The latest federal budget points to deteriorating Canadian public finances, but rating agency DBRS says it believes the risks are manageable.

DBRS reports that the federal government is forecasting deficits of $33.7 billion in 2009-10 and $29.8 billion in 2010-11, which equate to roughly 2% of GDP.

It says the risks associated with rising deficits, “appear to be manageable as a result of Canada’s strong track record of responsible fiscal policy and its intention to return the budget to balance by 2013-14.”

It notes that Canada has relatively low debt levels, credible fiscal and monetary policies, a flexible exchange rate, and that it continues to maintain two of DBRS’s key conditions for AAA ratings – a fundamentally sound financial system, and unquestioned liquidity. “Given the current economic environment and limited fiscal cushion carried by the federal government in its last budget, the return to deficits is not surprising,” it says.

Even without the additional measures proposed in the budget to stimulate spending, the government would be facing deficits of $15.7 billion in 2009-2010 and $14.3 billion in 2010-11, DBRS notes. But measures to encourage spending and housing construction and to build infrastructure result in the larger deficit projections. “While the majority of fiscal stimulus is intended to be temporary, roughly $3.8 billion represents permanent tax reduction (by 2013-14), which DBRS believes could lead to a structural deficit if the assumed economic recovery takes longer to materialize,” it warns.

DBRS notes that through a series of strong fiscal results and over a decade of declining debt burden, the government has “considerable flexibility” to provide temporary fiscal stimulus. However, it says that if government commitment to reduce the deficit weaken over the medium term, or if financial stress requires government intervention in financial entities, thereby increasing the deficit, the rating trends could come under downward pressure.

Economic conditions will remain challenging for Canada, it adds. The budget assumes real GDP will decline by 0.8% in 2009, followed by a strong rebound to 2.4% in 2010. “This forecast is notably weaker than what was indicated at the time of the fall 2008 economic statement but does remain above the latest IMF forecast, which projects real GDP to fall by 1.2% in 2009 and then rise by 1.6% in 2010,” says DBRS.

It also says that the budget’s proposed measures to improve access to credit are viewed positively “as they should help reduce the impact of tightening credit conditions globally for businesses and consumers in Canada.”

IE