OREANDA-NEWS. The wider deficits projected in Canada's 2016-2017 federal budget do not imply dramatic deterioration in the sovereign's debt trajectory, but will reduce public finances' resilience to potential economic shocks, Fitch Ratings says.

The first budget since the Liberal Party won a surprise election victory last October foresees a deficit of CAD29bn (USD22bn, 1.5% of GDP) in each of the next two fiscal years, gradually falling to CAD14bn in FY20-21. Federal debt peaks at 32.4% of GDP in FY17-18. The federal budget was balanced in FY14-15, and the Department of Finance expects a deficit of 0.3% of GDP in FY15-16.

The shift from a balanced or close-to-balanced federal budget is not a surprise and complements the Bank of Canada's policy rate cuts in 2015. The Liberals' election campaign promised deficits to stimulate a slowing economy, and pledged to repeal the Harper government's Federal Balanced Budget Act. But slower GDP growth and the expected impact of low oil prices on national income have caused the fiscal outlook to deteriorate since the new government took office.

The Department of Finance's February economic outlook (based on private-sector data) forecasts real GDP growth of 1.4% in 2016, down from 2.0% in the Fall Update. We made the same revision in our latest "Global Economic Outlook", largely due to the lower oil prices. Tax revenue is sensitive to estimates of nominal GDP, and the budget takes a conservative approach, assuming virtually zero nominal GDP growth in 2016, and revising down projected revenues by around CAD11bn on average for FY16-17 and FY17-18. There will be some room for extra spending, or quicker rebalancing of the budget if the economy grows faster.

Tuesday's budget also increased spending, in line with the government's election pledges. Annual increases to programme expenses total more than CAD50bn in the next five fiscal years, around 2.5% of GDP, due to higher infrastructure and social spending, including revisions to child benefit and employment insurance. This will boost growth, but the Department of Finance's estimate that stimulus measures will raise real GDP by 0.5% in FY16-17 and by 1% in FY17-18 assumes a relatively high fiscal multiplier for an advanced economy not in recession.

The new federal deficit projections imply that gross general government debt will rise in 2016 and stabilise slightly above our forecast when we affirmed Canada's 'AAA' sovereign rating in August. The path of general government debt (our standard measure to compare sovereign debt burdens, which includes central and subnational governments' debt) also depends on other factors, including whether the Canadian provinces can continue to narrow their deficits. The two most highly indebted provinces, Ontario and Quebec, are making progress in balancing their budgets, the latter recently proposing a second successive balanced budget and a progressive reduction in debt.

But larger federal deficits over the coming five years mean economic shocks or growth underperformance would be more likely to undermine Canada's debt trajectory.

The new government says it "remains committed to returning to balanced budgets", but has dropped its pledge to balance the federal budget by FY19-20. Successive governments' strong commitment to, and solid track record in delivering, fiscal adjustments are an important foundation of Canada's creditworthiness, given its high public debt.

Gross general government debt/GDP will approach 90% in 2016, the second-highest debt burden in the 'AAA' category after the US. Net debt, accounting for substantial pension fund and other assets at the provincial level, compares more favourably with peers, at less than 40% of GDP. We identified lower-than-expected growth leading to persistent increases in government debt as a sovereign rating sensitivity at the time of our August affirmation.