Fitch Ratings has affirmed its sovereign rating for Canada at ‘AAA’ with a stable outlook, although it warns that household debt remains a vulnerability.
The rating agency says that it believes that Canada’s general government debt has peaked and should start to decline in 2013-2015 in line with its plans for fiscal consolidation. “Prudent budgetary practices provide sufficient confidence that the consolidation path is realistic,” it says.
That said, it also notes that, at 88.2% of GDP for 2012, general government debt is the second highest among the ‘AAA’ rated sovereigns, which suggests that Canada has limited fiscal flexibility.
Additionally, Fitch says that elevated household indebtedness (particularly mortgages), and the strong appreciation of house prices in recent years, means the Canadian economy is vulnerable to adverse shocks. “The authorities have taken measures to mitigate risks and the initial signals suggest some moderation in the housing market and stabilization of household indebtedness,” it says. “However, external and/or domestic economic shocks can lead to a faster adjustment which would be negative for the banking system and the broader economy.”
Fitch says that it believes Canada’s banking system is relatively well-capitalized and can absorb a “moderate level” of stress from the housing market. “This is supported by a strong regulatory framework and an early implementation of Basel III which is already in effect for all banks in Canada,” it says.
Currently, tightening credit conditions and high household indebtedness are also taking the steam out of economic growth, it says. “The economy faces the challenge of rebalancing growth drivers away from consumption and construction to exports and business investment in a context of high uncertainty for the country’s energy sector as well as competitiveness issues confronting the manufacturing sector,” it says.
Fitch says that its stable outlook reflects its view that downside risks to the rating are currently not significant. However, it cautions that a disorderly unwinding of household indebtedness could have negative rating implications, as could a material weakening in macroeconomic projections.
Indeed, Fitch assumes that economic growth in the US (Canada’s largest trading partner) will pick up in 2014, that the Eurozone remains intact, that China will avoid a hard landing, and that oil prices will remain at relatively high levels. It also assumes that the Canadian housing market will achieve a soft landing and that “the Canadian government will remain proactive and pragmatic in its approach to address macroeconomic and banking sector vulnerabilities.”