Fitch Affirms Province of Quebec at 'AA-'; Outlook Remains Negative
In addition, Fitch affirms the outstanding 'F1+' short-term ratings on the Province of Quebec.
The Rating Outlook remains Negative.
SECURITY
Senior unsecured obligations are direct and unconditional obligations of the province to which the province's full faith and credit is pledged. Commercial paper notes are promissory notes ranking equally with Quebec's other unsubordinated and unsecured indebtedness.
For Financement-Quebec, payment of debt service is unconditionally guaranteed by the province from the consolidated revenue fund.
KEY RATING DRIVERS
NEGATIVE OUTLOOK BASED ON FISCAL BALANCE: The Negative Outlook, revised from Stable in late 2013 when the province delayed its fiscal consolidation target, reflects the slower than expected economic and revenue growth during the current economic expansion and the risk that additional under-performance could derail the province's achievement of balance, expected by the province to occur this fiscal year.
HIGH DEBT: Debt is high relative to resources and has grown since the multi-year fiscal consolidation plan was announced in 2009. Debt management is strong and centralized, and the province maintains ample access to liquidity for both operations and debt service requirements, supporting the 'F1+' short-term rating.
FISCAL FLEXIBILITY: The province continues to adjust tax policy and spending commitments to achieve balance. It has had notable success in curbing spending growth to date and now has articulated actions needed to achieve balance on a forecast basis. However, anticipated future spending growth is also below historical experience and achieving these lower growth targets will remain a persistent challenge.
DIVERSE ECONOMY: The economy is large and diverse, but historically slower growing and less wealthy than the Canadian average. Moderate growth continues. Vulnerabilities include global trade links, particularly with the U.S. market, and a large manufacturing sector.
SOVEREIGNTY MOVEMENT REMAINS: The sovereignty movement has been a source of uncertainty in the past although it is not a current issue.
FINANCEMENT-QUEBEC'S RATING LINKED TO PROVINCE: The rating for Financement-Quebec reflects the credit strength of the province given the province's unconditional guarantee.
RATING SENSITIVITIES
ECONOMIC AND REVENUE UNDERPERFORMANCE: Unexpected near-term economic and revenue deterioration, or an inability to attain currently forecast fiscal targets including balance in the current fiscal year, could result in a rating downgrade.
SUCCESSFULLY ACHIEVING NEAR-TERM BALANCE: Achieving fiscal balance in the current year, including meeting economic and revenue targets and successfully implementing planned savings, could result in a return to a Stable Outlook at the current rating level.
CREDIT PROFILE
The Negative Outlook on Quebec's long-term 'AA-' rating is based on the weaker-than-expected economic and revenue performance during the current recovery and the risk that these factors could affect the province's return to full fiscal balance, forecast to occur in the current fiscal year (ending March 31, 2016). The province's fiscal 2016 budget is balanced on a forecast basis, and Fitch views the wide range of planned actions, both to maximize revenues and curb spending growth, to be achievable if economic and revenue gains match or exceed present forecasts.
Despite its recent, material budget successes, Quebec's fiscal challenges extend beyond the short-term achievement of fiscal balance. Longer-term, the province has set forth ambitious revenue and spending targets to achieve modest annual surpluses and allow gradual resumption of debt burden reduction. Fitch views the province's resumption of progress in lowering debt as being an important longer-term credit consideration, but one for which budget balance is a necessary prerequisite.
DEBT BURDEN WILL REMAIN HIGH
Fitch views Quebec's debt burden as elevated at the current rating category, a factor offset by its consistently solid fiscal management and the success it demonstrated before the last recession at lowering its debt burden.
Outstanding gross debt, which includes debt of consolidated entities and pension liabilities, stood at C\\$206.2 billion in fiscal 2015, equal to 54.9% of GDP. Debt service, at C\\$10.3 billion in fiscal 2015, consumed 10.8% of consolidated revenues, a high but manageable level. Much of the current debt burden stems from accumulated deficits built over prior decades and in the years since the 2008-2009 recession, amounting to about C\\$124.8 billion in fiscal 2015 or 33.2% of GDP. Total public sector debt, at C\\$274.5 billion, equals 73.1% of GDP.
Fitch expects the province's debt burden to remain high, although a return to consistently balanced budgets provides it with a window of opportunity to resume debt reduction. The province forecasts that its debt burden relative to GDP peaks as of fiscal 2015 and will decline from fiscal 2016 onward. It likewise maintains its longstanding statutory fiscal 2026 target of gross debt-to-GDP at 45%, and an accumulated deficit to GDP target at 17%. Debt figures are net of the Generations Fund balance, a reserve for debt reduction, which is funded at about C\\$6.9 billion in fiscal 2015.
The province is a sophisticated debt manager and has demonstrated broad market access for current liquidity, new borrowing and to refund maturing debt. Liquidity is ample, particularly given the province's establishment of a reserve for prudential liquidity averaging about half of one year's annual financing requirements. Almost a quarter of total public sector debt is self-supporting, mainly for the Province's large water power utility, Hydro-Quebec (rated 'AA-' by Fitch).
ECONOMIC GROWTH BEGINNING TO PICK UP
Quebec's economy is diverse, mature and generally more slow-growing than Canadian averages. Similar to other Canadian provinces, it has significant exposure to the U.S., the primary destination for a wide range of its exports, including from its large manufacturing sector. The province's economic performance during the current expansion has generally been positive, albeit less robust than past economic expansions given the slow global recovery. Lower oil price trends beginning in the second half of 2014 and a more favorable exchange rate environment have provided additional lift in recent months.
Real GDP growth, at only 1% in 2013, accelerated to 1.3% in 2014 and is estimated at 2% in 2015. Steady household consumption growth has provided a baseline for recent gains, with recent export strength adding to gains. Business investments, which recently have been a drag on growth, are forecast to resume gains in 2015 and beyond. The province forecasts real GDP growth at 2% in 2016, with growth continuing at a slower pace thereafter through the 2019 forecast period.
Quebec's labor market trends, which historically have been weaker than Canadian averages, have closed much of that gap over time; average annual employment growth in the province was 1% between 2004-2014, just below the 1.1% Canadian rate, while average unemployment over the same period was 7.8%, compared to 7.1% for Canada as a whole. More recent trends have generally been positive. May 2015 employment is up 1.7% in Quebec compared to a year earlier, versus 1.1% for Canada. Unemployment, at 7.6% in May 2015, remains higher than the 6.8% Canadian rate. The Province's economic forecast assumes unemployment at 7.5% for 2015, and 7.3% in 2016.
Overall forecast economic expectations for 2015 and 2016 appear reasonable, in Fitch's view. Key forecast uncertainties include whether recent energy and exchange rate trends and improving U.S. performance continue to favor Quebec's economy, and whether recently weak business investment trends reverse and begin contributing again to GDP gains.
FORECAST BALANCE ACHIEVED
As with many Canadian provinces, Quebec responded to the last recession with stimulus spending and a multi-year plan to restore fiscal balance. An unsteady recovery and difficulties in meeting its spending targets led it to announce, in late 2013, a two-year delay in its fiscal consolidation target, to fiscal 2016 from fiscal 2014; the setback led Fitch to revise the Province's Rating Outlook to Negative, from Stable.
In the time since the delayed consolidation was announced, the province has identified a range of revenue and spending changes to close its remaining forecast gap. From a fiscal 2014 deficit of \\$2.8 billion (4% of budgetary revenues), the gap was narrowed in fiscal 2015 to \\$2.35 billion (3.3% of budgetary revenues), and the budget tabled in March 2015 for fiscal 2016 closes the remaining gap on a forecast basis. Under the government's fiscal 2016 budget, the fiscal year would end with a \\$1.6 billion surplus, before Generations Fund deposits.
The province's success in recent years in curbing spending growth has proven that it has materially more fiscal flexibility than shown by the revenue measures that dominated the earlier budgets during the fiscal consolidation. Recent policy actions have sought to slow growth across a range of spending categories, including employee remuneration, health care delivery and education.
Fitch continues to view spending growth targets to be achievable albeit politically challenging, particularly as a wider range of public services are affected over time. Program spending is estimated to have risen a low 2.1% in fiscal 2015, and is budgeted to rise only 1.2% in fiscal 2016. This growth pace, well below the 5.6% average annual pace recorded from fiscal 2007-2010, assumes full realization of a range of specific spending measures, including delayed salary increases, staffing freezes, and efficiency improvements.
The province's revenue forecast appears reasonable, although Fitch notes the persistent uncertainty that has been a hallmark of the current economic cycle in Quebec and elsewhere. The province forecasts consolidated own-source revenues rising 4.4% in fiscal 2016, after rising 3.5% in fiscal 2015. Gains reflect in part the recent uptick in Quebec's economic performance, as well as a modest range of tax changes; the latter includes a range of tax expenditure cuts arising from the province's tax reform commission.
AFFIRMED RATINGS
Fitch's affirmation of the long-term 'AA-' rating and Negative Outlook applies to the following senior unsecured bonds of the Province of Quebec and Financement-Quebec:
Province of Quebec:
--Senior unsecured debt;
--Local currency long-term rating;
--Long-term issuer rating.
Financement-Quebec:
--Senior unsecured debt;
--Local currency long-term rating;
--Long-term issuer rating.
In addition, Fitch affirms the short-term 'F1+' ratings on the Province of Quebec and Financement-Quebec, as follows:
--Province of Quebec short-term issuer rating;
--Province of Quebec short-term commercial paper;
--Financement-Quebec short-term issuer rating.
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