Analysis

What happens if New Brunswick defaults on its debt?

It’s a hypothetical scenario that seemed ever-so-slightly less hypothetical this week: what would happen if the New Brunswick government defaulted on its debt?

Federal government has 3 options if the province is unable to pay interest on debt

Don Drummond, a professor at the Queen’s University School of Policy Studies says it's likely if a province defaulted on its debt there would be federal bailout but it would probably come with strict conditions. (Canadian Press)

It's a hypothetical scenario that seemed ever-so-slightly less hypothetical this week: what would happen if the New Brunswick government defaulted on its debt?

A report by the Dominion Bond Rating Service said the agency was shifting its assessment of New Brunswick's economy from "stable" to "negative" — reflecting a worsening fiscal outlook for the province.

DBRS said it's all but certain it will downgrade the province's credit rating, which would lead banks to charge the province higher interest rates on the money it borrows. The province expects to spend $675 million on debt-interest charges in the coming year.

That, in turn, would make a balanced budget, and a reduction of the total accumulated debt, even harder to achieve.

But what is likely to unfold if that downward spiral continues and the province finds itself unable to even make interest payments?

What would government do?

Don Drummond found himself among top civil servants grappling with that question in 1991, when he was an assistant deputy minister in the federal Department of Finance in Ottawa.

Saskatchewan's debt had jumped in a single year from 17 per cent of GDP to 28 per cent. Banks were threatening to stop lending the province money.

Drummond and other officials "did a lot of internal work at that time trying to figure out first of all what [our] obligations were, in terms of the constitution and in terms of the legality," he said in an interview.

They also discussed whether Ottawa would have "almost a moral obligation" to bail out a bankrupt province, given Saskatchewan's collapse might scare off investors from Canada as a whole.

"My own feeling was at the time that if there had been a default, the federal government would have stepped in and helped," said Drummond, now a professor at the Queen's University School of Policy Studies and the author of several studies on provincial finances.

Roy Romanow's newly elected NDP government was in touch with Ottawa about what might happen.

"There was, as I recall, some talk of a provision which would allow the federal government to move in and kind of act as a bankruptcy trustee," Romanow said.

Roy Romanow, a former premier of Saskatchewan, says his advice to Premier Brian Gallant is to devise a plan of tough measures and do it. (CBC)

"It would in effect put the government, the elected government of the province of Saskatchewan, under the effective decision-making control of another agency."

Romanow said he wasn't going to let that happen. He used the threat of resignation to force his reluctant caucus to accept tough measures, including a tax increase, spending cuts and the closure of 52 rural hospitals.

The budget was balanced in three years, and the key question — what would happen in a default — remained unanswered.

Three options

In 1940, banks refused to refinance the New Brunswick government bonds, according to a paper by historian R.A. Young. But a wartime economic boom lifted the economy enough to postpone tough decisions.

A decade later, with a new bond crisis looming, the Liberal government of John McNair imposed a four per cent sales tax to boost revenue, contributing to its election defeat in 1952.

Dominion Bond Rating Service shifted its assessment of New Brunswick’s economy from “stable” to “negative” on Monday. (Sarah Petz/CBC )

If a province did go bankrupt, Ottawa would have three options, Drummond said: direct financial assistance, a loan or a guarantee of the province's debt — an assurance to banks that would let the province continue borrowing.

He figures a federal government would have little choice. "If you have a province go down, it is a reputational investor risk for the whole country, so it's not just a local matter."

New Brunswick isn't near that cliff yet. The province's credit rating from DBRS is still "A-high," and some analysts believe Newfoundland and Labrador is closer to an eventual default.

But the release from DBRS said it will be hard to reverse New Brunswick's slow but steady economic deterioration, and that makes a credit downgrade likely after the next budget.

"We'd need to see a materially better outlook than what has been presented thus far, on both the fiscal and ultimately the economic outlook — which is not something that governments can readily change," Dominion vice-president Travis Shaw told CBC's Information Morning in Fredericton.

"That's not to say it can't happen. Our view is that it is not likely we will see a significant enough improvement to alter the course and ultimately cause us to not downgrade the rating in the coming year."

Eventual impact likely

Auditor-General Kim MacPherson said last year that the province's growing debt "may eventually impact" its ability to meet its financial obligations, including payments on the debt.

Drummond agreed with DBRS that New Brunswick's aging population presents a double challenge: there are more people who need more expensive health care and fewer working-age people to generate the economic growth to pay for it.

Finance Minister Cathy Rogers said this week the province is tackling that very issue, including with $20 million in new spending on senior care.

Finance Minister Cathy Rogers says new spending this year is needed to boost the economy. (Stephen MacGillivray/Canadian Press)

"Where [DBRS] identified our challenges is exactly where we are focused. So I don't know what else we could do," she said.

But the Liberal approach is to spend more money to fix the problem, which only adds to the debt and pushes back the target for a balanced budget to 2022.

New spending needed says Rogers

DBRS said that repeated pushing back of the target led it to question the credibility of the current government's fiscal plan. The PC government of David Alward originally promised to balance the budget in 2014-15.

Rogers said the new spending this year is needed to boost the economy. More money for education will produce a better workforce, she said.

But Drummond said many of those better-educated graduates are likely to leave the province for better jobs. Another problem DBRS flagged is a lack of major private-sector capital spending on the horizon, meaning slow economic growth and fewer job opportunities.

"Unless you can shake that, it's hard to see how this comes to a happy end," Drummond  said.

He said any federal bailout would probably come with strict conditions, including a strict deadline for the province to get the budget balanced quickly.

"You almost have an obligation to Canadian taxpayers to not do it, unless there's some kind of agreement and some kind of assurance," he said.

Federal-provincial jurisdiction concerns would also have to be put aside. "The normal 'keep your paws off provincial stuff' would kind of go out the window if you're giving them some sort of guarantee," he said.

And even that wouldn't be the end of the crisis, because while a balanced budget would stop the debt from getting bigger, it would take years and years of surpluses to actually reduce it.

"The problem doesn't go away" with a federal bailout, Drummond said. "That's just the first step."

Romanow said he doesn't envy the Gallant government's position "but if I were to offer any advice … I would say devise a clear plan, explain it to the public, why it is necessary and do it.

"That means making a decision you're ready to go down to defeat politically, but you do so with the knowledge you're doing the right thing for the people of New Brunswick."

About the Author

Jacques Poitras

Provincial Affairs reporter

Jacques Poitras has been CBC's provincial affairs reporter in New Brunswick since 2000. Raised in Moncton, he also produces the CBC political podcast Spin Reduxit.

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