compares with about 38 percent for Ontario.
In real terms, Ontario is Canada’s most indebted province. It’s projecting about C$311 billion of net debt as of March 31 compared with about C$187 billion for Quebec.
Ontario has also been benefiting from a strong economy with its housing and financial services bubbling, sending its unemployment rate to 5.5 percent, also near a record low. But it’s chosen a different fiscal path.
Premier Kathleen Wynne is pledging to deliberately go back into the red to increase spending on healthcare, childcare and pharmaceutical coverage. That will push the province back into deficit next fiscal year, breaking a promise to balance the books through 2020.
The uncertainty is likely to weigh on Ontario bonds, Bissett’s Calder said.
“Bondholders are interested in seeing long-term sustainable plans, and this is not what we’re getting from Ontario,” he said. “They are kicking the can down the road. They are taking the easy way out. There’s no hard deadline. That is a little bit frustrating.”
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