Although some slowdown in Canadian economic activity is expected in 2006 as a result of the impact of the stronger Canadian dollar, high oil prices, and rising interest rates, overall economic conditions are expected to remain favorable in 2006, according to a report published today by Standard & Poor’s Ratings Services.

The commentary “Elevated Capital Spending To Fill Infrastructure Gap Could Weigh On Canadian Provincial Credit Quality” notes that consumer confidence remains resilient to date, as continuing strength in employment and favorable interest rates continue to bolster consumer spending. As the U.S. Federal Reserve and the Bank of Canada are likely to continue to raise interest rates in 2006, some of this optimism is expected to wane, but not enough to derail the economy.

The report also examines the looming gap between the provinces’ aging infrastructure and the funds required to revitalize the system.

“We have observed that the perception of an infrastructure gap, real or otherwise, has already guided provincial and municipal governments to increase capital spending significantly in the past two years,” said Standard & Poor’s credit analyst Mario Angastiniotis, in a release.

“Moreover, capital spending is expected to remain at an elevated level in the medium term as governments attempt to readdress this perceived gap. We expect that unless Canadian provinces take steps to mitigate the potential increase in debt burdens in the medium term resulting from stepped-up capital spending requirements, overall provincial credit quality may deteriorate,” Angastiniotis added.

One possible solution is public-private partnerships (PPPs), which have established a foothold and are gaining momentum in Canada as an alternative capital asset procurement vehicle.

“Although Standard & Poor’s acknowledges the benefits of PPPs in the procurement of much-needed infrastructure, off-balance-sheet treatment of the debt associated should not be a motivating factor in using this approach,” said Angastiniotis. “From a credit analysis perspective, we typically recognize project company debt as a contingent liability during the construction period, and thereby acknowledge that the province effectively achieves some risk transfer during construction,” he added.