The storm clouds had been gathering for weeks. When Finance Minister Paul Martin tabled one of the most austere budgets in Canadian history on Feb. 27, many financial analysts applauded. Even Canadian taxpayers, faced with major cuts to government services and social programs, seemed ready to swallow Martin’s bitter medicine. But there was one prominent exception. Moody’s Investors Service of New York City, the world’s leading bond-rating agency, which had warned earlier that it might downgrade Canada’s credit rating, said that it wanted to study the federal budget in more detail. Finally, last week, in what amounted to a stinging indictment of Martin’s effort, Moody’s knocked Canada’s rating from triple-A to double-Al—a decision that could ultimately increase the government’s borrowing costs.
Moody’s reasons: a run-up in interest rates could shatter Martin’s budget projections and send Canada’s $550-billion national debt soaring. Said Martin Murenbeeld, a Victoria-based currency analyst:
“Moody’s is saying reducing the deficit may be much more difficult than the government thinks.”
Despite Moody’s prolonged rumbling, when the rating cut finally came, the dollar stumbled briefly before rapidly rebounding and closing at 72.57 cents (U.S.), up 0.26 cents on the day. The dollar continued to gather strength overnight in London and Tokyo, and analysts were quick to point out that international financial markets had already compensated for the Moody’s downgrading.
Even so, in the future the reduced rating could make it more expensive for Canadian government and corporations to borrow money. Ottawa may be hit first: over the next two years $200 billion, or 40 per cent of Canada’s total federal debt, will come due. The finance department will have to refinance that debt, and the Moody’s decision, coupled with a failure by the government to meet its deficit-cutting targets, could significantly increase the interest rates it must offer to attract investors. “If there was evidence that the government was getting off its fiscal track,” said Ted Carmichael, chief economist for investment dealer J. P. Morgan Securities Canada Inc., “investors might not want to buy the debt.”
Clearly, Moody’s is convinced that Ottawa’s fiscal plan will be derailed. In a news release, the firm stated: “The overall size of the public-sector debt is such that any deviation from a medium-term stabilization program could have very negative financial consequences.” Martin’s budget also proposed to slash cash transfers to the provinces, causing them in
turn to drastically reduce government services. And, said Moody’s, “reducing overall public-sector deficits may prove far more difficult and painful than presently anticipated by many observers.”
On a visit to Hong Kong last week, Martin insisted that he is determined to meet his deficit-reduction goals. The deficit soared to a record $42 billion last year, but under his plan it will be reduced to $24.3 billion in 1996-1997, or three per cent of estimated gross domestic product. Said Martin: “Meeting our fiscal objectives is a key priority and we will stay on track.” Prime Minister Jean Chrétien, who was attending a Liberal fundraising dinner in Calgary, also downplayed
Moody’s decision. “Most of the other rating agencies,” said Chrétien, “have recognized that we have had a very good budget.” Despite those assurances, the negative effect from the Moody’s downgrade could be widespread. Moody’s rating system does not allow any corporation, municipality or province to have a higher standing than Canada’s federal government. As a result, the government of British Columbia, numerous municipalities and even blue-chip corporations like Imperial Oil Ltd. and Sun Life Assurance Co. of Canada, both of Toronto, have had ratings on some categories of their debts reduced along with Canada’s. “We just got blindsided by our own government,” said Sun life chairman and chief executive John McNeil. “The government did not, and will not, come to grips with the deficit problem.” Canada’s foreign currency borrowing also took a hit from Moody’s and was downgraded from double-Al to double-A2. These funds, consisting of debt issued by Canada in the currency of another country, account for about $10 billion of Canada’s federal debt, as well as $10 billion in B.C. government and B.C. Hydro bonds. In its news release, Moody’s stated that it was forced to reduce the rating on these funds because foreign markets have become extremely volatile. And it said that Canada has virtually no way to control fluctuations in the value of its foreign-denominated debt. Added Moody’s: “Highly indebted countries are particularly susceptible to sharp swings in international capital flows.”
While the downgrade may not have registered an immediate impact, Anita Lauria, an economist with the sovereign debt group at Salomon Bros. Inc. in New York, said that Canada will now have a difficult time restoring its triple-A rating because of the country’s huge debt-load. Lauria says that she has compared Canada’s debt with that of other industrialized nations. “A comparison of credit-sensitive indicators showed that Canada was no longer a triple-A country,” said Lauria, “and there’s little prospect that those numbers can be improved anytime soon.” And that could cost Canadian taxpayers dearly.
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