Even modest interest rate hikes could endanger Ontario government’s promise of a balanced budget

TORONTO—A higher than expected rise in interest rates could jeopardize provincial government promises of balanced budgets and surpluses, finds a news study released today by the Fraser Institute, an independent, non-partisan Canadian public policy think tank. “During this era of record low interest rates, governments in Canada have accumulated significant debt, which could pose serious risks to their budgets if interest rates begin to rise and return to normal levels, causing debt interest payments to increase,” said Jean Francois Wen, professor of economics at the University of Calgary and author of The Impact of Higher Interest Rates on the Cost of Servicing Government Debt.

The study spotlights the interest rate risks faced by governments across the country using Ontario and Quebec—Canada’s two largest and most indebted provinces—as examples. It analyzes two scenarios: one where interest rates rise from a projected 3.8 per cent in 2017/18 to 4.5 per cent and another with hikes to 5.0 per cent. In 2015/16 for example, Ontario expects to spend $11.4 billion on debt interest payments – equivalent to 9.2 per cent of total revenues. If, however, interest rates rise faster than expected, Ontario’s annual interest payments on government debt could increase by between $409 million and $857 million in 2017/18, putting Ontario’s plan to balance its budget in jeopardy. Alarmingly, Ontario’s interest bite (defined as interest payments on government debt as a percentage of revenues) could rise to between 9.7 per cent and 10.2 per cent by 2019/20. “Higher than expected interest rates would not only put Ontario’s plan to balance its budget at risk, it would also result in a larger percentage of revenues going to service outstanding government debt rather than to public programs that Ontarians value,” Wen said.

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The study notes that provincial governments have shifted the structure of their debt toward longer term maturities as a means to postpone the need to refinance their debts at higher interest rates, if rates were to rise. But, this should not lull governments into a false sense of security—eventually, all public debt has the potential to be exposed to higher interest rates. In another example, the study examines the effect of potential interest rate hikes for the province of Quebec. Unlike Ontario, the Quebec government is projecting budget surpluses in the near-term. But if interest rates were to rise, those surpluses would be lower than planned, requiring the province to devote a larger share of revenues to financing interest payments on debt. “Ultimately, governments and their citizens should not be complacent about the risks of interest rate hikes,” Wen said. Media Contact: Aanand Radia, Media Relations Specialist, Fraser Institute, aanand.radia@fraserinstitute.org