Dagong Downgrades the Sovereign Credit Outlook of Canada to Negative; Maintains AA+ Rating
Dagong Global Credit Rating Co., Ltd.
April 25, 2018
Dagong Global Credit Rating Co., Ltd. (hereafter referred to as “Dagong”) has decided today to downgrade the sovereign credit outlook of Canada to negative, while maintaining its local and foreign currency sovereign credit ratings at AA+. Given its remarkable external vulnerabilities, Canada’s economy slows down as a result of negotiations on North American Free Trade Agreement (NAFTA), the U.S. tax cuts and Federal Reserve’s interest rate hikes. That, coupled with relatively high risks in the real estate market and a persistently high fiscal deficit, renders government debt heavy and therefore places government solvency under pressure.
The key reasons for downgrading Canada’s sovereign credit outlook are below:
First, Canada’s political and credit ecologies bring about only limited adjustments in its economic structure, while the credit system faces high leveraging and risks of structural imbalance. The country has long been running a fiscal deficit, and its immigration policy has been under question while the ruling Liberty Party meets challenges from the conservative party and other opposition. Hence, there exists considerable uncertainty over the 2019 election. Besides, NAFTA talks have made slow progress, thus policy continuity could be easily affected. Given Fed’s rate increases, Canada adopts a tightening monetary policy. Considering long-standing high leveraging, resource mismatch, and downward pressure upon Canadian property prices, the country’s credit system faces liquidity risks.
Second, the Canadian economy maintains low growth while long-term growth potential is inadequate on the account of its singular industrial structure and over-dependence upon the U.S. economy. In the short term, the U.S. tax cuts and Fed’s rate hikes will cause the Canadian capital to flow abroad, cutting Canada’s investment advantages. The risks inherent in NAFTA talks will constrain domestic consumption and export growth, thus it is projected that in 2018 and 2019, Canada’s growth rate will drop to 1.6% and 1.4%, respectively. In the medium and long term, seeing how the Canadian economy relies heavily upon its export of energy and basic commodities, its industrial structure will likewise remain relatively rigid; meanwhile, Canada’s economy will remain highly integrated into the U.S. economy, bringing about significant external vulnerabilities. As a result, it is forecasted that Canada’s growth will average around 1.5% over that period.
Third, the fiscal deficit remains high and financing needs further climb from an already high level, undermining repayment resources. The government’s tax cuts cause slight falls in fiscal revenues. Facing downward pressure upon the economy, limited spending cuts and extra expenditures on immigrants, the Canadian government has very limited space to reduce its fiscal deficit. Therefore, it is expected that in 2018 and 2019, the Canadian general government’s fiscal deficit will stand at 2.4% and 2.3%, while the ratio of general government’s financing needs to fiscal revenues at the same period will hit 49.5% and 51.1%. A tightening monetary policy and capital outflow cause insufficient liquidity at home while yields on national bonds keep rising with the ten-year treasury yield having reached 2.11% in March 2018, hence sapping government repayment resources.
Fourth, government debt is heavy with inadequate foreign reserves, putting pressure on government solvency in local and foreign currency. The Canadian government’s plan to run a large deficit and take on new debt to repay the old will cause heavy government debt, thus it is projected that in 2018 and 2019, the ratio of Canadian general government debt to fiscal revenues will rise to 237.8% and 239.4%. Extremely high mortgage loans and downward pressure upon property prices might incur major liability risks facing the government. Meanwhile, the government sees a mounting external debt burden. In 2017, the total external debt burden rose by 0.5 percentage points to 115.3% while foreign exchange reserves coverage on short-term external debt dropped by 0.9 percentage points to 12.8%. Economic slowdown and the slower pace of rate increases bring the Canadian dollar under downward pressure, posing risks against government solvency in local and foreign currency.
The main reasons for maintaining the sovereign credit ratings for Canada include: the political situation is stable, property prices register a slower growth rate, financial regulation is strict and banks face relatively small off-balance sheet risks. Besides, economic growth continues, government debt expansion is manageable, and short-term debt accounts for only a small proportion of the total - all the while government solvency remains stable. Dagong will follow closely any changes to the risk factors discussed and make adjustments to its credit outlook in accordance.