Will Canada's double whammy of tax cuts and defence spending hurt its AAA credit rating?

Yahoo

3 days ago

Canada's top-tier credit rating remains intact despite a post-election surge in federal spending and tax cuts, according to a new Desjardins report — but growing debt and a costly NATO defence commitment could threaten that standing in the years ahead.
Canada currently holds some of the highest possible credit ratings among advanced economies — AAA from S&P, Aaa from Moody's and AA+ from Fitch — making it one of the best-rated bond issuers in the G7. Desjardins' report says that standing appears safe for now, despite growing fiscal pressures.
'The likely substantial increase in borrowing ahead probably doesn't mean much for the government of Canada's top-notch credit rating, at least in the near term,' it said.
A sovereign credit rating is both an absolute and a relative assessment. On an absolute basis, it reflects a sovereign country's outstanding debt and its capacity to manage it, while also taking into account the relative credit developments of other sovereign countries.
At NATO meetings at the end of June, member countries agreed to increase defence spending up to five per cent of their GDP by 2035. The spending is to be divided into core defence expenditures of 3.5 per cent and 1.5 per cent in defence-adjacent spending, according to Desjardins.
For Canada, which lags behind its fellow NATO members in spending, this is a significant increase from its current defence outlay of 1.4 per cent of GDP. It has now committed to raising that number to two per cent by the end of the 2025-26 fiscal year.
Randall Bartlett, chief economist at Desjardins, said that the spending could impact Canada's AAA credit rating.
'Canada has a lot of things going for it on the fiscal front. But over time, if our fiscal situation erodes, particularly if we can't find those savings, that does put Canada in a precarious position of potentially putting our AAA credit rating at risk,' he said.
Bartlett noted that Canada has a long way to go to close the gap with its NATO partners, and a much further way to go than most other members to meet the new requirements.
'For the amount of spending that requires, the share of GDP is going to be a lot higher in Canada than it is in other countries, and that's certainly going to increase the debt burden of the federal government,' he said.
According to IMF forecasts cited in the report, Canada's gross general government debt as a share of GDP would need to be about seven per cent higher if defence expenditure is to reach 3.5 per cent of GDP by 2030. This is assuming no new spending and/or revenue cuts are introduced in other sectors to offset military spending.
Bartlett reiterated that, in the near-term, Canada's rating is safe due to its strong fiscal positioning. However, he emphasized that the debt to GDP ratio will move higher.
The new NATO defence spending framework could prove to be an issue for countries like Canada who have committed to meeting the targets and might find it hard to live up to that commitment, Bartlett said.
He also raised concerns regarding Canada's fiscal path moving forward, citing the lack of information from the government.
'I think the fiscal path in Canada is certainly headed in the wrong direction at this point. Not only is spending higher, but the federal government has decided to cut taxes at the same time. That could put us in a very challenging situation in the future, which would potentially require deeper savings through spending cuts and lead to some very difficult choices,' Bartlett said.
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He further emphasized that the lack of a fiscal plan is a major concern, especially considering the dynamics of the global economy.
'I think it is deeply concerning, because not only does our forecast and those of others show that the GDP ratio is rising consistently over time, but it speaks to a lack of transparency in financial reporting (from the government)' he said.