In response to the COVID-19 crisis, the Bank of Canada has been buying Federal, Provincial and Corporate Debt.  What happens when this support stops? 

 

On April 30, the Bank of Canada (BoC) released details on the $50 billion Provincial Bond Purchase Program (PBPP). This, on top of the BoC’s Government of Canada Bond Purchase Program (GBPP) and corporate debt purchase announcement. Intended to provide support for provincial governments in raising debt capital of up to $125 billion in the fiscal year 2020/21, the PBPP focuses on Canadian dollar issued provincial or territorial debt maturing on or before April 15, 2031 (cf. CIBC Capital Markets, April15 and 30). The amount of debt purchased per province or territory will be based on that entity’s share of Canada’s GDP (Gross Domestic Production) and the issuer’s debt outstanding compared to other provinces.

Further purchases may or may not be in the cards, depending on the duration of the current crisis and the particular needs of each province in trying to cope with a revenue shortfall. 

 

In a September 28 article, Michelle Schriver of Advisor’s Edge suggested that provincial deficits could reach about $100 billion, compared to $12 billion last year. Most recently, in late September, the Newfoundland and Labrador 2020 budget, announced by the new Premier Andrew Furey and the Minister of Finance Siobhan Cody, came forth with an estimated 2020/21 budget deficit of $1.84 billion, about $1 billion more than was projected this time last year (cf. CIBC Economics, September 30). As a result, the province’s borrowing requirements will amount to approximately $3 billion, representing an increase of about $1.8 billion year over year. The Bank of Canada is expected to absorb about half of that previously unexpected overage. 

 

The real story here, is what happened to provincial bond interest rates in late March and early April, when the markets determined that the provinces’ borrowing requirements would be dramatically on the rise. Let’s take Ontario as an example. The difference on the rate of interest paid on the 10-year provincial bond versus the Government of Canada 10-year issue had hovered around 0.60% up to February of this year. That difference (the “spread”) shot up to 1.20% by late March. With the announcement of Bank of Canada support, the spread has been backing off, now standing at 0.68% (see Chart 1). 

 

Chart 1

 

Source: Bloomberg, 10yr Ontario vs 10yr CDA (YTD chart)

 

Even once the economic crisis brought on by the pandemic ends, one may wonder how provincial budgets and borrowing requirements will look down the road. Much depends on the rate of economic recovery. Equally important, what will provincial bond interest rates look like as the BoC support winds down? Will our provinces have to pay considerably more interest in order to float their debt? What will that do to interest rates in general, such as in borrowing costs for individuals? 

 

While interest rates have traditionally moved up and down with rate of inflation, the enormous and unprecedented borrowing by governments at the federal and provincial levels, and the timing to the end of the BoC’s buying support, may be enough to propel interest costs far higher in the future.