MNI EXCLUSIVE: BOC, Feds May Limit Provincial Fiscal Relief

--BOC, Federal Government Likely To Limit Covid Aid To Provinces

--Provincial Finances Unsustainable

By Greg Quinn

     OTTAWA (MNI) - Canada's federal government and central bank will likely

restrict backstops for provinces to what's needed for riding out Covid-19, to

protect monetary policy independence and maintain fiscal discipline, said policy

experts, after an official watchdog told MNI regional finances are

unsustainable.

     The Bank of Canada's plan to buy up to CAD50 billion of provincial bonds

will bankroll healthcare networks and relief payments, while part of a federal

deficit heading for 15% of GDP will also go to provinces, but authorities may be

wary of signaling weaker regions will be saved from chronic deficits.

     "If that becomes an essential part to rolling over their debt on a regular

basis, then concerns about moral hazard could start to arise," said Kyle

Hanniman, an expert on fiscal policy at Queen's University who's writing a book

on government default risk. "The Bank of Canada might find it's difficult to

exit the provincial market -- I'm not convinced that's the case."

     Provinces have wide powers to run deficits and sell bonds like the federal

government, but have less fiscal firepower, and some are also dependent on

cyclical industries, such as energy. They often sold debt at close to federal

government yields on the expectation Ottawa would prevent a default, but spreads

surged earlier this year and sales froze up, prompting BOC intervention.

     --POLITICAL ENTANGLEMENT

     Federal debt as a share of GDP is set to climb towards 50%, where it was in

the 1990s when Canada's credit ratings were slashed, but direct federal spending

and BOC moves to keep markets liquid will help blunt the argument that provinces

need longer-term support.

     "The overall fiscal hit for the federal government is going to be a lot

larger as a share of GDP than it is for the provinces" said Michael Smart, a

University of Toronto professor who co-chairs a working group of the Canadian

Tax Foundation, which includes 12,000 lawyers and accountants.

     The federal government will be aware of the political difficulty of

imposing fiscal rules on provinces, Hanniman said, adding that any of them in

real trouble would quietly get a quick fix over a precedent-setting public

bailout, he said. "I'm just not convinced that increasing transfers will

necessarily decrease deficits, just because provinces do have that capacity to

borrow, it might just be an excuse to put off their deficits."

     Responding to an MNI question at a press conference Wednesday, Canadian

Finance Minister Bill Morneau said he would continue to talk to provinces about

the financial strain of Covid-19. Asked about risks to Canada's triple-A credit

rating, he said his focus is on a strong economy.

     The BOC has set a one-year time limit on provincial buying, contrasting

with its pledge to buy more than CAD5 billion a week in federal bonds until

recovery is well underway.

     "Although it's naive and misleading to say central banks are apolitical,

they don't feel the same pressure to bend to the will of provincial premiers and

other political actors," Hanniman said.

     The BOC isn't disclosing exactly what provincial bonds it is buying or

setting a lower limit on credit ratings. On Tuesday it added more transparency,

showing how its actions will be tied to a province's GDP and share of debt

markets, rather than any fiscal crisis, a move MNI first reported on last week.

     --STIGMA

     "What they want to avoid is a stigma effect, where if you say that you are

purchasing debt of Government X, that it creates the impression in the market

that there is a particular problem for that jurisdiction," said Gregor Smith, a

BOC fellow from 2006-15.

     Provinces may need to borrow an extra CAD50 billion this fiscal year, for a

total approaching CAD150 billion, BMO estimates. Energy rich-provinces are

suffering most, with Newfoundland's deficit estimated at 6% of GDP, and

Alberta's at 5% of GDP.

     Canada's parliamentary budget officer Yves Giroux told MNI provincial

finances look unsustainable over the long term while the federal government is

on more solid ground even as its deficit surges. "There will be renewed demands

for pandemic preparation kits for increased public health care expenditures,"

Giroux said.

     "Two years from now, I think that we will be past this crisis, the dust

will settle, and provincial debt to GDP ratios will be on the order of 5

percentage points higher than today. That's a major shock to the provincial

sector, but it's a shock that I believe we can tolerate," Smart said.

--MNI Ottawa Bureau; +1 613-314-9647; email: greg.quinn@marketnews.com

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