2012 canada euroweek nbc sponsored yearly report

Canada Investor Relations Series Interviews with Selected Public Sector Borrowers

June 2012

Sponsor

AlbertaCanada Housing Trust

British Columbia

Quebec

ManitobaOntario

000 Cover Canada IR 2012.indd 1 11/06/2012 19:17

Canada’s economic fortunes have rarely been in such sharp contrast with other OECD nations. While the latter have generally struggled to achieve economic growth and meet deficit targets, particularly in Europe, Canada’s growth is proceeding at a decent pace. As a result, the federal and most provincial governments are well on their way towards balancing their respective budgets.

It has not always been that way. Less than two decades ago, Canada was grappling with similar challenges to those currently facing several European economies, with massive debt and deficits culminating in an S&P ratings downgrade. Canada’s leadership at the time saw opportunity in adversity, and implemented major structural reforms that were designed to be sustainable and therefore credible. Those crucial policy actions continue to bear fruit today. A well-managed economy, vast natural resources and favourable demographics all boost Canada’s credentials as a country that is open for business and with solid prospects for continued prosperity.

The Bank of Canada now stands alone among major world central banks in considering tighter monetary policy. The BoC’s stance rests on an improving economy which has allowed both Canadian output and employment to recover from the Great Recession and to rise to more than 5% above 2007 levels, in sharp contrast to the performance stateside.

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2007 2008 2009 2010 2011 2012

Canada: Recovery has been smooth relative to the US

NBF Economy & Strategy (data via Global Insight)

Index = 100 (Jan 2007) Index = 100 (Jan 2007)

Real GDP Employment

There are some concerns from the central bank about household debt accumulation which it views as “the biggest domestic risk” – thanks to rising rates of home ownership, the oft-mentioned debt to disposable income ratio is now at a record 150%. Currently, debt servicing is quite manageable for most households with mortgage payments as a percentage of disposable income remaining close to the average of the last decade despite home prices soaring over 40% in the last ten years. Thank record low mortgage rates for that.

The risk, of course, is a sudden sharp increase in interest rates. That scenario is highly unlikely in our view. While rates are set to rise, they should do so very gradually. The BoC would be aware of the threat posed by an overshooting currency should the overnight rate stray too far from the Fed Funds rate which itself is destined to remain near zero for the next few years. Moreover, the BoC would prefer an orderly ramp down in debt rather than provoke, via aggressive rate hikes, a disorderly de-leveraging (the latter tends to be hazardous to the economy if recent US experience is any guide). There are already promising signs on that front, with consumer credit growth falling on its own to the lowest levels in almost two decades.

That said, residential credit growth remains strong and is one of the reasons why the Canadian housing market continues to outperform. With Canadian housing prices surging in recent years, there are concerns about a sharp correction in the pipeline. While we do not rule out temporary price declines in some cities and some segments of the housing market (condo prices in Toronto and Vancouver come to mind as potential risk areas), the outlook remains positive for Canadian housing as a whole.

Negative real interest rates and a healthy labour market have played an important role in supporting housing demand and prices so far, but favourable demographics have also been

instrumental. Population growth for people aged 20-44, the age cohort generally associated with marginal demand for a residential asset, has picked up significantly since 2007 and is projected to remain positive through the next decade, in sharp contrast with the rest of the OECD.

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ISRCANCHENORSWEAUSBELFIN

DEUFRAKORJPNNLDNZLITA

GBRGRCESPDNKUSAIRL

NBF Economy & Strategy (data via OECD, Statcan, Teranet - National Bank, United Nations)

Canada: Why are home prices outperforming the OECD?

Real house price growth since 2007Q1

OECD

Canada

%

%

The surge in home prices in

Canada …

…remains supported by positive demographics

So notwithstanding temporary dips, residential investment should generally remain in decent shape. Non-residential investment should also be well supported. According to a recent Statistics Canada survey, non-residential investment is expected to grow 7.2% or $19.8 billion this year.

That is a new record, for both total non-residential investments and those of the private sector. More than 40% of the growth is expected to come from oil & gas extraction (+14.8% or $8.3 billion). The strong showing in business investment will help offset the impacts related to the end of several federal infrastructure programs.

The outlook for investment in real assets is positive, but so is the potential for a ramp up in investment in Canadian financial assets. Canada’s government bonds have never looked as good in a shrinking AAA universe. With the public sector well on track to balance the budget and reducing overall debt over the coming years, Canada’s fiscal rectitude shines when compared to countries experiencing missed deficit targets and a growing debt load.

Canadian general government net debt relatively low At year end, as % of GDP (IMF projections for 2012 to 2017)

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CanadaU.S.EurozoneOECD

Source: IMF, Fiscal Monitor April 2012

% of GDP

20112011Canada: 33.3 U.S.: 80.3 Eurozone: 68.4 OECD: 72.4

Foreigners will also be enticed by the stable investor base for our government bonds, given that over 40% of gross government debt is held by domestic institutional investors in Canada.

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GBR

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Canada: A stable investor base for government bonds

% of gross general government debt

* Pension, insurance and mutual funds NBF Economy & Strategy (data via IMF April 2012 Fiscal Monitor, Standard & Poors)

Holdings of government debt by domestic institutional investors*

AAA club could become even more select

rating outlookAustralia AAA StableCanada AAA StableDenmark AAA StableFinland AAA NegativeGermany AAA StableHong Kong AAA StableLiechtenstein AAA StableLuxembourg AAA NegativeNetherlands AAA NegativeNorway AAA StableSingapore AAA StableSweden AAA StableSwitzerland AAA StableUnited Kingdom AAA Stable

That, combined with well anchored inflation expectations and fiscal discipline, bode well for Canada’s bond market. Clearly, in Canada’s case, reforms of the past are gifts that keep on giving.

Euroweek Canada: Reaping the

benefits of past reforms by Krishen Rangasamy, Senior Economist

Euroweek Canada: Reaping the

benefits of past reforms by Krishen Rangasamy, Senior Economist

The information in this article is for informational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy any security. National Bank of Canada Financial Markets is a trademark of National Bank of Canada used under licence. National Bank Financial Inc. is an indirect wholly-owned subsidiary of National Bank of Canada, and is regulated by IIROC and a member of CIPF. National Bank of Canada Financial Inc. and NBF Securities (USA) Corp. are indirect wholly-owned subsidiaries of National Bank of Canada, and are regulated by FINRA and members of SIPC. NBF Securities UK is a branch of National Bank Financial Inc. and is regulated by the FSA. Please refer to our full disclosure at http://www.nbcn.ca/disclosure_english.jhtml

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Canada: Investment intentions remain positive in 2012

$ billion

Non-residential investments (2012: intended)

2012 intended non-residential investment growth, $B and %

Non-residential investments expected to reach a new high in 2012…

NBF Economy and Strategy, (data from Statistics Canada)

Private sector

Total

Public entreprises

Oil & gas

Private sector except oil & gas

Publicadmin.

…oil & gas accounting for more than 40% of the increase

$ billion

4.7%

1.1%

14.8%

17.3%

4

Sponsored statement

Ontario

Ontario intensified its attack on its deficit in April when the govern-ment announced plans for a new

“deficit-fighting” tax bracket. By increas-ing income tax by two percentage points on individuals with an annual income of C$500,000, the government hopes to gen-erate additional revenue of $280m in 2012-13 rising to $470m in 2013-14 and $470m in 2014-15.

Ontario hopes this new measure will help turbo-charge its moves to pare its deficit to $14.8bn in 2012-13, $12.8bn in 2013-14 and $10.1bn in 2014-15. According to the new plan, the deficit will be eliminated by 2017-18, by when it expects to register a small surplus of $500m.

Analysts were surprised when Moody’s downgraded Ontario’s credit rating just one day after the announcement of its deficit-fighting initiative. After all, the new tax bracket, which will be removed when the deficit has been eliminated, and adds to deficit-cutting initiatives introduced by the government in its March budget. As National Bank Financial (NBF) com-mented in a recent analysis: “Ontario’s 2012-13 budget marked a distinct change in the province’s fiscal management, with

a clear focus on restraint in spending. Expenditure control dominates the forecast deficit reductions.”

The cut in the Moody’s credit rating was not entirely unexpected, given that Ontario had been on negative outlook since mid-December 2011, when the agency’s rating of Aa1 was two notches higher than the S&P and DBRS ratings.

For Ontario, cutting the deficit is regarded as an imperative, not a luxury, if future generations are to enjoy the same living standards as their parents and grand-parents. Ontario calculates that for every 1% increase in interest rates, its debt servic-ing costs would rise by about $467m in the first year. If no action were taken to balance the budget now, Ontario would find itself paying almost as much to service its debt in 2017-18 as it spends on its entire education budget today.

Extensive spending cuts need not, how-ever, mean that essential social services will be a casualty. The province prides itself on the quality of its healthcare and education, with a recent McKinsey study classifying Ontario’s schools as the best in the English-speaking world. While some spending cuts will be unavoidable, Ontario’s Action Plan for Health Care, outlined earlier this year, will shift the focus to delivering improved value for money.

Encouraging signsOntario’s deficit-cutting drive will be sup-ported by an improving macroeconomic climate, along with greater investment in machinery and equipment, which rose by 15.2% in 2010 and by 19.8% in 2011. Although forecasts for economic expansion have been revised down over the last year, the projected growth trajectory remains encouraging, with GDP forecast to grow by 1.7% in 2012, 2.2% in 2013 and 2.4% in 2014.

“The growth picture has remained broadly positive,” says Mike Manning, executive director of capital markets at Ontario Financing Authority (OFA) in Toronto. “Since the depths of the recession our GDP is up by 6.4%, so the economy is recovering well relative to Canada itself. The same is true on the employment front. Since the recession Canada has cre-ated about 700,000 new jobs, roughly 350,000 of which have been in Ontario.

Ontario has redoubled its commitment to reducing its fiscal deficit by introducing tough measures on tax and expenditure. This, twinned with a solid economic recovery, will continue to underpin demand for its bonds among local and international investors.

Defi cit-fi ghting Ontario is on the up

Sponsor:

National Bank of Canada Financial Markets is a trademark used by National Bank Financial Inc. and National Bank of Canada Financial Inc. under non-exclusive licence.

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Fiscal forecast** 2012 budget plan* Revised outlook

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0.5Actual Interim Plan

Medium-TermOutlook Extended Outlook

Fiscal Balance($bn)

* For 2009-10 and 2010-11, actual results are presented** Forecast for 2012-11 to 2012-12 based on the 2010 budget. Projection for 2009-10 from the 2009 Ontario economic outlook and fiscal review

Accelerating Ontario’s plan to balance the budget

Accelerating Ontario’s plan to balance the budget

Source: Ontario Ministry of Finance

004-005 Ontario 2012.indd 4 11/06/2012 19:19

5

Sponsored statementO

ntario

So although the growth story has been impacted by the international economy, Ontario is still generating new jobs.” The pace of job creation in Ontario since June 2009 is ahead of the US and the UK.

Unemployment fell from 9% in 2009 to 8.7% in 2010 and 7.8% in 2011, and the government’s projections are for a con-tinued decline to 6.7% by 2015. This will be supported by ambitious infrastructure investment. Over the next three years, Ontario plans to invest more than $35bn in infrastructure projects that will create or preserve over 100,000 jobs on average each year.

Much of this will be financed through Ontario’s Alternative Financing and Procurement (AFP) initiative which will allow the specialist agency, Infrastructure Ontario (IO) to transfer risk to the private sector. Similar to Public Private Partnerships (PPP), the AFP programme has supported more than 50 big projects worth some $23bn since it was launched in 2005.

The economic recovery since 2009 has also supported a healthy and well-balanced housing market in Ontario. Home resales are expected to moderate in 2012 after a strong rise in recent years, while modest and steady growth in demand for new homes will help to keep housing afford-able and minimise the risk of a housing bubble emerging.

While growth will be an important component to trimming the province’s deficit, the main pillar of Ontario’s pro-gramme to return to surplus is a clear focus on cutting expenditure. Over the next three years, expenditure reductions amounting to more than $17bn will be achieved through an aggressive combina-tion of public sector wage restraint, admin-istrative savings and other cost reductions. At the same time, the province will intensify its programme to combat tax evasion.

Ontario in the capital marketsAlthough its recent deficit-fighting measures have reduced Ontario’s funding needs, it is still comfortably the most heav-ily indebted of Canada’s prov-inces in absolute terms, with net debt estimated at 37.2% of GDP as of March 2012.

It also has the highest bor-rowing requirements of all the provinces. Manning says that in 2012/13, Ontario will have a funding requirement of $34.9bn, of which $14.8bn will be for deficit financing, with $10.5bn allocated for capital investment and $17.3bn ear-marked for refinancing existing debt.

Historically, the size of its funding programme has meant that Ontario has been the most regular issuer among the Canadian provinces in the international capital markets. In 2011, however, the provinces enjoyed strong demand from local as well as international investors in the Canadian dollar market. As a result, Ontario funded 81% of its programme in the domestic market last year, which was way above its original projection for 2011, which anticipated a 60/40 split between domestic and international funding.

“The main characteristic of our fund-ing programme is its flexibility,” says Manning. “Because we recognise that we would be unable to fund the entire programme in the domestic market, we are always on the lookout for the oppor-tunity to issue in overseas markets at an after-swap cost that is competitive with the Canadian dollar market.”

In 2011, the strength of the domes-tic bid meant that those opportunities were few and far between. In September, Ontario maintained its presence in the dollar market by printing a $2bn five year global bond. This generated demand of $2.2bn, which was an encouraging response from the international inves-tor community at a time of heightened volatility.

In niche markets, Ontario was able to grasp small but compelling funding opportunities in the Norwegian kroner and Australian dollars. “These were oppor-tunities where the take-out was of course smaller than in the core currencies but the funding costs were significantly lower,” says Manning.

The same was not true of the euro market, where Ontario has been a popular issuer in the past. “It was not possible to issue in euros last year for two reasons,”

Manning explains. “The euro-dollar basis swap made it too costly, and the volatility caused by the Eurozone debt crisis meant that there were fewer windows of opportu-nity for issuance.”

Looking ahead, Manning doubts that Ontario will be able to complete as much of its funding programme in the domestic market in FY2012 as before. “Last year may have been unique and there was probably more demand for Canadian dol-lars in 2011 than we’ll be able to count on in 2012,” he says. “One reason for the demand last year was the strength of Canada’s economic fundamentals. Another was that there were some specific portfo-lio shifts by investors that benefited our domestic market. This year we think the domestic market will account for at least 70% of our programme, but this will be subject to market conditions.”

Extended maturityOntario took full advantage of the dynam-ics working in favour of the Canadian dollar market in FY2011. As the market is open to the issuance of large volumes at the long end of the yield curve, the province was able to extend the average term of its new borrowing to 13 years, compared with 12.8 in 2010 and 8.1 in 2009. “Extending the average maturity of our funding two years in a row was very satisfying because it helps to minimise refinancing risk,” says Manning. “It has also given us more flexibility with regard to maturities, because it has opened up some room for us to do some three-year borrowing if necessary.”

Ontario also explored new ways to cater to large orders. “In October we put a new procedure in place to accommodate large orders in our domestic syndicated deals,” Manning explains, adding this can be acti-

vated for orders of $600m or more for issues under 10 years of matu-rity, $500m or more for issues with terms of 10 to 29 years, and $400m or more in the case of 30 year deals. “We were pleasantly surprised by how often we were able to use this procedure, which simultaneously allows us to satisfy demand from large investors and issue bonds for smaller accounts.”

Ontario used this system four times between October and the end of the fiscal year in March, and Manning says the last of these deals was especially noteworthy. “We had indications of demand for a large order of more than $400m for a 30 year bond together with additional demand for 30 and 10 year bonds,” says Manning. “This meant we were able to complete a dual tranche $1.4bn issue split into a $900m 30 year bond and a $500m 10 year tranche.” �

Toronto rivals New York as North America’s most attractive business location, while Ontario accounts for 40% of national

GDP and is Canada’s financial hub

004-005 Ontario 2012.indd 5 11/06/2012 19:19

6

Sponsored statement

Manitoba

Manitoba prides itself on its track record of economic stability. Between 2005-10, it was the

best-performing of Canada’s provinces, posting real annual average GDP growth of 2.4%, comfortably above the nation-wide average over the same period of 1.2%. In 2009 Manitoba fared better than other Canadian provinces by avoiding a sharp contraction in real GDP.

Manitoba also compares favourably with the other provinces by other economic yardsticks, with unemployment, household debt and net provincial debt to GDP all well below the national provincial average.

Narendra Budhia, director of economic and financial analysis at Manitoba Finance Department in Winnipeg, attributes this relative strength to a number of factors. Foremost among these is the diversity of the economy, which Moody’s recently called “a major source of credit strength”.

Industrial diversity is a key reason why Manitoba continues to be one of the most stable provinces in terms of growth, says Budhia. “No single industry dominates in the province,” he says. While manufactur-ing remains the largest sector, its contri-bution to GDP is just under 11%, with transportation, agriculture, electric energy generation, mining and finance and insur-ance all well represented in the economy.

Manitoba’s geographical location at the heart of Canada has played an big part in its development as a manufacturing and wholesale distribution centre for north-western Ontario, the western prairies and the northern territories, Budhia says.

Another notable source of stability for Manitoba’s economy, says Budhia, is the highly diversified distribution of its exports. “Manitoba has a unique trade pattern between interprovincial and international destinations,” he says. “Our exports are also more diversified than those of other provinces. Over the last decade, 49.5% of exports went to other provinces, with the remaining 50.5% sent to coun-tries outside Canada. This ratio is the most balanced among the Canadian provinces and ensures that economic growth is more aligned with overall national growth than with foreign markets.”

Manitoba’s export base, however, is becoming increasingly diversified, with a marked decline in its dependence on the US, whose share of exports has fallen to 61%, from 79% in 2001. Exports to Asia, meanwhile, have doubled from 11% to 23% over the same period.

Two other sources of economic stability are the healthy state of household balance sheets and the resilience of the labour market. “Manitobans have the lowest household debt per capita in Canada,” says Budhia. “Likewise, mortgage arrears in 2011 were just 0.28%, which is the lowest among the provinces and below the national rate of 0.41%.”

In the jobs market, meanwhile, Manitoba has traditionally had among the highest provincial labour force participa-tion and lowest unemployment rates. In 2011, its unemployment rate was 5.4%, the second lowest among the provinces and 2% below the national average.

None of this is to suggest that Manitoba’s economy has been immune to the global downturn, nor to other unpre-dictable factors such as the weather. The manufacturing sector contracted by an annual average of 0.3% between 2006-11, led lower by the fragility of the interna-tional economy. Agriculture, meanwhile, declined by an annual average of 2.8% over the same period, reflecting the dam-aging impact of extensive flooding in the spring of 2011 and growing restrictions on

Geographically and economically, Manitoba stands at the heart of Canada. The province’s diversified economy and the consistency of its fiscal management underpins its stability and the resulting warm endorsement it continues to receive from ratings agencies and investors alike.

Manitoba — a diversifi eddriver of national growth

Sponsor:


Manitoba’s capital Winnipeg epitomises the province’s steady growth

006-007 Manitoba 2012.indd 6 11/06/2012 19:20

7

Sponsored statementM

anitoba

US imports of Canadian livestock.The underperformance of manufactur-

ing and agriculture have been more than adequately compensated for, however, by other key sectors. Construction expanded by an annual average of 6.8% between 2006-2011, supported by the govern-ment’s stimulus programme launched in response to the global recession, support-ing key projects in the province.

Last October, for example, the new ter-minal at Winnipeg International Airport opened. Aside from providing a stimulus for construction, airport passenger num-bers, rose by close to 8% in the first quar-ter of this year.

Retail trade is another vibrant sector, growing by an annual average of 3.4% between 2006-11, and the potential for continued growth has not gone unno-ticed by the world’s largest retailers. As Budhia points out, Ikea is one example of a successful multinational preparing to open its first outlet in Winnipeg.

The strength of these sectors, twinned with expectations of a gradual acceleration in global demand, bodes well for economic growth in Manitoba. So does the outlook for population growth, which is an impor-tant pillar of GDP expansion in a multi-ethnic province with high levels of net immigration. Immigration to Manitoba has more than tripled from 4,600 in 2002 to almost 16,000 in 2011, which is the largest influx since 1946. This supported a 1.3% growth in the population, ahead of Canada’s rate for the second consecutive year.

Budhia says Manitoba’s economy is set to grow steadily over the next two years. “The Manitoba Finance survey of economic forecasters conducted in March projects that Manitoba’s real GDP will expand by 2.3% in 2012, above the national increase of 2.1%,” says Budhia. “In 2013, Manitoba’s real GDP is expect-ed to increase by 2.4%, matching the projected rate of national growth.”

This solid growth will provide impor-tant support for Manitoba’s deficit-

cutting programme, which aims to bring the province back to fiscal balance by 2014-15. Another key component of this fiscal plan is spending restraint, which will limit increases in overall expenditure to an annual average of 2% from 2011-12 to 2014-15.

While the current five year fiscal plan continued to allocate investment to front-line services such as health care, education and policing, innovative ways of cutting spending are also a key feature of the plan. These include reducing the number of regional health authorities, rolling back salaries for government ministers by 20%, reducing travel costs across all govern-ment departments and implementing portfolio management reviews.

The Canadian banks have warmly endorsed the plan. “The part the agencies most like is the balance we are achieving between raising revenues and cutting costs as a means of bringing the budget to balance,” says Budhia.

Manitoba in the capital marketsManitoba’s net debt rose from just under C$19.4bn at the end of 2009 to C$22.9bn as of March 31, 2011. Of that total, about C$1.1bn was raised for capital spending programmes, and C$0.9bn to fund capital spending at Manitoba Hydro, with C$1bn covering the province’s deficits and unfunded pen-sion liability and C$0.5bn for a number of other crown corporations and agencies. Total net debt to GDP is projected to be 27.4% at March 2013, which is below the average for the Canadian provinces.

Garry Steski, director of capital mar-kets at the treasury division in Winnipeg, says the total net funding requirement for 2012 will be around C$3.7bn, in line with previous years. Refinancing will account for C$2bn (of which C$1.4bn will be for the province and C$600m for Manitoba Hydro), with the balance ear-marked for new capital spending.

This fiscal year, says Steski, Manitoba will not require any deficit funding. “Although we are still running a deficit, we are projecting to recover the money that we borrowed in the last fiscal year to cover the emergency expenditure we incurred as a result of the flooding,” he explains. “The portion of the money we are due from the federal government is expected to come through this year. Coupled with the planned contribution from our Fiscal Stabilisation Fund, this will net out any deficit funding require-ment for fiscal 2012.”

Over the next few years, says Steski, Manitoba expects its annual borrowing needs to be between C$3.5bn-C$b4bn. “While the total will be stable, we expect the funding mix to change,” says Steski. “We have now finished covering the province’s unfunded pension liability, and our five year fiscal plan means that our deficit funding should also continue to decrease. However, Manitoba Hydro’s funding requirement will increase to cover its capital investment programme.”

Funding shiftThis shift in the funding mix, says Steski, is likely to have an impact on the overall average maturity of Manitoba’s debt port-folio. “Because Manitoba Hydro’s needs are for long term funding, we would expect our yield curve to start stretching out in the next few years,” he says.

Its modest annual funding require-ment means that Manitoba will never be a prolific borrower in the international markets, although it aims to maintain a consistent presence outside the Canadian dollar market. “We put a lot of time into our investor relations work with overseas investors, because we want to maintain our access to international markets as and when opportunities arise to issue at levels that are competitive with the Canadian dollar market,” says Steski. “International funding accounts for 20%-25% of our annual programme and I would expect this share to remain stable.”

Like other Canadian provincial bor-rowers, Manitoba has benefited from international investors’ appetite for top-quality SSA borrowers. There was plenty of demand for its most recent global bond, a six year $600m deal in February.

“We thought that if we could price at below 20bp over swaps, that would be a great achievement,” says Steski. “But demand built up quickly and we had at least 80 investors in the book, all of them good quality names. That meant we were able to increase the deal from the mini-mum of $500m, and to price at mid-swaps plus 19bp. Our syndicate banks say our name continues to be added to the books of international investors that have not previously bought into the Manitoba credit, which is very positive.” �

Manitoba real GDP growth — 2006-13f

Source: Manitoba Bureau of Statistics, Manitoba Finance

Manitoba outperforms Canada 2006-09

Manitoba expected to exceed or match Canada in 2012f-13f

006-007 Manitoba 2012.indd 7 11/06/2012 19:20

8

Sponsored statement

British Colum

bia

British Columbia is unambiguous about its principal fiscal objective. Following deficits of almost $2.5bn

in 2011-12 and a projected $968m in 2012-13 it aims to have eradicated its budget deficit by 2013-14, generating a modest surplus of $154m, rising to $250m in 2014-15.

To emphasise its commitment to the task, BC’s government has warned that the corporate tax rate will rise by 1%, albeit from a very low base, if required in 2014-15. “We feel comfortable about sending out an early signal about how we plan to safeguard our targets for a balanced budget against any unanticipated economic down-turn,” says Sabine Feulgen, assistant deputy minister and deputy secretary to the treas-ury board.

The business community has responded constructively to this warning. “The corpo-rate sector and the general public recognise the value of our triple-A credit rating and that this is part of the medicine we may need to take to protect the fiscal plan,” says Feulgen.

It is a medicine that large cross-sections of the BC population are being required to take in a collective endeavour to balance the budget as annual expenditure growth is limited to 2% over the next three years. Over the same period, it is estimated that

revenues will increase by an annual average of 2.9%.

This does not mean cutting back on essential public services, with $10.7bn of taxpayer-supported capital investments in the current fiscal plan allocated towards hospitals, schools, post-secondary facilities, transit and roads. The 2012 budget targets average annual spending growth in the health sector of 3.2% between 2012-13 and 2014-15, down from 4.8% between 2009-10 and 2011-12 and 7% between 2005-6 and 2008-09. Annual spending growth slows more dramatically in the cur-rent fiscal plan to 0.6% in K-12 education and 1.6% in post-secondary.

Collective belt-tightening has meant that the majority of public sector employ-ees have accepted pay freezes enshrined in initiatives such as the Net Zero Wage Mandate (2010 and 2011). They will also be asked to accept modest increases combined with offsetting productivity sav-ings under the Co-operative Gains Wage Mandate (2012 and 2013).

This public engagement in fiscal management is one reason why Feulgen is convinced that BC will deliver on its targets. Its track record of sticking to its fiscal objectives is another. “We haven’t set ourselves unreasonable targets, but we have been very focused on achieving them,” she says.

The drive to balance the budget will also be supported by a benign macroeconomic climate, with BC’s finance ministry pro-jecting real GDP growth for the province of 1.8% in 2012, 2.2% in 2013 and about 2.5% a year between 2014 and 2016. These projections are more conserva-tive than those of the Economic Forecast Council, which is expecting growth in BC of 2.2% in 2012 and 2.5% in 2013. Combining the lower economic forecast, contingencies and other prudent measures, the fiscal plan has over $2bn for manag-ing downside risks. The result is that debt remains affordable at an estimated 16.4% in 2011-12, and peaking at 18.3% in 2014-15 before returning to a downward trend.

BC’s finance ministry’s lower forecasts for growth reflect its caution over the outlook for the global economy in general and the US economy in particular, as well as uncertainty about the prospects for

Given the strength of British Columbia’s recent track record of economic and debt management, it is easy to see why demand for its benchmarks remains so robust. “This was a gem,” one investor said in response to the province’s two-tranche $1.5bn global offering in April.

Sharing the burden

Sponsor:


Vancouver: gateway to Asia

008-009 British Columbia 2012.indd 8 11/06/2012 19:21

9

Sponsored statementB

ritish Columbia

Europe. With housing starts on the rise again, there is also a question mark over the outlook for the BC housing market, given the relatively high level of house-hold debt in the province. Jim Hopkins, assistant deputy finance minister, says there are few signs of the same specula-tive broth that may have characterised BC house prices in previous cycles. “We don’t see houses being flipped as they were in the early 1990s when the ratio of houses being bought and sold again within six months was close to 10%,” he says. “Today, it is close to normal levels of about 2%.”

The outlook for more solid growth in BC is supported by a number of key indi-cators. The labour market remains steady and the province’s unemployment rate stood at 6.2% in April 2012, down from 8.1% in March 2011.

Retail sales have also recovered ahead of those of most other provinces, rising by 5.4% in 2010 and 3.1% in 2011. In the first two months of 2012, retail sales were up by 5.9% compared to the same period in 2011.

Business confidence in BC is supported by a corporate tax rate among the lowest in the G7. It also has the lowest provincial personal income tax burden in Canada for individuals earning up to $120,000 a year, and the second lowest tax rate for the highest wage earners.

Another encouraging pointer towards its long term growth prospects is the increased diversity of BC’s exports. “We now have a much better balance in our exports than we had 10 years ago, when the US was our dominant trading part-ner,” says Feulgen. Between 2009-11, the US accounted for an average of just 46% of BC’s exports, with trade links between BC and the fast-track Asian economies expanding at a very healthy clip. In 2011, Japan accounted for 14.1% of BC’s

exports, China for 14.9% and other Asia for 12%.

This large and growing share is due in part, as Hopkins acknowledges, to BC’s proximity to Asia. But it also a product of a carefully developed strategy to bol-ster trade by building a transportation infrastructure second to none. The $22bn Gateway Strategy has been built around the refurbishment and expansion of the ports at Prince Rupert and in the Lower Mainland and improvements to road and rail transportation facilities through-out the province, all aimed at speeding up the shipment of goods through the province and eradicating bottlenecks at the key entry and exit points. The result is that goods can be transported from, say, Shanghai to Chicago about 60 hours faster through British Columbia than via the principal US west coast ports.

British Columbia inthe capital marketsBC’s borrowing requirement for this fis-cal year is projected at $8.5bn. This will fall in 2013-14 and 2014-15 to between $7bn-$7.6bn as the government moves towards its target of achieving fiscal bal-ance, and trims its capital spending budg-ets closer to historical levels.

BC’s strategy in the capital market has been to generate most of its funding from the domestic market, with 85% of its debt portfolio sourced from Canadian dollar public and private markets. The balance has been raised offshore, almost all of which is swapped back into Canadian dollars. BC adheres to a firm policy of issuing outside the domestic market only when offshore funding costs can improve upon those available in the domestic market on an after-swap basis. Although BC can maintain unhedged exposure in foreign currencies, it recently closed down the government’s only non-

Canadian dollar position, which was in yen.

“We keep a daily vigil on opportunities in all offshore markets,” says Hopkins. “We are constantly looking to achieve savings for the BC taxpayer, and we rec-ognise that by diversifying our investor base and ensuring we maintain access to a broad range of capital markets around the world we can reduce our funding costs over the long term and ensure access to liquidity in turbulent markets.”

In the US dollar market, a favour-able credit differentiation favouring the province has allowed BC to achieve competitive funding levels while ensuring that transactions are priced attractively for investors. “When we approach an off-shore public market, we are always mind-ful that the timing, sizing and pricing of our offerings are such that they generate a positive performance for investors,” says Hopkins. “We want to be certain that we will be welcome next time we come to the market.”

In 2011, offshore funding accounted for an unusually large 35% share of the province’s total issuance for the year as a whole, which amounted to $6.7bn.

The success of its first offshore issue of FY2012 suggests that there would be enough demand to underpin a similar share this year. With demand for Canadian public sector borrowers very strong among investors looking for expo-sure to top-quality SSA borrowers, the Aaa/AAA rated BC was able to generate well-diversified demand for a benchmark in April split into a $1.25bn five year glo-bal and a $250m 10 year tranche.

While there is no question about the strength of international demand for exposure to BC, domestic demand has also been pushing the province’s spreads to increasingly low levels and further through its domestic peers. And as Hopkins explains, the domestic market is especially compelling at the longer end of the curve, with the basis swap making issuance beyond 10 years in US dollars uncompetitive. The average maturity of BC’s debt is now seven years, which is longer than its benchmark, and spreading the province’s issuance out across the yield curve is an important component of its debt management strategy for minimizing refinancing risk.

Another important component of BC’s funding strategy is its use of Public Private Partnerships (PPP), for which it is recognised as a North American pioneer. Since 2003, more than 35 key projects worth some $12bn have been completed on a PPP basis, all of which are reported on-balance sheet.

Blazing a trail in the PPP sector with a strong track record complements the suc-cesses scored by BC in the dollar global market. �

32.2

34.2

36.6

38.3 39.4

40.3

41.8 42.8

43.5 44.3

05/06 06/07 07/08 08/09 09/10 10/11 11/12 12/13 13/14 14/15

Budget 2012 expenditure track

(C$bn)

Three-year average

annual growth: 2.0%

Budget 2012 Fiscal Plan

Before

economic downturn –

average annual growth: 5.9%

Expenditure management

impact to date – average annual

growth: 3.0%

Budget 2011 spending track

41

B d t 2012

1 For comparative purposes, the Budget 2012 expense amounts exclude refundable tax credit transfers, which were netted from revenue in Budget 2011.

39.4 40.3

Expenditure

Budget 2012 expenditure track

Source: Government of British Columbia

008-009 British Columbia 2012.indd 9 11/06/2012 19:21

10

Sponsored statement

Canada Mortgage and H

ousing Corporation (CMH

C)

In 2011, demand among central banks and official institutions for Canada Mortgage Bonds (CMB) continued to

rise, with their share of total distribution reaching 9%, compared with 7% in 2010 and 2% in 2009.

This growing demand is significant for two reasons. First, it reflects the increasing-ly important role that the Canadian dollar is playing as a reserve currency in the port-folios of central banks across the world, which in itself is a vote of confidence in the stability of the Canadian economy.

Second, this growth in demand is testa-ment to investors’ comfort with the credit profile of CMB, which are regarded as a proxy for Canadian government risk. The CMB programme was originally set up in June 2001 to support Canada’s mortgage market by guaranteeing mortgage-backed bonds, underpinning the provision of low-cost funding for lenders and therefore promoting competition in the Canadian mortgage market. CMB are issued by the Canada Housing Trust (CHT) and fully guaranteed by the Canada Mortgage and Housing Corporation (CMHC). “Because the timely payment of principal and inter-

est on CMB are guaranteed by CMHC, which is a crown corporation, they are ultimately backed by the Government of Canada,” says Mark Chamie, CMHC’s Ottawa-based Treasurer. “This is why they are rated AAA and will continue to track the rating of the Canadian government.”

The CMB market has played a key role in promoting the stability of the Canadian housing market, which was widely regarded as being a notable reason for the resilience of Canada’s economy during the global downturn of 2008 and 2009. As Canada had no US-style subprime sec-tor, there was no destabilising speculative boom and bust in the Canadian housing market in the 2000s, with housing starts steady and MLS (Multiple Listing Service) sales remaining stable. According to the Canadian Bankers Association (CBA), as of January 2012 just 0.38% of mortgages in Canada were in arrears. “The rate of arrears is more than 10 times higher in the US [than in Canada],” noted the CBA.

An accelerated expansion in the Canadian economy, taken with the con-tinuing rise in the number of new jobs and an increase in household debt, are all fac-tors that support arguments for sustained strength in the housing market.

The consensus among economic fore-casters is that Canada’s economy, as meas-ured by gross domestic product (GDP), will grow in the mid-to-low 2% range over

International investor demand for exposure to the strongest public sector Canadian borrowers remains robust. Their liquidity, transparency and undisputed credit quality make Canada Mortgage Bonds — which carry the full faith and credit of Canada — a firm favourite among local as well as international investors.

Promoting competition in the Canadian mortgage market

Sponsor:


Predictions for the continuing strength of Canada’s housing market are supported by the expansion of the economy and the corresponding rise in the number of new jobs

010-011 CMHC.indd 10 11/06/2012 19:22

11

Sponsored statementCanada M

ortgage and Housing Corporation (CM

HC)

2012 and 2013, with 2013 being the stronger of the two years. This growth will help drive moderate employment gains and gradual reductions in Canada’s unemployment level.

The impact of a stronger economy on the housing market, however, is expected to be offset by a gentle rise in interest rates. On April 17, the Bank of Canada announced that it was leaving the target for the overnight rate unchanged at 1%. Subsequently, in its April Monetary Policy Report, the Bank commented that there is reduced slack in the economy and some signs of firmer inflation. Mortgage rates, particularly adjustable mortgages, are closely correlated with the Bank’s target for the overnight rate. Consequently, mortgage rates are likely to remain stable throughout most of 2012 before increas-ing modestly towards the end of the year.

Although there have been considerable swings in monthly estimates of housing starts activity, the trend rate of housing starts has been rising slowly, reaching 208,700 units as of April 2012. Strong labour market conditions will continue to drive the construction of new homes, but some deceleration of the current robust pace is expected later this year and next year, particularly once mortgage rates begin to edge up.

Total residential sales through the Multiple Listings Service (MLS) increased 0.4% in the first quarter of 2012 and are expected to remain relatively stable over the remainder of this year and into 2013. This stability will help maintain balanced market conditions in most parts of Canada, which implies that price growth over the next year and a half will be roughly in line with inflation. The average MLS price rose by 2.2% dur-ing the first quarter of 2012, and future growth is expected to be somewhat more subdued.

As BMO Capital Markets concluded in a recent analysis of the Canadian residen-

tial mortgage sector, “the housing boom will more likely cool than correct”.

As CMHC’s Chamie points out, CMB carry the government guarantee and the quality of the CMB portfolio is very high. The vast majority of CMHC-insured mortgages have loan-to-value (LTV) ratios of 80% or less, based on updated valu-ations. Additionally, the average equity in CMHC’s insured portfolio in 2011 remained constant from 2010, at 44%.

Nevertheless, Chamie says that the government is mindful of the risks associ-ated with house price inflation and has been monitoring lending activity closely. “Since 2008 the government has tight-ened up the rules on mortgage lending three times,” he says. “Today, it is recom-mending that consumers be prudent in their home purchases and not overextend themselves.”

Over the immediate future, Chamie says he foresees no change in the CMB programme. “The objective has been, and will continue to be, the promo-tion of competitiveness in the Canadian mortgage market by ensuring a consistent supply of low cost financing for lending institutions,” he says.

To meet that objective, Chamie says that total issuance of CMB this year will be in line with 2011. “Based on our issu-ance in the first quarter of 2012 we expect total volume to be around $40bn,” he says.

As of the start of March 2012, $174.5bn of the $206.2bn outstanding in the CMB market was accounted for by fixed rate bullet maturity bonds, with the balance in floating rate notes (FRNs). The bulk of fixed rate issuance is in the five year maturity, in which benchmarks are issued in March, June, September and December, with 10 year fixed rate bonds and five year FRNs offered in February, May, August and November. CMHC’s issuance policy has always been based on consistency and transparency. Indeed, it was due to CMHC’s regular presence

in the market that it was able to issue a highly successful $10bn two-tranche bond two days after the collapse of Lehman Brothers in the autumn of 2008.

“The five year fixed rate CMB is the cornerstone of our programme, and will continue to account for the bulk of our issuance, complemented by 10 year and FRN bonds,” says Chamie. CMB issuance in FRN format dates back to 2005, while its first 10 year bonds were launched in 2008. “However, the expecta-tion that Canadian interest rates are likely to rise may generate more demand for FRNs from investors.”

One notable feature of the CMB programme in recent years has been the rise in secondary market trading volumes, supported by a 12-member market-making syndicate, which in 2011 reached more than $750bn. “This was a notable increase over 2010’s total of just over $600bn, and the $560bn we saw in 2009,” says Chamie. CMB are included in the DEX Universe Bond Index and are listed on the Euro MTF of the Luxembourg Stock Exchange.

Rising liquidity in the CMB pro-gramme is one of a number of reasons why the market has been increasingly appealing in recent years to international investors. Others include the 0% risk-weighting under BIS guidelines, the absence of any Canadian withholding tax, and the optimum rating assigned to CMB by Moody’s, S&P and DBRS. Additionally, in a world in which the sup-ply of top-quality triple-A assets is dimin-ishing, Canadian public sector bonds have been in demand as relatively safe haven assets.

The result is that in 2011, 28% of CMB bonds were distributed outside Canada, compared with 22% in 2009, although a number of individual transac-tions were characterised by unusually high overseas demand. In the case of the 10 year bond issued in August 2011, for example, 52.1% of the bonds were bought by investors outside Canada.

Unsurprisingly, US investors continued to lead international demand for CMB in 2011, accounting for 15% of original distribution. Europe took 4%, while Asia accounted for 3% and the Middle East and other regions for 6%.

Despite this demonstrable strength of demand for CMB, Chamie says that CMHC has no immediate plans to issue outside the Canadian dollar market. “At some point in the future we may look at international markets, but it is not something we are considering in the short term,” he says. “The main reason is that any issuance in foreign currencies would need to be hedged back into Canadian dollars, and it is still unclear how the final regulations on OTC derivatives will impact the currency swaps market.” �

The absence of a US-style subprime sector meant Canada’s housing market maintained steady housing starts and stable sales despite the financial crisis

010-011 CMHC.indd 11 11/06/2012 19:22

12

Sponsored statement

Alberta

The provincial government’s revenues in 2011-12 reached $40.3bn, up $1.8bn from the

original forecast for the year due to a robust labour market and buoyant tax receipts. Last year, employment growth in Alberta was 3.8%, which was the highest rate among the Canadian provinces. Alberta accounted for almost 30% of new jobs created in Canada over the last year, nearly triple its population share. Unemployment averaged just 5.5% last year, with employment growing by 77,000 people, to more than 2.1m.

Investment in Alberta, meanwhile, was more than $88bn in 2011, more than double the national average on a per capita basis. Much of that investment is being channelled into the oil and gas sector. Alberta has proven oil reserves of 171.3bn barrels, 169.9bn of which are in the form of bitumen and the remaining 1.4bn in conventional oil. Alberta’s reserves are the third largest in the world and are sufficient to meet Canada’s entire oil demand for almost 400 years.

Investment in Alberta’s oil and gas sector is having a demonstrable trickledown impact throughout the province’s economy. Retail sales rose by 9.0% in March 2012 on a year-on-year

basis. There is little evidence to suggest that buoyant retail sales have exerted any upward pressure on inflation or house prices. Alberta’s monthly inflation rate has been falling in every month since October 2011, with April’s inflation hitting 0.8%, the lowest in Canada.

“We’ve seen some very positive economic numbers,” says Lowell Epp, executive director of capital markets at Alberta Treasury Board and Finance in Edmonton. “But beyond the numbers, we have also seen many new oil sands projects being announced. If all announced projects proceed, economic activity in the province will ramp up substantially.”

Still, making precise projections about the provincial government’s revenues is difficult. Every $1 drop in the WTI oil price leads to a decline in annual provincial government revenues of $223m, while every $0.10 fall in the price of natural gas prompts a decline of $28m. The export-driven nature of Alberta’s economy makes government revenues sensitive to currency fluctuations. For every one cent rise in the value of the Canadian dollar relative to the US dollar, the province’s revenues decline by $247m.

Nevertheless, the recent strength of the Alberta economy underpins the provincial government’s confidence that its robust revenue stream will allow it to perform something of a three-card trick in delivering value for Albertans.

In fiscal year 2011-12, Alberta made full use of its extensive natural resource base to deliver a range of macroeconomic indicators that exceeded the national average and the province’s original projections for the fiscal year.

Alberta: the three-card trick

Sponsor:


Economic activity in Alberta is poised to ramp up substantially

012-013 Alberta 2012.indd 12 11/06/2012 19:23

13

Sponsored statementA

lberta

First, Alberta will balance its budget ahead of most other Canadian provinces. After 14 years of surplus, Alberta chalked up deficits as financial markets collapsed and the world sank into recession in 2009. That fiscal trend has turned around, with the province predicting a return to surplus in 2013-14. “The economic activity we’re seeing right now is very good for the construction industry and retail sales, but the royalty stream from new oil sands projects won’t flow until those projects come on-line,” says Epp.

Second, the strength of the economy allows Alberta to maintain a tax regime that is the most competitive in Canada. The province has the lowest overall corporate and small business tax burden in the country – with the lowest fuel tax rate, no capital tax and no sales tax. Overall, if they were taxed at the same rate as their counterparts in other Canadian provinces, Albertans and Alberta businesses would pay

approximately $11bn more in taxes each year than they do now.

Third, Alberta’s robust macroeconomic indicators will allow the provincial government to increase its investment in infrastructure over the next few years. Since 2000, infrastructure spending by the provincial government has averaged $4.2bn per year; in the next three years, this will rise to $5.5bn. Alberta’s per capita infrastructure spending is already about $1,500, well above the national average.

“Our population has grown by 10% over the last 10 years,” says Epp. “Given that many western populations are stagnant or even shrinking, that is a dramatic rate of growth, and that growth is creating demand for infrastructure like hospitals, schools, roads and highways.”

A key priority for the government is upgrading highway infrastructure in the province, including Highway 63, which connects Alberta’s capital city, Edmonton, to the thriving oil sands town of Fort McMurray in the north of the province and established oil sands operations north of the town.

Alberta in the capital marketsThe province has no plans to borrow to fund capital projects at the current time and is prohibited from borrowing to cover budget deficits. Alberta’s fast-declining deficit will continue to be offset by the Sustainability Fund, which holds Alberta’s short-term savings built up from past surpluses. The fund, which had assets of just over $8bn in March 2012, is used to help manage the effects of revenue volatility, protect priority programmes and services, and build infrastructure while maintaining Alberta’s competitive tax system during challenging economic times.

The current year’s budget calls for no

new borrowing for the province itself, says Epp.

While Alberta does not borrow to cover deficits, it is active in the international capital market on behalf of three provincial corporations – Agriculture Financial Services Corporation (AFSC), Alberta Capital Finance Authority (ACFA) and Alberta Treasury Branches (ATB). The 2012 budget estimates that the consolidated financing requirement of these three corporations will fall from $4.2bn in 2011-12, to $3.5bn in 2012-13, $3.4bn in 2013-14 and $1.6bn in 2014-15.

Epp explains that as Alberta borrows in the provincial government’s name and on-lends to these provincial entities, its funding strategy is driven principally by the borrowing requirements of AFSC, ACFA and ATB. “In recent years, this overall requirement has tended to be fairly short term,” he explains. “This is because the biggest provincial borrower is ACFA, which has funded primarily through the use of shorter dated floating rate notes (FRNs) in recent years.”

“In the case of Alberta Treasury Branches, all its funding is in terms of five years and less,” says Epp. Agriculture Financial Services Corporation, meanwhile, has much smaller requirements in pockets of $100m or $200m.

In common with Canada’s other provincial borrowers, the bulk of Alberta’s borrowing needs are very comfortably covered by its domestic funding programme, where Alberta’s bonds tend to trade tighter to the government curve than all other provinces. Epp says Alberta is receptive to funding opportunities outside the Canadian dollar market, which is why it recently restored its Global Medium Term Note (GMTN shelf ).

Epp says that Alberta has yet to make use of its GMTN programme, chiefly because the province has yet to receive a sufficient volume of reverse enquiry. “We haven’t yet seen much in the way of reverse enquiry, but at the moment the banks seem to be focusing mainly on the liquid billion dollar global deals, which we don’t have a requirement for at the moment,” says Epp.

“When we set up the GMTN we made it very clear that it was all about identifying opportunistic financing, which usually comes in the form of reverse enquiry,” says Epp. “If we could generate better funding costs in international markets after swapping back into Canadian dollars, we would certainly look at opportunities in US dollars or other currencies. But we won’t fund outside the domestic market only to break even with the domestic market.” �

-6%

-4%

-2%

0%

2%

4%

6%

Apr 09 Oct 09

Apr 10 Oct 10

Apr 11 Oct 11

Apr 12

Employment Growth (Year-over-year change)

Alberta

Rest of Canada

Alberta’s employment growth (year-over-year change)

Source: Statistics Canada

Alberta: set to balance its budget before Canada’s other provinces

012-013 Alberta 2012.indd 13 11/06/2012 19:23

14

Sponsored statement

Quebec

Quebec is committed to ensuring that future generations are not left vulnerable to a repeat of the

downturns of the 1980s and 1990s, nor saddled with high debt burdens. This is why an attack on the province’s public debt is at the top of the government’s economic agenda. As National Bank Financial notes in a recent research bulletin, “though fiscal balance is within reach, this is no time for complacency. In our view, the plan to reduce the ratio of debt to GDP over the period from 2013 to 2017 is essential for a return to lasting soundness in public finances and for a fairer deal among the generations. This amounts to the next megaproject for the Quebec government.”

For Quebec, the fiscal challenge is in some respects tougher than in other provinces, given the size of its debt, which is the highest among the provinces. Part of this is the result of an extensive programme of infrastructure investment. “Over the last nine years, 80% of the increase in the debt has been accounted for by what we call good debt,” says Bernard Turgeon, associate deputy minister in Quebec’s Ministry of Finance. “It has either been used for infrastructure investment or has gone to government corporations to foster economic development. Very little has been deficit financing.”

Nevertheless, this year Quebec’s debt amounts to 55.3% of GDP, a total which the province is aiming to reduce to 45% by 2026, chiefly by increasing the price of electricity, which is well below the national average. Starting in 2014, the price will be increased by one cent per kilowatt hour over a five year period. Receipts from this price increase will be put into Quebec’s Generations Fund to reduce the province’s debt. This will represent $1.6bn in 2018-2019 and in the following years.

Bernard Turgeon says that at 11% of revenues, debt service charges are manageable and well down on the level of 16 % at the end of the 1990s.

Before tackling the debt, Quebec will focus on its objective of eliminating its deficit by 2013-14. Impressive progress on this front was made in the year to March 2012, in which the deficit is estimated to have reached $3.3bn, or $600m less than originally projected. This includes a contingency reserve of $300m.

Turgeon says that he is confident that the province will meet its targets on eliminating the deficit and paring the debt, thanks chiefly to an uncompromising attack on expenditure. He says that in recent years Quebec has been second only to British Columbia in terms of controlling its expenditure, and that there is widespread commitment to maintaining this rigorous approach to expenditure management. “On the deficit issue there is definitely a consensus, and there has been since 1996 when the previous government adopted zero-deficit legislation for the first time,”

Quebec has exciting and ambitious plans for the next 25 years, with the Plan Nord to develop the north of the province already gathering momentum. At the same time, the government is making progress toward balancing the budget next year and reducing the province’s debt.

Quebec: the next megaproject

Sponsor:


2011 2012 2017 2026 2011 2012 2017 2026

55.3

4618

20

22

24

26

28

30

32

34

36

38

48

50

52

54

56

58

54.3

55.0

52.1 27.7

Objective 45.0 Objective 17.0

35.2

35.0

Gross debtDebt representing accumulated deficits

(as of March 31, as a percentage of GDP)

The government is continuing its efforts to reduce the debt burden

Source: Finances Québec

014-015 Quebec 2012.indd 14 11/06/2012 19:34

15

Sponsored statementQ

uebec

says Turgeon. “All political parties today agree that we need a balanced budget.”

One of the main spending measures aimed at returning to a balanced budget has been an agreement with the labour unions to limit pay increases for public sector employees to 6% over the five year period ending in March 2015. The overall public sector payroll, meanwhile, will remain frozen until 2013-14, and retiring public sector employees will be replaced only at the rate of one for every two retirees. “Salaries represent 55% of programme spending, so if you control salaries you’ve gone a long way towards controlling overall expenditure,” says Turgeon.

The other main pillar of Quebec’s plan to return to balance has been a range of revenue-gathering initiatives, including an increase in the sales tax of 1% in January 2011 and 2012. Other measures are the gradual implementation of a general heath care contribution which began in July 2010 and is projected to reach $200 in 2012 and an increase in the fuel tax by one cent per litre each year from 2010 to 2013.

More broadly, economic expansion will also support rising tax receipts. Much of this expansion will be underpinned by a continued robust rebound in exports. Having plunged by 7.4% during the downturn of 2009, exports rose by 0.8% in 2010 and by 1.4% in 2011, and are forecast to expand by 3.4% in both 2012 and 2013. Since the early 1990s, Quebec’s exports have almost doubled, and in the last decade, these have been successfully targeted to fast-growth regions of Asia and other emerging markets. While the share of Quebec’s exports accounted for by the US dipped from 84.5% to 67.6% between 2001 and 2011, in the case of Asia and other countries outside the US and Europe, the share almost tripled, from 6.2% to 17.9%.

GDP growth in 2011 was impacted by the fragility of the international economy, reaching 1.7% versus an original projection of 2.2%. GDP expansion is now expected to weigh in at 1.5% in 2012 and 1.9% in 2013, with job creation rising from 21,300 to 35,700 over the two year period. That should ensure that unemployment, while relatively high at 7.8% in 2011, is projected to stabilise at around this level in 2012 and 2013.

Encouraging business investment trends should underpin job creation in the next few years. According to Turgeon, private sector investment rose by 7.7% last

year and is projected to increase by 7% in 2012. Investment in manufacturing increased to $5bn in 2011. “Considering that the manufacturing sector is facing challenges created by the strong dollar and competition from low-cost countries, $5bn of investment in the sector is very encouraging,” says Turgeon. “I think this reflects the quality of our labour force and our favourable tax regime.”

Looking to the much longer term, a conspicuous source of sustainable economic growth is the Plan Nord, a 25 year project to develop a 1.2m square kilometre region of northern Quebec covering 72% of the province’s territory. This largely unexplored and underdeveloped region is rich in minerals such as gold, nickel, zinc and rare earths, and has extensive potential in hydroelectric, wind power and forestry products.

The Plan Nord is already generating healthy investment inflows. In the mining, oil and gas sector, there was a 62% increase in private sector investment in 2011. In the mining sector alone, $4.4bn of investment is expected in 2012, which is a record.

Quebec in the capital marketsIn 2011-12, Quebec borrowed $20.1bn, of which $9.5bn was for rolling over maturing debt. This year, the province’s funding programme calls for total borrowing of $14.95bn (of which 22.4% had been completed by late May), rising to $17.77bn in 2013-14.

In common with a number of other Canadian provinces, Quebec has been enjoying something of an embarras de richesse in the domestic market in recent years, which has limited its issuance outside the Canadian dollar sector. “The domestic market is always going to be our main source of funding,” says Turgeon. “But we have been a regular borrower in international markets for many decades. Our policy is to ensure that we don’t pay more in foreign markets having swapped back to Canadian dollars than we do in

the domestic market. In the last two years, foreign markets have been more often than not the more costly of the two.”

The consequence was that in 2010-11 and 2011-12, the domestic market accounted for 91.8% and 91.9% respectively of Quebec’s borrowing, which compares with 68.5% in 2008-09. As of March 2012, while 83.4% of the government’s total debt had been in Canadian dollars, with US dollars accounting for 8% and euros for 5%, on a post-swap basis, 99.5% of its gross debt was in the domestic

currency.“We want to maintain a regular

presence in the US market, and our aim is to continue to do at least one benchmark issue in US dollars per year,” says Turgeon. In July 2010 and August 2011, Quebec raised $1.5bn and $1.4bn respectively in well-received US dollar benchmarks. The province has also enjoyed a strong following in Europe, but has not issued in euros since April 2009.

As Turgeon adds, however, issuance in Canadian dollars and maintaining an international investor base are not mutually exclusive. Far from it. Attracted by Canada’s safe haven credentials and the diversification benefits offered by the Canadian dollar, more and more international investors, including central banks, have been increasing their exposure to Canadian public sector borrowers in the domestic currency. “A number of investors who used to buy us in euros and Swiss francs now buy Quebec bonds in Canadian dollars,” says Turgeon.

Balancing the need to minimise funding costs while maintaining a commitment to its US dollar investor base has been one notable characteristic of Quebec’s recent funding strategy. Another has been using robust investor demand across the yield curve to extend the maturity of its debt. The average maturity of Quebec’s debt was extended last year to 12 years, compared with 11 at the end of 2010, with almost a quarter of the province’s issuance in 2011 in the 30 year maturity, with 10 year issuance accounting for 46.9%.

Another notable feature of Quebec’s funding policy over recent years has been its decision to increase the province’s liquidity as a means of safeguarding against markets freezing up in any future crisis. “The federal government announced last year it was increasing its liquidity by $35bn over the next three years,” says Turgeon. “We think it is prudent to do the same, so we’ve decided that over the next two years we will increase our liquidity by $6bn.” �

Quebec is making impressive progress towards eliminating its deficit by 2013-14

014-015 Quebec 2012.indd 15 11/06/2012 19:34

corporate, government & infrastructure finance: underwriting • sales & trading • risk management

NatioNal BaNk of CaNada fiNaNCial Markets

BriNgiNg CaNada to the world

Contacts: National Bank of Canada financial Markets

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Montréal

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Yvan Langlois (514) 879-2341 [email protected]

New York

torontoRalph Barcan(416) [email protected]

Paul Badeski(212) [email protected]

Guillaume de Dalmas(212) [email protected]

londonYoland [email protected]

Angus [email protected]

nbf.ca

C$13,900,000,000Bonds

Lead ManagerJune 2011 - May 2012

C$500,000,000Bonds

Co-Lead ManagerJune 2012

C$24,750,000,000Bonds

Joint Lead ManagerJune 2011 - May 2012

C$500,000,000Bonds

Lead ManagerOctober 2011

US$1,200,000,000Bonds

Joint Lead ManagerFebruary 2012 & May 2012

C$2,500,000,000Bonds

Lead ManagerJune 2011 - May 2012

Steven Fleckenstein(604) 623-6752 [email protected]

Randy Keegan(212) [email protected]

Vancouver

2012 canada euroweek nbc sponsored yearly report

Documents

canada fra0

canada survey

euroweekeuroweek canada

giventhe bank of canada

gross government debt

massive debt

debt servicing

debt load