Fiscal conditions will remain challenging for Canadian provinces in 2010-2011, demanding spending cuts or tax hikes to bolster provincial finances, says Moody’s Investors Services.

The rating agency says that credible fiscal consolidation efforts will be required to restore budget balance and to stabilize, and ultimately reduce, debt burdens.

Moody’s expects a modest recovery for the Canadian economy and does not believe that high revenue growth will solve provinces’ fiscal problems over the next few years. “Therefore, fiscal consolidation efforts will require some combination of expense restraint and tax increases”, says the report’s co-author, assistant vice president, Jennifer Wong.

A sluggish economic recovery, coupled with continued expense pressures and increasing debt burdens, will lead to deterioration in Canadian provinces’ credit profiles,” adds Wong. Despite these challenges, the rating agency does not expect the core factors that underpin the narrow rating range for Canadian provinces to be affected in 2010.

“While our outlook for the sector as a whole is negative and we expect further deterioration in fiscal performance and debt metrics, the magnitude of the erosion is manageable in the current rating range”, says Wong. “For many provinces, the anticipated deterioration comes after years of improvements and most Canadian provinces have sufficient fiscal flexibility to reverse the recent deteriorations in their finances over a multi-year period.”

That said, Moody’s notes that downward rating pressure would emerge if debt affordability deteriorates, further reducing provinces’ fiscal flexibility.

“Moreover, a failure to communicate and implement clear, realistic and effective fiscal consolidation plans would exert negative rating pressure”, says Wong.

A double-dip recession leading to further revenue contraction and eroding provinces’ balance sheets further, while not Moody’s central scenario, would also lead to downward rating pressure, she says.

IE