Canada has lost its AAA sovereign credit rating from Fitch Ratings, which downgraded the country’s long-term foreign currency issuer default rating to AA+, citing the effects of Covid-19 on government finances.
The rating agency said the downgrade reflects that Canada will run a much higher deficit in 2020, and, after the economy recovers, public debt ratios will be much higher.
“The higher deficit is largely driven by public spending to counteract a sharp fall in output as parts of the economy were shuttered to contain the spread of the coronavirus,” it said. “Although this will support recovery, the economy’s investment and growth prospects face challenges.”
Fitch said the pandemic lockdown, coupled with depressed global oil demand, will cause a “severe” recession in Canada, with GDP dropping 7.1% in 2020, followed by a 3.9% recovery in 2021.
Against this backdrop, Fitch said it expects Canada’s deficit to widen to 16.1% of GDP in 2020, following a series of small surpluses over the past five years. The deficit is expected to narrow to 6.5% of GDP in 2021, and to 3% in 2022.
It expects the government’s response to the pandemic will produce government debt that represents 115.1% of GDP in 2020, up from 88.3% in 2019.
At the provincial level, the pandemic has also derailed deficit-reduction plans, and Fitch said the crisis will “likely increase the need for federal support of provinces.”
Following the downgrade, Fitch said the rating has a stable outlook, reflecting its expectation that the government debt/GDP ratio will stabilize over the medium term, and that the economy will gradually recover.
The rating agency dropped Canada’s outlook to negative in April suggesting it was facing the risk of a downgrade.
While Canada has a record of restoring government finances to good health, Fitch said the decentralized fiscal framework increases the complexity of the challenge.
“This increases downside risks to Fitch’s expectation that general government debt will broadly stabilize beyond 2021,” it said.
The credit ratings for Canada’s big banks aren’t affected by the sovereign downgrade.
The rating agency already has a negative outlook on the banking sector but said “the sovereign rating action does not apply incremental pressure to bank ratings […].”
Nor does the country downgrade impact Fitch’s assessment of the operating environment for Canadian banks, which already assumes “significant macroeconomic deterioration,” it said.