Sonnez l’Alarme!
So I keep hearing that Quebec’s fiscal situation is not alarming, that austerity drives are not necessary and that the Jean Charest Liberal government is in the pocket of ‘Big Business’. So I did some snooping around and some number juggling to investigate whether the government’s current drive for a balanced budget is reasonable or just neo-conservative ideological pandering.
So I had to crunch some numbers a little and here is what I have found:
Often you hear people say our situation is not bad we are middle of the pack in the OECD in terms of net debt. Alright so having taken StatsCan’s number’s for Quebec’s net debt than adding on its proportional share of federal government net debt, Quebec indeed is middle of the pack. But who exactly is in the OECD you ask? Well out of 31 countries in the club of developed nations 5 have accepted IMF or EU bailouts (Greece, Hungary, Iceland, Ireland and Portugal). Another 4 countries (Belgium, France, Italy, Spain) have come close to being shut out of credit markets or seen the spead between their yields and comparable safe haven bonds increase to historical highs*. Many more OECD members have seen their long term credit ratings cut since 2007. All this to say that benchmarking ourselves against the OECD is just plain deceptively simplistic. Looking at the chart, one can see that Quebec is also middle of the pack of those that were bailed out. Bigger countries like the US, UK and Germany can get away with higher debt levels, it’s the nature of capital markets to respect bron over brain. However small countries need to be prudent. Ireland and Iceland had very small debt burdens before the crisis and look where they are now: bailed out and battered.
Now that we’ve established that Quebec is part of an unenviable club of high debt small countries, let’s look at its particular situation and find out why people still think things are okay. First sign is bond yields. Quebec’s 2 year bond is yielding ~1.35% or approximately 35 basis points above the Central Banks key rate. In the US the 2 year yield is roughly 27 basis points (at friday march 2nd close) or ~25 basis points above its target rate. So Quebec isn’t borrowing in real terms much more expensively than the US government, allegedly the safest debtor in the World (not that I believe they should be). Another indicator that would suggest no immediate problem is Quebec’s credit rating.
None of Quebec’s credit ratings are Prime, meaning Quebec isn’t the safest bet possible but they remain in the High Grade to Upper Medium Grade categories. So one could be forgiven for believing that Quebec is fiscally alright given that large swaths of the financial and capital markets community still respects Quebec’s ability to service its debt. Now you are probably wondering why the ratings agencies are so kind to Quebec. There are many reasons why Quebec might be more financially than the European periphery or developing nations, I’ll focus on the three that seem most important to me (and probably the credit rating agencies):
Firstly, according to the Canadian Constitution property rights and natural ressources are a Provincial jurisdiction. In essence the Quebec government can legislate any which way it wants with regards to natural ressources. Nationalisation, royalty regime changes and taxation are weapons the government can use to raise revenues or assets. These circumstances are what led the Quebec government to own one of the largest utilities in the World (Hydro Quebec). This coupled with the fact that the Province has a land masse of over 1.5 Million square kilometers containing an abundance of mineral and hydrocarbon ressources puts it a notch above the failing states of Europe in terms of natural wealth endowment.
Secondly, the province’s government has a relatively high liability coverage ratio. That is for every dollar of debt the government owes it has 51.25 cents of assets as of 2008 compared to an OECD average of 44.91 cents in the same year. Now comparing to the OECD is once again very tricky since some of the members have coverage ratios in the triple digits while others have miserable ratios.
Lastly, Quebec has an immense advantage over the PIIGS in that, it is part of a functioning monetary and fiscal union. Now functioning is very relative but it works great for Quebec. Quebec’s budget is partially immune to boom bust cycles because some of the automatic stabilizers are federal responsibility. For exemple Unemployment Insurance (called EI in Canada) is covered by the federal government. Quebec is also the recipient of fiscal adjustment transfers. Currently just above 10% of the Quebec budget expenditure is paid for through fiscal transfers from the federal level. This means very simplistically that the government can afford aheftier debt services payments oft least 10% more than its peers (if not much more).
The preceding points and the second graph would seem to imply that the province has the means to pay down its debt and that it has done so since the middle of the 1990′s. However from the third graph (Can & Qc Budget Balances) it is obvious that much, if not all of the heavy lifting in terms of debt consolidation has been done at the federal level. Another factor that has led to a decrease in the overal debt load is the shrinking share of the federal government debt. The data presented here takes into account a generational decrease in Quebec proportion of the debt do to a decreasing share of the population, from 26.38% in 1981 to 23.14% in 2011. The decreasing share of population indicates another problem is present. Quebecers are no longer making babies (okay they still are just not a lot). Quebec is well beneath the population replacement ratio of 2.1 children per woman (~1.5 last I checked, even though we are in the midst of a little echo boom). Which means that the labour participation rate is headed down way down in a near future.
Admittedly that problem isn’t quit immediate and can always be buffered by laxer immigration policy.
Remains the elephant in the room: the gross debt. Not a lot of countries can claim higher gross debts than Quebec without terrifying bond investors or having the IMF knocking on your door. I’ve explained above why this might be, now I’ll explain why it might not last. The bail out situations varied from country to country but in Ireland and Iceland’s cases it was a question of nationalizing banks then watching as the asset side of the balance sheets evaporate, net debt quickly rose towards the gross debt levels. While this isn’t likely to happen to Quebec (most Canadian banks are safe and headquartered in Ontario) it isn’t impossible either. A likelier problem would be a repeat of the Caisse de Depots et Placements seeing its assets shrink in value creating a massive unfunded pension liability for the government (one is already present but most actuaires say it is manageable). Mis-management of state enterprises ‘a la Grecque’ or PDVSA style seems quite possible to me in the long run. With Hydro Quebec being the most indebted corporation in Canada (over 35 Billion $) and paying out a heavy dividend to the government its book value should be higher but isn’t. Also not to be neglected is secession from Canada. While politically unlikely now, it wasn’t so long ago that a referendum was won to preserve the confederation by a voting margin of less than 1%.
The bottom line is that Quebec is viewed as stable for a few good reasons, however neglecting the fact that Quebec is as financially precarious and politically unmanageable as some of the worst developed World debt offenders. Buy Quebec debt at your risk, within the next ten years austerity will become an obligation not a choice, I’m not hopeful that our politicians and the citizens they represent will show themselves more responsible than their Greek equivalents.
P.S. Thank you to all those who voted NO to seperation in 1980 and especially in 1995. Quebec would look like a colder version of Greece or Ireland right now if it wasn’t for your assiduousness.
* By “historical highs” I mean Euro era historical highs versus comparable German Bunds yields.
MTL ECONOMIST 
Au pire des cas on vend hydroquebec
tu penses que ca vaut combien?
Je m’occupe de la value live 🙂 . Good job stat addict guy