Canada’s AAA ratings are likely safe, for now

While the federal government is planning a sharp increase in defence spending, which will likely boost debt and degrade the government’s balance sheet, Canada’s top-notch sovereign credit rating should hold up as most of its peers will be boosting spending too, Desjardins Group says.

In a new report, the firm’s economists examine the implications for Canada’s sovereign rating from the expected sharp rise in spending and government debt stemming from the government’s pledge to boost military spending to 5% of GDP by 2035.

As it stands, the big three rating agencies — Standard & Poor’s, Moody’s Ratings and Fitch Ratings — have Canada’s debt rated AAA, Aaa and AA+, respectively.

“Canada’s sovereign credit rating is currently among the best of its peers such as the G7, Australia, New Zealand and Spain,” the report noted. The country is rated as highly as possible by S&P and Moody’s — although Fitch cut its rating from AAA in 2021, due to a deterioration in government finances that accompanied the pandemic.

If the government follows through with promises to sharply increase government spending, its finances will likely deteriorate further.

“Based on IMF forecasts, Canada’s gross general government debt as a share of GDP would need to be about 7% higher if defence spending increased to 3.5% of GDP by 2030 instead of holding steady at the 2024 level of 1.4% of GDP,” the report noted. That calculation assumes no new revenues or spending cuts to offset the increased military expenditure.

However, that doesn’t necessarily spell trouble for Canada’s sovereign rating, the report said, because most of its peers are also promising to boost their spending on defence too — and sovereign ratings involve both absolute and relative rankings, it said.

“It’s absolute in that it pertains to the change in a sovereign’s outstanding credit and ability to service that debt, and it’s relative in that the evolution of other sovereigns’ credit positions is also considered,” the report said.

So, while Canada’s finances look set to deteriorate, “the country is likely to remain in a respectable fiscal position relative to comparable advanced economies,” the report noted.

“As long as interest payments stay moderate as a share of revenues, Canada should maintain a middling level of fiscal flexibility going forward even as debt servicing costs continue to rise,” it said.

While the downside risks to government finances have increased, the report suggested that these risks aren’t big enough to threaten the sovereign rating in the short term.

“The bar for a credit downgrade is high, suggesting things would need to get much worse than they are today, and any further downgrades would likely be well into the future if they occur,” it said.

James Langton

James is a senior reporter for Advisor.ca and its sister publication, Investment Executive. He has been reporting on regulation, securities law, industry news and more since 1994.