ALBERTA - BMO



Atlantic Canada Economic Outlook

North American Economic Context

Expansionary fiscal and monetary policies prompted a significant acceleration in US economic activity in the second half of the 2003. Key contributing factors included a robust housing sector and strengthening business investment in machinery. For the entire year, the US economy grew by 3.1%.

The US economy began 2004 on a robust footing, with manufacturing exhibiting a firming pattern and business investment gathering even more momentum. While recently showing some signs of an improvement, labour market conditions have remained soft, as firms boost output through productivity-raising capital spending rather than through hiring. Overall, the US economy is slated to grow by 4.7% for the year. This would be a significant improvement from the average annual increase of 1.9% during the previous three years. Further out, the expansion should temper to 3.9% in 2005 and 3.3% during the 2006-2008 interval.

After outpacing its US counterpart during the previous four years, the Canadian economy grew more slowly in 2003, with a real GDP gain of just 1.7%. Factors contributing to the slower rate of expansion included weak, halting US growth in the first half, a sharp rise in the Canadian dollar, the SARS outbreak, and the discovery of ‘Mad Cow’ disease. Towards the end of the year, however, the economy appeared to be embarking on a recovery path, with growth picking up to a pace near 4% in the fourth quarter from just over 1% in the third.

This year, strong results in resource-based sectors and home construction are being tempered by a manufacturing sector which is still coming to terms with a higher Canadian dollar. Thus, we expect the average pace of economic growth to rise only moderately to 2.6%. Looking further out, Canada’s economic performance should improve, with real GDP growth rising to an average of 3.4% during the 2005-2008 interval. As growth strengthens and excess capacity is used up, we expect the Bank of Canada to gradually raise interest rates. The 90-day t-bill rate is projected to rise from an average of 2% in 2004 to 3% in 2005 and to reach its ‘policy-neutral’ level of 4.5% by late 2006.

From its low point of just under 62 US cents in January 2002, the Canadian dollar rose rapidly, climbing 27% to its recent peak of 78.8 US cents in mid January of this year. Since its peak, the dollar’s value has eased to about US 73.5¢ (April 28, 2004). Looking through recent short-term gyrations, we expect the Canadian dollar to consolidate at around US 76 cents during the next couple of years.

Commodity Prices

During the past couple of years, commodity prices rose sharply, providing a healthy boost to Canada’s resource-based industries. This has been very important to sustaining economic growth in Atlantic Canada in a period of generally weak macroeconomic conditions in North America and adverse developments such as SARS, rising global terrorism, and extreme weather.

BMO Financial Group’s monthly Commodity Price Index, which tracks the progress of 19 commodities produced in Canada, rose 56% from a recent trough in January 2002 to March 2004. All major sub-categories recorded strong increases over that period: oil and gas surged 110%, metals & minerals climbed 42%, agricultural products rose 34%, and forest products increased 29%.

Tight market conditions for crude oil and products and for natural gas have raised energy prices to very high levels. While oil prices are not likely to remain at their current level in the upper-$30 range for US benchmark West Texas Intermediate (WTI), they are projected to remain high by historical standards. We expect the price of WTI to just edge down from an average of US$31.15/barrel in 2003 to US$30/barrel in 2004 and US$25 in 2005. Global production is growing strongly enough to return inventories of crude to comfortable levels, even with strong demand in Asia. However, concerns about gasoline refining capacity in the United States and supply risks associated with Middle East violence and political instability in Venezuela and Nigeria have kept the risk premium on oil very high. For their part, elevated natural gas prices reflect a fundamental shortage of the commodity in North America. Over the next several years, high prices will be required to “price out” some demand and validate the economics of major projects to expand the import infrastructure for liquefied natural gas and to build pipelines to access northern frontier supplies. High energy prices are supportive of existing and expanding projects offshore Newfoundland and Nova Scotia.

Within the metals & minerals sub-index, particularly strong gains were recorded for nickel (129%), copper (100%), and lead (71%). Aluminum recorded a significantly weaker gain (22%), held back by difficult conditions in end markets such as automotive and aerospace manufacturing. The sharp increase in nickel and copper prices stemmed from tightening global inventories of the commodities as the rebound in US economic growth and a very fast pace of expansion in Asia, particularly China, bolstered demand. Additionally, there have been a number of work stoppages at major mines and little in the way of new project development. More recently, metal prices retreated sharply as authorities in China indicated they might have to take even stronger measures to bring growth down to a more sustainable pace. Nevertheless, prices have remained relatively high and should remain strong over the next two years, given supply restraints and our expectations that global economic growth should improve. This is positive for the major mining project under development at Voisey’s Bay in Labrador.

Over the same period, forest product segments showed a more varied performance. Booming residential construction in North America sharply boosted the demand for panelboard and lumber. The price of oriented strandboard surged 240% to record-high levels, while lumber prices climbed 42%. However, the prices of market pulp and newsprint continued to labour under generally weak demand conditions and more-than-adequate inventories in North America. Rising consumption of pulp in China has allowed for a moderate rise in prices while buyers of newsprint have provided considerable resistance to price increases. Over the course of this year, improving global economic growth, the summer Olympics, and the US presidential election should raise the demand for and prices of newsprint. The improving price picture for market pulp and newsprint should provide some welcome relief for related mills in New Brunswick and Nova Scotia.

The agricultural sub-index has risen, as very tight global inventories of grains and oilseeds have run into periods of poor harvests and rising demand in the developing world. Although prices are likely to remain volatile, buffeted by changing forecasts of growing conditions, grain and oilseed prices should remain firm due to generally low inventories and rising global demand.

Atlantic Canada Overview

Atlantic Canada’s economy underwent a pronounced weakening in business conditions in 2003, when the pace of the region’s economic growth slowed to 2.8% from a Canada-leading 6.7% in 2002. Nevertheless, even with this slowdown, the region’s economy outpaced that for Canada as a whole by close to one percentage point. This relatively good growth performance for the Atlantic Canada region largely stemmed from strong market conditions in the natural resource sector, particularly for oil and gas and metal mining. Real output in the natural resources sector rose by close to 8%, following a 21% jump in 2002. The construction and business services sectors also recorded healthy growth rates in 2003.

In part, the downswing in the region’s growth in 2003 reflects one-time, special factors in Newfoundland and Prince Edward Island. Newfoundland’s economy received a huge boost in 2002 from the coming onstream of new oil from the Terra Nova field and from resolution of earlier production problems at Hibernia. PEI’s economic growth in 2002 was boosted by the return to normal growing conditions for the potato crop, following a drought-induced decline the previous year. However, aside from the special-factor impacts, the pace of economic growth also slowed substantially in Nova Scotia and New Brunswick. In Nova Scotia, growth fell to less than 1% -- the slowest pace since 1996 – reflecting production problems at the Sable Island natural gas field and the completion of construction of a drilling platform the previous year. New Brunswick’s economy fared better, with growth outpacing the national level, albeit well down from the previous year. While home-building and non-residential construction advanced sharply, a decline in exports held back overall growth in the province’s economy. For the Atlantic Canada region as a whole, very weak performance of the hospitality industry (accommodation and food) also contributed to lower economic growth in 2003. This reflected collateral damage from the SARS scare, the impact of the rising Canadian dollar, and terrorism-induced declines in both personal and business travel.

Looking ahead, we anticipate the region’s economic growth to moderate even further to an average of 2.5% over the 2004-2005 interval. That would be approximately half a percentage point below the expected national average. This further moderation in growth largely reflects anticipated developments in Newfoundland, where production of oil is expected to grow more slowly. Conditions in the other three provinces should actually strengthen moderately. The manufacturing and tourism sectors should benefit from a stronger North American economy and adjustments by both producers and consumers to the higher level of the Canadian dollar. Major oil and gas, metal mining, and infrastructure projects should keep construction and overall business investment on a growing track. The half percentage point gap between the Canada and Atlantic Region’s expected growth during the next couple of years reflects differing profiles of population growth. The population in Atlantic Canada has actually been edging down at an average annual pace of 0.1% during the past four years, while that for Canada as a whole has been rising 1%. Thus, on a per capita basis, our projections show average growth in the Atlantic Canada of 2.6%, compared to 2% for the country as a whole.

New Brunswick

The New Brunswick economy is expected to continue expanding at mid-speed in 2004, reflecting mixed results among sectors.

In 2003, the pace of activity slowed considerably, although it still exceeded the national average. The first decline in exports since 1991 represented the biggest drag on overall performance. The sharp rise in the Canadian dollar, weak US demand through the early part of the year, and tough market conditions for many commodities important to the province all negatively affected the external sector.

Deterioration in the labour market – employment fell in the year – also contributed to dampening economic activity in 2003. However, the impact on consumer spending has been, fortunately, minimal. Strong growth in services expenditures more than offset a decline in durable goods purchases.

The main area of strength in the province has been capital investment. On the residential side, the hottest housing market in 20 years kept home builders and renovators very busy. On the non-residential side, highway construction and the refurbishing of the Coleson Cove power plant provided much of the impetus behind a strong rebound in investment, after three years of decline.

The main positive factor for the provincial economy in 2004 will be an expected turnaround in the external sector. With the Canadian dollar projected to remain stable, the stronger US economy and improved world commodity markets should boost demand for New Brunswick exports.

Also supporting overall growth this year will be continued work on large capital projects. A recent Statistics Canada survey indicated that capital spending intentions are up nearly 10% in 2004, the second highest growth rate among provinces, after Newfoundland and Labrador.

On a less positive note, advances in consumer spending are expected to moderate. Smaller gains in labour income following surprisingly strong increases in 2003 (given the weakness in employment) are projected to dampen domestic demand. Housing starts are also forecast to moderate from their 20-year high in 2003.

Finally, the fiscal situation will impose a drag on the economy. The recent 2004 provincial budget called for spending restraints in order to keep the balance in the black. The government plans to freeze public service wages and cut employment (by about 750 positions). Overall, a $54 million surplus is projected for the 2004-2005 fiscal year, after a $123 million deficit in 2003-2004.

All considered, economic growth in 2004 is projected to remain little changed from 2003, up marginally by 0.1 percentage point to 2.7%. This rate of expansion is seen to be only minimally surpassed in 2005.

Nova Scotia

The Nova Scotia economy is expected to rebound in 2004 from a poor performance in 2003. Still, projected growth this year remains well short of the national average.

In 2003, Nova Scotia ranked last among provinces in economic growth, as overall activity was adversely affected by declines in natural gas output, exports, manufacturing activity, and business investment. Lower volumes of natural gas production reflected maintenance work at offshore facilities and smaller reserve estimates of existing gas fields off Sable Island. Exports fell for the first time since 1995, hit by weak US demand in the first part of the year, the rise in the Canadian dollar, and softer conditions experienced by a number of key industries, including tire manufacturing.

The drop in exports weighed heavily on the manufacturing sector. The effect was compounded by a steep fall in shipbuilding activity, following the completion of a drilling platform in 2002.

Business investment softened as a result of a sizable drop in capital spending on machinery and equipment. Solid performance by residential construction – with housing starts reaching a 12-year high – and sustained demand for non-residential structures from energy project developers provided some offset. Damage caused by Hurricane Juan also contributed to boost reconstruction and repair work in the province.

The main drivers keeping the economy afloat in 2003 were steady growth in consumer spending and a rebound in public administration output. Total consumer spending was sustained by rapidly rising outlays on services. An increase in government program spending allowed the public administration to grow for the first time in three years.

The economic engine is expected to pick up steam in 2004, as natural gas production receives a boost from the entry into service of a new field – Alma – and as manufacturing exports benefit from stronger US demand.

Continued capital spending in the energy sector will fuel business investment. This should more than compensate for some slowing in housing starts. A Statistics Canada survey done earlier this year signaled an increase (albeit marginal) in capital spending intentions for 2004, after a decline in 2003.

Low interest rates and moderate growth in employment should continue to sustain consumer spending, although the rollback of part of a personal income tax (PIT) cut by the provincial government has made conditions less stimulative than earlier expected.

The cancellation of most of the 10% PIT cut, which came into effect only this past January, was the main feature of the 2004 provincial budget presented in April. It became necessary in order to ensure that the budget balance remains positive in the face of rising expenditures. Program spending in the 2004-2005 fiscal year is slated to rise quite rapidly, with health care receiving a substantial boost in funding. Community services also will get noticeably more. While the budget will remain in the black, the Nova Scotia government appears to have abandoned its tax cutting plans in favour of enhancing government services.

Overall, growth in the Nova Scotia economy is projected to bounce back to 1.9% in 2004 from 0.9% in 2003. While this would represent an improvement, it would not be sufficient to raise the province from the bottom of the provincial standings. Further improvement to 2.9% is projected for 2005. Actual performance could be even stronger if the Deep Panuke natural gas project goes ahead. The project has been on hold since 2002, while its economics were being re-evaluated.

Prince Edward Island

After a robust expansion in 2002 – largely reflecting a sharp recovery in crop yields – economic growth in PEI decelerated in 2003. The slowdown largely reflected a fall-off in tourism activity, weakness in agriculture, and a decline in exports. SARS, a stronger Canadian dollar, and uneasiness regarding travel combined to hamstring the tourism industry, with the number of visitors falling close to 4% in the year. The export sector was also hurt by the dollar’s strength, as shipments abroad were pulled down by a large decline in seafood

products. Additionally, farm cash receipts fell in the face of soft prices for some key products.

Still, the island economy outperformed its national counterpart in 2003, growing by almost 2% compared with 1.7% for Canada as a whole. Provincial economic growth was supported by improved conditions in construction. Driven by low interest rates and buoyant labour market conditions, home-building activity strengthened substantially, with housing starts climbing to a fourteen-year high of 814 units. Non-residential construction was also solid in 2003, partly reflecting capital expenditure on road building and repair, education- and health-related projects, and the building of manufacturing and hospitality facilities.

The manufacturing sector turned in a solid performance in 2003 as output rose 7% on the strength of exports of aerospace products and new activity in the printing industry. A respectable potato crop also provided the basis for an increase in frozen food output. However, from a revenue standpoint, manufacturing shipments increased by just over 2% – a rate well down from recent years – reflecting the negative impact of the Canadian dollar’s strength.

Mirroring robust activity in construction and manufacturing, employment creation quickened to a pace of 2.5% in 2003. While this rate of job growth was sufficient to push down the unemployment rate more than a full percentage point to 11%, healthier labour market conditions could not manage to boost consumer spending. Retail sales remained essentially flat in the year (-0.4%), lacking the contribution of a more vibrant tourism industry.

The province is expected to see economic activity pick up in 2004, largely on continued strength in construction and an improvement in the tourism and manufacturing industries. While residential construction is likely to temper, low interest rates will be a continuing source of support. Housing starts are slated to top a relatively high 700 units and renovation will likely continue apace. [Residential building permits are being issued at a rate well above the national average]. Moreover, non-residential construction activity should remain robust judging from the strength of building permits and a recent Statistics Canada survey which shows intentions to raise investment by 7%.

Consumer spending is expected to rise in 2004, although gains will likely be minimal amid a tempering in job creation. Retail sales are slated to register a meager increase (0.7%), after remaining flat in 2003.

The public sector is also not expected to contribute significantly to growth in light of the higher taxes and spending cuts announced in the recent budget, as the provincial government attempts to eliminate its deficit and reduce debt levels. Overall, economic growth in PEI is projected to run at an average annual pace of 2.4% during 2004 and 2005.

Newfoundland & Labrador Newfoundland and Labrador turned in another outstanding performance in 2003, with the economy growing 6.5% following an outsized expansion of 15.4% in 2002. The increase in output largely reflected strong activity in crude oil extraction as raised daily production limits at the Hibernia and Terra Nova oil fields contributed to brisk crude oil output growth [in excess of 20%]. Economic activity in the province was also driven by non-residential construction, reflecting project development in energy and mining (White Rose, Voisey’s Bay) and public sector infrastructure (highway construction, and school and health care facilities). Residential construction also experienced buoyant activity in 2003, spurred by low interest rates and upbeat labour market conditions, including substantial gains in personal income.

Robust activity in non-residential construction gave a fillip to job creation in 2003, helping to nudge the province’s elevated jobless rate down. Improving labour market conditions boosted consumer confidence and fueled a sharp acceleration in retail sales (5.2%). Home building continued at a fast clip, with starts, at 2,690 units, hitting their highest level since 1991. Manufacturers also contributed to the province’s strong performance, with 12% growth in shipments which, at the national level, had remained flat. Although exports suffered a substantial drop (-14%), as the higher Canadian dollar reduced the value of sales of commodities such as oil and gas and paper, there were bright spots in refined petroleum products, fishing and seafood products, and iron ore.

Economic growth in the province is expected to temper notably in 2004, largely reflecting more moderate gains (or possibly declines) in crude oil production. However, non-residential investment associated with major mining projects should continue to support the expansion. Residential construction, too, should remain at a fairly high level of activity. While some moderation in home building activity is anticipated, housing starts are expected to remain at a fairly high level (1,800 units) and low interest rates should continue to encourage renovation activity, which has been running at a very brisk rate.

The manufacturing sector should also continue to register good growth in 2004, with firm demand for refined petroleum products. Shipments of iron ore have also been increasing at a fast pace, boosted by strong global demand for steel. Retailing activity should also remain buoyant in 2004, as consumer spending is bolstered by rising employment and labour income. So far, retail sales have increased at a pace near 7%, much faster than the national average, and are expected to grow by 6% for the year as a whole.

In contrast, the public sector will not add any impetus to provincial economic growth as the government grapples with deficit and debt reduction. Public spending is budgeted to rise very slowly, some taxes are to be raised, and approximately 4,000 public sector jobs are slated to be cut.

Overall, the economy of Newfoundland and Labrador is projected to grow by 2.4% in 2004, well down from its heated pace of the past two years. Nevertheless, growth at that rate would be close to that projected for the country as a whole (2.5%). In 2005, the economic expansion in Newfoundland and Labrador is expected to continue at a similar pace.

Fiscal Finances: Analysis of Budgets for 2004-2005

New Brunswick

New Brunswick’s 2004-05 budget, presented on March 30, calls for a $54 million surplus after a $123 million deficit in 2003-04 on a consolidated basis. The corporate tax rate on small business was lowered to 2.5% — the lowest in the country. A public service wage freeze will be implemented, and about 750 public service positions will be eliminated in order to keep spending under control.

2003-04 results

New Brunswick Fiscal Summary

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The balance for 2003-04, budgeted at a deficit of $101 million, is now estimated to be a deficit of $123 million. The government claims that the deficit is $21 million (not shown on the table at right), but this is including a $102 million transfer from the province’s fiscal stabilization fund, and is therefore not on a consolidated basis. The fiscal stabilization fund will no longer cause any confusion about the true surplus or deficit, as the $102 million withdrawal from the fund in 2003-04 left it fully depleted.

Revenues were $31 million (0.6%) under budget. Own-source revenues were $35 million (1.1%) above budget, despite real GDP growth in 2003 coming in below the projection in last year’s budget — 2.0% vs. 2.8%. (We estimate 2003 real GDP growth at only 1.6%.) Personal income tax and sales tax revenues were well above budget, but corporate income tax revenues were well under. Federal transfers were $66 million (3.5%) under budget due to the downward equalization adjustments that affected all the equalization-receiving provinces.

Spending was $38 million (0.7%) under budget. Program spending was $71 million (1.6%) over budget, with most of the spending overrun occurring in the Department of Health and Wellness. However, low interest rates and a strong Canadian dollar reduced debt service costs by $109 million (16%).

New Brunswick’s balanced budget legislation requires that the province balance its budget cumulatively over a four year period. A four year period ended at the end of 2003-04, with the cumulative surplus over that period estimated at $162 million.

2004-05 budget

For 2004-05, the government projects a surplus of $54 million. The province has instituted a change in accounting policy for 2004-05. It has moved to full accrual accounting, whereby capital assets are recorded as assets and then expensed gradually over their useful lives, rather than expensed in the year of acquisition. Under the old accounting policy, the budgeted surplus for 2004-05 would be $2 million.

There were no new taxes or tax increases in the budget, and one tax cut. The tax cut was to the small business corporate income tax rate, which will fall from 3% to 2.5% on July 1, 2004. This will make New Brunswick’s rate the lowest in the country. (At 3%, New Brunswick was tied with Alberta for the lowest rate.) Also, on July 1, 2004, the net income limit for eligibility for the small business rate will increase from $400,000 to $425,000. These tax measures will cost the provincial coffers $2 million in 2004-05.

Though there were no tax increases, higher fees for some government services, along with increased fines and penalties are expected to raise $23 million.

In total, revenues are budgeted to rise $259 million (5.1%) in fiscal 2004-05. Own-source revenues are slated to rise $106 million (3.2%), including the above-mentioned tax cut and increases in fees, fines and penalties. This rate of increase appears to be conservative in light of the economic outlook and the above-mentioned revenue enhancing measures. The government forecasts real GDP growth in 2004 of 2.8% (4.0% nominal) — almost identical to our forecast for real GDP growth of 2.7%.

Federal transfers are expected to rise $153 million (8.3%) in fiscal 2004-05, as both equalization payments and health and social transfers increase. The health and social transfers include New Brunswick’s share ($47 million) of the recently confirmed $2 billion federal supplement.

Ordinary account spending is budgeted to rise $51 million (1.0%). Program spending is budgeted to rise $35 million (0.8%), with the largest increases for the Departments of Health and Wellness ($68 million or 4.4%), Family and Community Services ($11 million or 1.6%), and Education ($10 million or 1.3%). Cost savings are to be found in General Government ($42 million or 9.2%) and a number of other areas. About 750 public service positions are to be eliminated, and the budget includes no funds for public sector wage increases. Debt service costs are to rise $16 million (2.7%).

Capital account expenditures are budgeted to rise sharply by $86 million (35%) in 2004-05, with increases for hospital, school and, especially, road construction.

Debt levels and credit ratings

Net Brunswick’s net debt stood at $6.713 billion at the end of 2002-03, and it is estimated to have risen to $6.836 billion as of the end of 2003-04. The net debt is budgeted to drop slightly to $6.864 billion by the end of 2004-05. As a percentage of GDP, net debt has fallen continuously for the past few years, reaching 31.0% at the end of 2003-04. Thus, the 2003-04 deficit ($123 million or 0.6% of GDP) was not large enough to increase the net debt/GDP ratio. The net debt/GDP ratio should fall further to 29.8% by the end of 2004-05 if the budget targets are achieved. This would result in New Brunswick having the lowest net debt/GDP ratio of the five eastern-most provinces (the Atlantic provinces and Quebec) — a position currently held by Prince Edward Island.

New Brunswick is rated high-A (with a positive outlook) by Moody’s, mid-A (with a positive outlook) by DBRS, and low-AA (with a stable outlook) by S&P. The actions taken in this budget to eliminate the deficit may prompt Moody’s and DBRS to upgrade the province.

Commentary

New Brunswick’s recent fiscal history has been fairly consistent, with a mix of small surpluses and small deficits, combined with declining debt/GDP ratios. It remains to be seen whether the spending restraint proposed in this budget can actually be implemented in the face of significant spending pressures. But even if a deficit results, it will likely be small enough to keep the net debt/GDP ratio on a downward track.

Nova Scotia

Nova Scotia’s 2004 budget, presented yesterday by Finance Minister Peter Christie, was balanced for both 2003-04 and 2004-05, but cancelled most of the 10% personal income tax cut which came into effect less than four months ago. A number of other tax increases were also implemented.

2003-04 in review

The government projected a small $3 million surplus for 2003-04 in its April 2003 budget, and announced a 10% personal income tax (PIT) cut, effective January 1, 2004. The 10% PIT cut had been a plank in the Conservative’s 1999 election platform — the Conservatives had promised to eliminate the deficit and then implement the 10% PIT cut. With the deficit eliminated, and the 10% PIT cut announced, but not yet in place, the government called an election for August 5, 2003. The New Democrats supported the tax cut, while the Liberals campaigned against it, arguing that the province could not afford it.

Nova Scotia Fiscal Summary

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The Conservatives were returned to power, but reduced to minority status. Shortly after the election, the fiscal situation took a turn for the worse. The government implemented $32 million in spending cuts in order to maintain a balanced budget in the wake of a slowing economy and spending overruns in health. Then, Hurricane Juan swept through the province on September 29. A few months later, the government warned that it would likely run a deficit, particularly as equalization payments from the federal government were reduced.

As it turned out, two developments allowed the province to run a surplus in 2003-04. The first was a large $152 million prior year’s adjustment on income tax collections. (Personal and corporate income taxes are collected by the federal government, and remitted to the provincial government based on estimates of the province’s share. When the actual share becomes known, a prior period adjustment is made, with the province either paying money to or receiving money from the federal government.) The second development was a change in accounting policy regarding capital assets which reduced program spending by $25 million. The result was a small surplus now estimated at $15 million.

Total revenues were $52 million (1.0%) above budget. Own-source revenues were $197 million (6.0%) above budget. But excluding the $152 million prior period adjustment, own-source revenues were still $45 million (1.4%) above budget, despite substantially weaker than expected economic growth in 2003. The government now estimates 2003 real GDP growth at only 0.4% compared to the 2.9% rate projected in last year’s budget. (High natural gas prices had little effect on revenues as the province will not collect significant royalties from Sable Island for several years.) Federal transfers were $145 million (7.3%) below budget as the province was hit with downward revisions to equalization transfers that affected most provinces.

Total spending was $30 million over budget, with program spending $61 million over (and would have been $86 million over budget it not for the change in accounting policy mentioned above). About $57 million of the spending overrun occurred in the Department of Health, and about $20 million was due to last spring’s flooding, last winter’s severe snow storms, and Hurricane Juan. Debt service costs were $26 million under budget, thanks to continued low interest rates and the strong Canadian dollar.

Tax cuts rolled back in 2004-05

A surplus of $2 million is projected for 2004-05. In order to maintain a balanced budget, the government was forced to implement a number of tax measures, including rolling back part of the 10% PIT cut.

On January 1, 2004, a PIT cut was implemented. The lower rate (on incomes up to about $30,000) was reduced from 9.77% to 8.79%, the middle rate (on incomes between about $30,000 and $60,000) was reduced from 14.95% to 13.58%, and the upper rate (on incomes above about $60,000) was reduced from 16.67% to 15.17%. Mr. Christie announced yesterday that only the lower rate cut will be maintained. The middle and upper rate cuts will be cancelled, retroactive to January 1, 2004. In addition, a new tax bracket will be introduced on incomes above $93,000 with a rate of 17.5%. Nova Scotia levies a 10% surtax on provincial income tax in excess of $10,000. With the surtax and the introduction of the new tax bracket, Nova Scotia’s top marginal tax rate jumps from 16.69% to 19.25%. Previously, Nova Scotia had the fourth lowest top marginal tax rate in the country, but it will now have the second highest, after Newfoundland and Labrador (see the chart below).

Corporate capital taxes were also increased. The corporate capital tax on large corporations was increased from 0.25% to 0.3%, while the rate on financial institutions was increased from 3% to 4%, both effective April 1, 2004.

There were a few modest tax cuts. The income limit for the small business income tax rate, currently $250,000, will be increased to $300,000 in 2005 — previously it was scheduled to increase to only $275,000 in 2005 and then to $300,000 in 2006. Also, the province will match a number of initiatives in the recent federal budget that benefit caregivers, people with disabilities, employees taking career-related courses at their own expense, and military personnel serving on overseas missions.

In total, the personal and corporate tax changes are expected to add $118 million to revenues in 2004-05. However, there were two other revenue enhancing measures announced in the weeks prior to the budget. On March 17, tobacco taxes were increased $5.00 per carton of 200 cigarettes, raising $23 million per year. And, a number of government service fee increases came into effect on April 1, raising $12 million per year. In total, tax and fee increases will boost revenues by about $153 million — thus, more than recovering what would have been the full annual cost ($147 million) of the 10% PIT cut had it remained in place.

In total, revenues are budgeted to rise $222 million (4.2%). Own-source revenues are to rise $70 million (2.0%). Adjusting for the tax changes and one-time items, we estimate the underlying rate of increase for own-source revenues at 4.6%. This may be optimistic considering that the government forecasts real GDP growth in 2004 at only 2.0% (3.4% nominal). Our forecast for real GDP is somewhat more optimistic, at 2.7%. Federal transfers are to rise $152 million (8.3%).

Program spending is slated to rise $261 million (5.4%). Excluding the $20 million in 2003-04 disaster spending, the rate of increase rises to 5.9% — a fairly hefty rate of increase for a province with nominal GDP growth expected to be only 3.4%. Health receives an 8.0% increase, Community Services 5.1%, and Education (including universities) 1.2%.

Debt service costs are expected to rise $11 million (1.3%) due to slightly higher interest rates and debt levels. Despite surpluses, debt levels are increasing due to capital acquisitions.

Debt levels

Nova Scotia’s net debt (net financial liabilities) stood at $12.206 billion (45.0% of GDP) as of the end of 2002-03, and is estimated at $12.340 billion (44.1% of GDP) at the end of 2003-04. If the targets set out in yesterday’s budget are achieved, the debt will rise to $12.459 billion by the end of 2004-05, but the debt/GDP ratio will fall to 43.1%. Nova Scotia has the second highest debt/GDP ratio among the provinces, after Newfoundland and Labrador.

Nova Scotia received one credit rating upgrade since its last budget — from DBRS. Moody’s, Standard and Poor’s, and DBRS all rate the province at low-A.

Commentary

Having successfully balanced the budget, Nova Scotia appears to have abandoned its tax cutting plans in favour of maintaining and indeed enhancing government services. This is likely a consequence of the consensus approach required of a minority government.

Prince Edward Island

Taxes were increased and spending cut in Prince Edward Island’s 2004 budget, presented on March 30. The province is attempting to reduce an $85 million deficit in 2003-04 to $33 million in 2004-05.

Deficit balloons in 2003-04

PEI’s 2003-04 deficit is now projected to be almost eight times as large as was budgeted last year: $85 million vs. $11 million.

Total revenues were $27 million under budget, mainly due to federal transfers. Own-source revenues were $8 million (1.4%) under budget, mainly due to lower-than-expected tax collections. Tax collections were lower than expected despite the economy performing slightly better — at least according to the government’s estimates. Real GDP growth for 2003 was projected in last year’s budget at 2.0%, but the government’s latest estimate is 2.1%. However, we estimate that PEI’s real GDP growth in 2003 was only 1.6%. Federal transfers were $24 million (5.8%) below budget as the province was hit by the downward equalization adjustments that affected all of the equalization-receiving provinces. Other revenue was $5 million above budget.

Total spending was $53 million (5.0%) over budget. Program spending was where the budget really got blown off course — $51 million (5.6%) over budget. Spending overruns were mainly in the Department of Agriculture, Fisheries, Aquaculture and Forestry, the Department of Health, and in General Government. Debt service costs were $2 million (2%) below budget thanks to continued low interest rates. Capital expenditures were $8 million (22%) above budget. And, the balance of crown entities was $4 million better than expected — a $2.9 million surplus (which appears in the table below as a -$2.9 million deficit), compared to a budgeted deficit of $1.1 million.

Tax hikes, spending cuts to reduce 2004-05 deficit

For 2004-05, the deficit is projected to fall to $33 million. The government plans to achieve this through a mix of tax increases and spending cuts.

Spending is budgeted to fall $40 million (3.6%). Program spending will be cut $29 million (3%), with the Department of Health and Social Services receiving a 1.7% increase, the Department of Education a 0.2% increase, and most other departments forced to take cuts. Notably, $9.5 million of the $29 million cut in program spending is to come from a program review, which is a way of saying that those savings have not yet been identified. Capital spending is to fall $16 million (38%). Debt service costs are projected to rise $3 million, while the surplus of crown entities is estimated to fall $2 million.

A $31 million (3.8%) increase in total revenue is expected. Own-source revenues will be boosted by a number of tax measures. The gasoline tax was increased by 3¢ per litre, the tobacco tax by $5.00 per carton of 200 cigarettes, the capital tax on financial corporations will rise from 3% to 5%, and fees will be increased for a number of government services. These measures are expected to raise $12 million per year. Including these measures, own-source revenues are budgeted to rise $23 million (3.9%) in fiscal 2004-05.

Prince Edward Island Fiscal Summary

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The own-source revenue estimates are based on forecast real GDP growth in 2004 of 1.2%. The government attributes the slowdown in growth to poor markets in the agricultural sector and reduced government spending. Our own forecast is for real GDP growth of 2.9%. However, our forecast was prepared before this budget was presented. The $45 million budgeted drop in program and capital spending represents 1.2% of GDP, which accounts for most of the difference between our forecast of 2.9% and the government’s forecast of 1.2%.

Federal transfers are expected to rise $11 million (2.9%) in fiscal 2004-05, while other revenues are slated to fall $3.6 million.

Debt levels

PEI’s net debt (net financial liabilities) stood at $1.166 billion (31.1% of GDP) as of the end of 2002-03. The large deficit in 2003-04 will push the net debt up to $1.27 billion (32.9% of GDP) as of the end of 2003-04. Clearly, this large a deficit is not sustainable, as it pushed the net debt/GDP ratio higher. The smaller deficit in 2004-05, if achieved, should result in an increase in the net debt to $1.303 billion, but a slight drop in the net debt/GDP ratio to 32.7%.

Commentary

Many provinces would be happy with an $85 million deficit — Ontario’s deficit, for example, is projected to be $5.6 billion in 2003-04. As a percentage of GDP, however, PEI’s 2003-04 deficit (at 2.2%) is twice as large as Ontario’s. Although PEI’s 2003-04 deficit/GDP ratio is nowhere near as large as Newfoundland’s (5.3%), it is still cause for concern. In our Commentary on last year’s budget, we noted that PEI had a tradition of running small but manageable deficits. (Deficits of up to 1% of GDP can be considered small and manageable.) However, that was before the 2002-03 deficit came in a 1.7% of GDP, and the 2003-04 deficit was estimated at 2.2%. Clearly, the province needs to take action to keep its debt levels reasonable. Whether or not its debt levels can be kept manageable depends on how well the province controls its program spending.

Newfoundland & Labrador

Newfoundland and Labrador’s 2004 budget, presented on March 30, implemented a plan to reign in the province’s burgeoning deficit, including cutting about 4,000 civil services positions over the next four years.

This was the first budget under the new Conservative government elected last fall. Following the election, the new government engaged PricewaterhouseCoopers to conduct a review of the province’s finances. The PwC report projected deficits of $1 billion and rising in each of the next four years.

2003-04 results

Newfoundland Fiscal Summary

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The deficit for 2003-04 is now estimated at $959 million vs. the budgeted amount of $666 million. The balance on the current and capital accounts, the province’s main operating funds, was actually $63 million better than expected. However, consolidation and accrual adjustments drove the deficit higher. Agencies outside the two main operating funds required a cash injection of $183 million more than budgeted, while accrual adjustments (mainly pension and other retirement benefit accruals) were $173 million over budget. The $959 million deficit represents 5.3% of GDP, which would make it one of the largest provincial deficits in Canadian history. (Alberta’s and Saskatchewan’s deficits in the mid-1980s were larger.)

2004-05 budget

For 2004-05, the deficit is budgeted to fall to $840 million. Total revenues are expected to fall in 2004-05, largely reflecting a notable drop in federal transfers. However, own-source revenues are slated to increase moderately (3.3%). The revenue projections are based on a forecast of 1.3% real GDP growth in 2004 (-0.9% nominal) after a 4.7% gain in 2003 (10.2% nominal). [This assumption of real GDP growth in 2004 is moderately lower than our forecast of 2.5%]. The government’s assumption that real GDP growth rate will slow is due in large part to an expected 2.9% decline in offshore oil production after a 17.9% increase in 2003. The even larger drop in the nominal growth rate is partly due to an expected decline in oil prices.

The province announced two tax measures which roughly offset each other in terms of their overall revenue impact. First, in 2005, the province will implement a low-income personal income tax reduction program costing $5 million per year. Under this program, individuals with incomes up to $12,000, and families with incomes up to $19,000, will pay no income tax. Second, tobacco taxes and vehicle registration fees were increased, raising $7 million.

Federal transfers are projected to drop significantly (15.2%) due to a decline in equalization payments from the federal government. Equalization payments are based on the average fiscal capacity of five standard provinces: British Columbia, Saskatchewan, Manitoba, Ontario and Quebec. The larger the gap between a province’s fiscal capacity and the average of the five standard provinces (especially Ontario, which makes up about half the average), the larger that province’s equalization payments. The poor performance of the Ontario economy recently has resulted in lower equalization payments for most provinces.

Program spending is budgeted to rise only 0.8%. The government implemented a public wage freeze in January. With this budget, the government announced that 4,000 of the 32,000 civil service jobs will be cut over the next four years. (On April 1, several of the province’s public service unions went on strike to protest the wage restraint and the layoffs.) A number of capital projects were cancelled. The number of health boards and school boards will be reduced.

The deficit on the current and capital accounts is actually budgeted to increase, from $150 million to $325 million. The overall deficit reduction is expected to come from reduced borrowings of agencies outside the two main operating funds, and from reduced accrual adjustments. Since less information is provided on these amounts (borrowings of outside agencies, accrual adjustments), it is difficult to comment on whether these budgeted figures are reasonable.

Debt levels

Newfoundland’s debt levels are the highest in Canada. By our preferred measure of debt — net financial liabilities as a percentage of GDP — Newfoundland’s debt stood at 58.0% at the end of 2002-03. We estimate that it fell slightly to 57.9% at the end of 2003-04. Despite a lower expected deficit in 2004-05, we project that the debt will rise to 63.1% of GDP by the end of 2004-05, because of the expected decline in nominal GDP in 2004.

Commentary

The government’s four-year deficit reduction plan calls for the cash deficit ($407 million in 2003-04) to be reduced to $362 million in 2004-05, $320 million in 2005-06, $250 million in 2006-07, and zero in 2007-08. Notably, most of the reduction is to come in the final year of the plan. Even then, the province will be left with a total deficit in the $400 – $500 million range.

We noted in our Commentary on Newfoundland’s budget last year that the deficit had reached the point where drastic action was required. The new government has now started to take action, although it is facing a huge challenge.

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|Newfoundland & Labrador at a Glance |

|GDP, 2003 ($b) |18.0 |

|Population, 2001 (millions) |0.520 |

|Avg. Employ. growth, 3-yr. to 2003 (%) |2.0 |

| | |

|Net Debt/GDP (%), Mar. 31/04 est. |57.9 |

|Debt Rating (DBRS) |BBB |

| | |

|Sectoral Shares in 2003 (%) | |

|Natural Resources |23.8 |

|Manufacturing |6.1 |

|Construction/Transport |8.0 |

|Telecom/Information/Utilities |7.3 |

|Wholesale/Retail Trade |9.3 |

|Finance/Real Estate |15.2 |

|Education/Health |13.9 |

|Recreation/Hospitality |2.2 |

|Business Services |3.4 |

|Personal Services |2.0 |

|Public Administration |8.9 |

|Prince Edward Island at a Glance |

|GDP, 2003 ($b) |3.9 |

|Population, 2003 (millions) |0.138 |

|Avg. Employ. growth, 3-yr. to 2003 (%) |2.1 |

| | |

|Net Debt/GDP (%), Mar. 31/04 est. |32.9 |

|Debt Rating (DBRS) |A low |

| | |

|Sectoral Shares in 2003 (%) | |

|Natural Resources |6.8 |

|Manufacturing |13.2 |

|Construction/Transport |7.5 |

|Telecom/Information/Utilities |5.0 |

|Wholesale/Retail Trade |10.5 |

|Finance/Real Estate |19.4 |

|Education/Health |13.8 |

|Recreation/Hospitality |4.2 |

|Business Services |3.4 |

|Personal Services |2.6 |

|Public Administration |13.5 |

|Nova Scotia at a Glance |

|GDP, 2003 ($b) |28.8 |

|Population, 2003 (millions) |0.936 |

|Avg. Employ. growth, 3-yr. to 2003 (%) |1.3 |

| | |

|Net Debt/GDP (%), Mar. 31/04 est. |44.1 |

|Debt Rating (DBRS) |A Low |

| | |

|Sectoral Shares in 2003 (%) | |

|Natural Resources |5.3 |

|Manufacturing |11.0 |

|Construction/Transport |10.3 |

|Telecom/Information/Utilities |6.9 |

|Wholesale/Retail Trade |11.4 |

|Finance/Real Estate |21.4 |

|Education/Health |13.0 |

|Recreation/Hospitality |3.4 |

|Business Services |4.8 |

|Personal Services |2.3 |

|Public Administration |10.2 |

|New Brunswick at a Glance |

|GDP, 2003 ($b) |22.4 |

|Population, 2003 (millions) |0.750 |

|Avg. Employ. growth, 3-yr. to 2003 (%) |1.0 |

| | |

|Net Debt/GDP (%), Mar. 31/04 est. |31.0 |

|Debt Rating (DBRS) |A |

| | |

|Sectoral Shares in 2003 (%) | |

|Natural Resources |5.9 |

|Manufacturing |15.7 |

|Construction/Transport |11.1 |

|Telecom/Information/Utilities |7.1 |

|Wholesale/Retail Trade |11.0 |

|Finance/Real Estate |17.6 |

|Education/Health |11.8 |

|Recreation/Hospitality |2.8 |

|Business Services |4.7 |

|Personal Services |2.4 |

|Public Administration |9.8 |

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