26 July 2019

Osborne whistling past financial graveyard #nlpoli

Moody’s delivered a clear and serious message to the Government of Newfoundland and Labrador on Wednesday night by lowering the government’s credit rating.  The credit rating action came after a series of consistent warnings by Moody’s since it last lowered the government’s rating of credit-worthiness in 2016.

Wednesday’s downgrade suggests that Moody’s has doubts the provincial government can hit its target of balancing the provincial budget by 2022.  While Moody’s changed its trending to stable from negative,  bear in mind that Moody’s rating period ends before the government’s budget period expires.  It doesn’t mean – as both finance minister Tom Osborne and NDP leader Alison Coffin suggested on Thursday - that everything is fine.

In a news release issued on 24 July 2019, Moody’s cited three major reasons for the downgrade:
  1. “Newfoundland and Labrador's elevated debt and interest burdens”, 
  2.   “continued expectation of material consolidated deficits over the next 2 years”, as well as
  3.  “heightened credit risk stemming from the large debt level and weak financial metrics of Nalcor, the province's wholly owned utility, which raises the likelihood the province will need to provide financial support to, or assume debt service from, Nalcor.

Finance minister Tom Osborne dismissed the downgrade, telling reporters that the downgrade was “not a reason for alarm” and “nothing to be alarmed about”. Osborne said lenders were not surprised by the action, which would be true since both the warnings from Moody’s and the province’s failure to heed them have been well known for two years.

Osborne *is* whistling past the financial graveyard here as he responds to the short-term political imperatives of his own party as opposed to the longer-term interests of the province.  As SRBP noted in January, the provincial government abandoned its deficit plan from 2016 within 18 months of starting it. The spring budget understated the government’s financial state.   

The motivation was purely political just as the reaction to Moody’s is political.  If re-elected,” SRBP noted before the May election, “Dwight Ball is unlikely to make any changes to the government’s current trajectory unless forced to do so. The members of the Liberal caucus, primarily interested in securing their pensions and possibly becoming ministers in a post-Ball Liberal administration, would have no interest in doing anything that would jeopardise their political future.”

That statement was before the Liberals returned from the election with a minority government.  It was propped up by the provincial New Democrats in the budget session that followed the election.  That coalition, whether informal or not, guarantees that the government will not take any action that reduces government spending.  The NDP would never allow the government to take any action that upset the public sector unions even if, by some bizarre twist, the Liberals abandoned the political deal they cut with the unions in order to get re-elected in the first place.  The Liberals inclined to inaction when they had a majority will be even less inclined to do anything as a minority government.  And if they are forced to act on the government’s finances, the Liberals will do the bare minimum.

That is the opposite of what Moody’s has consistently warned was necessary.  In its 2016 downgrade, Moody’s noted that while the provincial government budget outlined “a very aggressive response to the fiscal challenges facing the province”,  Moody’s felt that to ”achieve the province's target of fiscal balance by 2021/22 will require even greater measures” than the tax increases included in the budget at the time.  The “greater measures” were the reductions in spending the Liberals abandoned in 2017.

Moody’s 2019 downgrade notes that the provincial government’s current budget plan calls for a level of spending reductions in over the next two years is a “highly ambitious” target.  In that context, “highly ambitious” appears to mean highly unlikely.  Moody’s also noted that while the current administration had held spending growth down significantly, the provincial government had not been able to achieve spending reductions in two consecutive years since entering the current period of consecutive deficits in 2012. 

In his scrum with reporters on Thursday, finance minister Tom Osborne did not talk about spending reductions. He talked only of keeping to the current plan, which basically means holding down spending increases.  Go back to the 2016 Moody’s warning – that corrective action would need reductions as well as new revenue – and you can see pretty quickly why Moody’s downgraded the provincial government’s credit rating. 

It may well wind up doing so again.  Moody’s forecast period only covers the province to 2021, the year before the supposed balanced budget.  Its warning in 2016 was aimed at a new government with no track record.  The latest downgrade action came after three years of experience. The latest action is therefore much more serious a warning.

Moody’s has been consistent.  The firm's 2017 budget commentary – issued before Osborne took control of the finance portfolio - highlighted the need for spending reductions in order to achieve the 2016 targets.  In 2018 – Osborne’s first budget as finance minister - Moody’s said the government’s plan to balance the budget by 2022 was risky.  The budget called for increased borrowing in the meantime and changes in revenue and spending in the final two years of the budget plan period that were higher than previously experienced.  That's still what Moody's was pointing to in 2019.

In its latest rating action, Moody’s noted that the provincial government is highly dependent on oil revenues.  The government assumes oil prices will increase but, as recent experience has shown, predicting oil prices is a fool’s game. Volatile oil prices means it is hard for the government to reliably predict how much money it will have. 

Put that against Moody’s reference to Nalcor’s weak revenue projections.  Nalcor’s revenue weakness is a combination of two things.  One is the shift of Nalcor revenues from oil and gas properties to rate mitigation.  Implicitly, Moody’s forecast also includes the elimination of new revenue built into the post-Muskrat Falls rate scheme.  

In other words, the government’s existing rate mitigation will weaken Nalcor financially.  Moody’s suggests that the provincial government will have to step in and support Nalcor financially either with a cash injection or by taking on some of Nalcor’s existing debt.  That mention of Nalcor debt appears to be a veiled reference to some of the options the provincial government has been looking at for rate mitigation.

The provincial government cannot reliably predict its own revenues, though, as Moody’s already pointed out. That’s the deadly combination that Moody’s has warned about and that still exist.  While Moody’s didn’t get into it,  that combination of factors is one of the reasons why the government’s rate mitigation scheme simply won’t work.

As a last point, recall that in May SRBP already noted the provincial government’s forecasts don’t include both known (Bay du Nord) and likely (rate mitigation) spending.  That spending would increase forecast deficits to almost a billion dollars in 2020, $1.2 billion in 2021, and almost a billion dollars again in 2022.  Unless the government saw significant new income or drops in spending, deficits of that magnitude would continue beyond 2022.  That’s basically the situation Moody’s is talking about when it mentions what would cause a further downgrade. 

Moody’s will be watching that until the end of its current forecast period in 2021.  Residents of Newfoundland and Labrador should do the same thing.