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Why Did Canada Lose Its Triple-A Rating?

Canada became the first major economy in the world to lose its coveted triple-A rating because of the COVID-19 fueled economic downturn. Now poised to post its largest deficit on record, the COVID-19 pandemic has sent the country into a recession and resulted in soaring unemployment, massive spending, and soaring public debt.

Fitch Rating, which is one of three big U.S. credit rating agencies, downgraded Canada’s rating to AA+ from AAA.Because of COVID-19, Canada is expected to run a much larger government deficit this year, around $256 billion, or roughly 12% of the country’s gross domestic product (GDP). That would lift Canada’s federal debt to $962 billion.

To put that number into perspective, for the 2019-2020 fiscal year, which ended March 31, the preliminary budget deficit was projected to be $21.77 billion, or 1.2% of the country’s GDP.

Fitch noted that in addition to public spending to combat COVID-19, which is pegged at $169.2 billion, social distancing and shutting down the economy, coupled with low oil prices, “will cause a severe recession” in Canada in the back half of 2020. The credit rating agency predicts a GDP contraction of 7.1% and said that the country’s economic outlook is below most of its peers.

Even before the coronavirus though, Canada’s economy was hardly robust. Leading up to the pandemic, our country’s GDP was an anemic 1.7%. Moreover, Fitch has had concerns about Canada’s credit rating for some time now. In March 2019, a full-year before the pandemic, Fitch warned that Canada could lose its AAA rating because of soaring debt levels. This could drive up the cost to borrow though higher interest rates.

Some economists believe this will not be the only downgrade from Fitch. Others have warned that Moody’s and Standard & Poor’s, the other two big credit agencies, could follow suit. If that happens, look for the loonie to get volatile.

It’s certainly not out of the question. The International Monetary Fund has lowered its GDP outlook for the Canadian economy. It now expects GDP to contract 8.4% this year—that’s 2.2% lower than its April estimate.

Didn’t Government Spending Help Canada during COVID-19?

The federal government spent billions of dollars in subsidies, tax deferrals, and grants to help prop up the Canadian economy as it dealt with the pandemic. This is responsible for seriously raising the country’s national debt in 2020 to 115.1% of GDP from 88.3% of GDP in 2019.

Ottawa did this as hundreds of thousands of Canadians were laid off due to the shuttering of the economy. Which sent the unemployment rate soaring. Canada’s unemployment rate currently stands at over 13%, making it one of the highest of developed countries and the highest rate domestically since the 1980s.

The unemployment rate isn’t expected to fall very quickly either. The Canada Emergency Response Benefit (CERB), the $2,000 taxable benefit designed to help those who lost their job to COVID-19 related business closures, has, some say, worked too well. Roughly 8.4 million Canadians, more than 40% of the country’s workforce, received at least one CERB payment. Today, just 1.2 million Canadians have stopped receiving it.

Won’t the National Debt Go Down Once the Economy Fully Opens?

While the Canadian economy is opening up, many employers have stated that because of the CERB, many Canadian workers have less incentive to return to their jobs. But they will eventually have to—the CERB payments can’t last forever.

But will Canadian workers have jobs to return or be able to find jobs? The high unemployment rate will impact young workers the hardest, which will have a negative long-term impact on the economy.

Because of the depressed economy and jobs market, it will also be difficult for younger Canadians graduating from university and college to find jobs. Those that do will be facing lower incomes for, some believe, up to a decade or more.

Don’t forget that the CERB is taxable. That means everyone who received a CERB payment will have to pony up some of that money come tax time in 2021. Thanks to high debt loads and virtually non-existent savings, it’s likely that most will be hard pressed to find the money to pay their taxes on the CERB payments.

All of this will have a material impact on spending and consumer confidence, which could undermine Bay Street and corporate earnings this year and in 2021. At the very least.

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Canada’s credit rating was downgraded by Fitch to AA+ as a result of the economic downturn and massive spending triggered by COVID-19. On one hand, the government had to increase spending to help prop up the economy. On the other, that increased spending is expected to have serious long-term impacts on the Canadian economy and average Canadian. How will that affect Bay Street and corporate earnings?

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