Ontario hiding savings from lower interest rates

The Ontario government Fall Economic Statement and Fiscal Review ignores and hides billions savings the province will gain from lower borrowing rates in coming years.

While this statement acknowledges that borrowing rates will be considerably lower in coming years–and more than 100 basis points lower in 2014–their forecast of debt interest costs (on page 85) is identical to what Ontario’s 2012 budget reported (on page 167).  This makes little to no sense, particularly with the province’s debt also lower than they had anticipated in the budget.

The only possible explanation would be a very large shift in composition from short-term debt with relatively lower rates to longer term debt to achieve greater savings over the longer term, but much of Ontario’s debt is already longer term.   No doubt the province will acknowledge these savings at a future, more politically opportune time.  (There’s a small adjustment of $18 million in debt interest costs for the current year –but the final figure will undoubtedly be larger.)

As I outlined in an article included in CUPE’s new Economy at Work publication, both the federal government and Ontario governments will save billions of dollars in coming years over the next five years from borrowing costs that are lower than forecasted in the 2012 budgets.    In fact these savings should for Ontario be very similar–approximately $5 billion over five years–to what the Ontario Finance Minister estimated they will get from its recently announced legislation to freeze public sector wages.

The CIBC drew attention to the large savings Canadian governments are getting from lower interest rates this past summer.  I analyzed outstanding debt for the the federal and Ontartio governments to estimate what their savings will be by year from lower interest rates than they forecasted in their recent budgets.

These calculations suggest the Ontario government will be able to save an additional $5 billion from lower borrowing costs over the next five years as a result of lower interest rates than they had forecasted in their 2012 budget.  By a surprising coincidence, these savings are almost identical to the amounts that they can be expected to save from their wage freeze legislation.  (Perhaps that’s why these interest savings weren’t acknowledged in their fall Statement.)

These savings are similar to what they expect to save from the two year wage freeze on public sector workers imposed through their Orwellian-sounding Protecting Public Services Act.

This means the Ontario government could reach its deficit targets without imposing these public sector wage freezes, which will dampen wage growth all around and slow down the economy, thereby reducing revenue growth. Even the IMF recently warned governments not to unnecessarily cut spending and impose austerity measures as this is leading to slow economic growth.

While lower borrowing rates provide governments with unqualified savings on their debt interest costs, cutting public spending and public sector wages leads to economic costs: less economic stimulus, lower household spending, slower economic growth and a loss of jobs, as less money is circulated through the economy. Cutting public spending at a time when there’s little demand from other sectors of the economy—consumer spending, business investment and exports—is especially damaging because it can lead to recessions, as is happening in Europe.

Savings from lower borrowing rates similar to wage freeze

In its 2012 Budget, the Ontario government forecast long-term interest rates (the benchmark 10-year Canada bond) would be 2.2 per cent in 2012, rising to 4.5 per cent in 2016. Already these forecasts have proven to be too pessimistic. Public longer-term borrowing rates declined to all-time lows this past summer—down to 1.58 per cent for the benchmark 10 year Canada bond—and is now expected to rise slowly to 3.5 per cent by 2016, instead of the 4.5 per cent forecasted by federal and provincial governments (see figure below and table further below).

Ontario’s borrowing rates are slightly higher than the federal government but the province has also benefited significantly from lower public borrowing rates. For instance this past summer the province was able to borrow at a rate of less than 2.5 per cent over ten years and at 1.65 per cent for a seven year bond.

Ontario will benefit particularly from lower long-term interest rates because more of its debt is held in longer term bonds. Analysis of Ontario’s outstanding debt shows the province should realize at least $200 million in interest savings this year compared to its budget’s estimates, rising to $1.7 billion in 2015 as more debt rolls over and approximately $5 billion during the next five years (see table). These savings could be increased if the province retires debt at a faster pace.

According to Ontario Finance Minister Dwight Duncan, a two year public sector wage freeze would save the province $2.8 billion over three years. With a first year savings of $550 million, this works out to $1.1 billion in the second year and approximately $1.1 billion for the third year and each year thereafter—as long as the freeze is only for two years and there is no subsequent catch up. Over five years the total savings amounts to approximately $5 billion (see table).

This amount is virtually the same as the windfall in savings Ontario will get from lower interest rates beyond what they forecasted in their 2012 budget. This means the Ontario government doesn’t need to engage in economically damaging spending cuts to balance its budgets.

Finance Minister Dwight Duncan has repeatedly warned that not cutting spending will lead to credit downgrades and higher borrowing costs for the province. However, exactly the opposite has happened since the province’s 2012 budget. Even though the province was downgraded by the rating agencies, its borrowing costs and interest costs declined instead of increasing. Credit rating agencies really shouldn’t have a lot of credibility themselves following their role in the financial crisis. There’s so little concern about Canada’s fiscal situation that credit default swaps (insurance against default) on Canadian government debt aren’t much traded.

Spending cuts will hurt the economy and increase unemployment

Ontario’s 2012 budget cuts will reduce employment in the province by over 100,000 within a few years and reduce the province’s economic growth by almost 1%, according to independent analysis by the Centre for Spatial Economics. Ontarians can little afford more cuts at a time when there are almost 600,000 unemployed in the province with an unemployment rate of 7.9%, when the economy is expected to grow at less than 2%, wages are growing slowly and household debt is now over 165% of disposable income.

With more weakness in the economy—as a result of severe cuts in the US or a housing bust in Canada—the spending cuts by the Ontario and federal governments could very well help plunge the Ontario and Canadian economies over the cliff into recession. Slowing down the economy and increasing unemployment is also bad for the province’s bottom line. For example, 1% slower economic growth will reduce Ontario’s revenues by $800 million (see pages 167-179 in Ontario 2012 Budget) and increase social spending, leading to close to $1 billion in higher deficits.

While the rest of the economy is ailing, cutting public spending can actually have the perverse effect of actually increasing deficits, instead of reducing them, as it has in the UK and other countries in Europe.

With interest rates at these historical lows and the economy in dire straits, it makes far more sense for governments to invest and stimulate economic growth, as even the IMF and a number of traditionally fiscally conservative and bank economists are now arguing. While this may temporarily increase deficits over the short-term, higher economic growth will more than compensate for these interest payments, reducing deficits and debt-financing ratios over the longer term.