The federal government is on track to balance its budget, but high provincial debt is weighing on the overall government balance sheet, says Fitch Ratings.

In a new report, the rating agency says that the federal government’s commitment to its budgetary targets in last week’s fiscal update bolsters its credibility on fiscal policy and keeps the government on track to balance its budget in 2015-2016. “But future federal surpluses will be slightly lower than previously forecast,” it says. And, it notes that high provincial deficits “mean the general government budget will not balance within our forecast horizon, limiting the pace of gross general government debt reduction.”

Fitch says that the latest federal government’s economic forecasts are broadly in line with its own. The government raised its growth estimates by 0.1 percentage points for 2014 and 2015, to 2.4% and 2.6%, respectively, thanks partly to stronger U.S. growth boosting Canadian exports.

However, it also cautioned that falling crude oil prices are likely to weigh on both GDP growth and Canada’s terms of trade. “A falling Canadian dollar and lower fuel prices for households and businesses have offset some of the impact, but the overall effect on growth and inflation means the government has reduced its forecast for nominal GDP in 2015-2018 compared with that in February’s 2014 budget,” Fitch notes.

Fitch says that these conditions will translate into slightly lower-than-forecast government revenues. However, it still believes that the government can balance its budget in 2015-2016, “barring a significant economic shock and taking into account the impact of tax cuts for families and employers, and money set aside for contingencies.”

And, the government has pledged to introduce legislation to require balanced budgets, which Fitch says could appear in the next federal budget in early 2015. “A balanced budget rule would reinforce” the government’s fiscal credibility, which is a ratings strength, it notes.

Yet, while federal government debt is falling, provincial debt remains high, Fitch also notes. “The two largest provinces, Ontario and Quebec, have found it harder to close budget gaps than the federal government and are running deficits,’ it says.

“So while we forecast the general government deficit to decline to 2.1% in 2014 and 1.5% in 2015, bringing it into line with the ‘AAA’ median, we do not expect the general government to move into surplus within our forecast horizon,” it concludes.