SASKATCHEWAN 2016 BUDGET Economics and Strategy May 31, 2016

Resource revenue MIA, but surplus still pledged for 2017-18 Highlights 

Saskatchewan’s fiscal performance has deteriorated, owing to a weaker commodity price backdrop that has robbed the province of significant resource revenue and left the economy on its back foot. The province estimates it ran a $427 million deficit in 2015-16 (0.6% of GDP). That’s a notable shift from the $107 million surplus that had been planned for a year ago.

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With oil and potash royalties falling and weakness in other resource revenue sources, a larger budget shortfall has also been identified for the current 2016-17 fiscal year. The deficit is now seen at $434 million (0.6% of GDP), compared to a $259 million shortfall flagged earlier this year. The budget shortfall is proportionately much smaller than that being run in the other oil-producing provinces or at the federal level of government.

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The budget reiterated a commitment to return to surplus by 2017-18. Getting there will require just over 3% revenue growth and no increase in total spending compared to 2016-17 levels. Following behind 2017-18’s modest $6 million surplus are two additional years in the black: a $55 million surplus for 2018-19 and a $97 million surplus for 2019-20.

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There were no new taxes or tax increases, and the government has sworn off severe spending cuts. That leaves the focus on “transformation change” as a means of putting its budget on a sounder footing. There are no formal contingencies set aside for this or next year, although you will find contingencies of $50 million and $75 million embedded in the forecasts for 2018-19 and 2019-20 respectively.

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The budget sees real GDP contracting again in 2016, but this real growth forecast (-0.6%) has been set below consensus. A recovery is anticipated for 2017, where GDP is seen growing by 2.5% in real terms and nearer to 7% nominally.

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The budget assumes that WTI will average just under US$45/bbl in fiscal 2016-17, rising to ~$53 in 2017-18, en route to $70+ in 2019-20. For 2016-17, a somewhat narrower differential and cheaper C$ are expected to help, but oil production is set to move lower. As for potash, the realized price is slated to fall more than 20% in US$ terms this fiscal year, although sales volumes are expected to recover.

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The province’s infrastructure/capital plan, alongside borrowing by/on behalf of Crowns, has pushed public debt higher. The corresponding debt-to-GDP ratio has risen from less than 11% in 2011-12 to just under 20% this fiscal year. The debt burden is still low by provincial standards and declines in the public debt burden are projected for 2017-18 and beyond. The government sets aside at 2% of the value of capital plan borrowings per year, in order to meet future retirement obligations.

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Infrastructure/Crown needs account for the bulk of the province’s gross borrowing requirement, which for 2016-17, has been set a bit above $2 billion. That’s actually a bit lower than the gross funding carried out in 2015-16.

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As we saw last year, the C$ public bond market should remain the primary funding source in 2016-17: $1.7 billion of domestic bonds have been flagged, or $250 million below the level issued last year. Saskatchewan’s prom-note program is likely to increase by more than $250 million, building on a ~$320 million increase in the prior year.

SASKATCHEWAN • 2016 BUDGET It’s a common enough refrain, one often emanating from new governments rising to power: the numbers are worse than we were led to believe. Most recently, this message was heard after votes in Manitoba and Newfoundland & Labrador. But political continuity doesn’t preclude fiscal deterioration, particularly when your local economy is levered (directly and indirectly) to a fragile global economy and volatile commodity prices. So a few weeks after having been handed another decisive majority mandate, Brad Wall’s government has acknowledged that wilting resource revenues are crimping Saskatchewan’s fiscal outlook. Although really, compared to many of its provincial peers, Saskatchewan’s fiscal standing (most notably its light debt burden) remains fairly enviable.

What’s changed, and by how much? Let’s start with 2015-16. In last year’s budget, Saskatchewan planned for a summary surplus of $107 million. That had morphed into a $262 million deficit at mid-year, reflecting fallout from lower-than-planned commodity prices. A Q3 update, issued prior to April’s provincial election, added some extra red ink, bringing the deficit for 2015-16 up to $427 million. That deficit figure was reiterated in the Saskatchewan Party’s election platform and repeated once more in today’s 2016 budget. And the drag from weaker-than-expected resource revenue now echoes louder in fiscal 2016-17. The current year’s budget deficit has been pegged at $434 million. That’s a $175 million deterioration relative to the $259 million shortfall most recently telegraphed and is clearly much further removed from the $121 million surplus figure set down in last year’s fiscal blueprint.

Measuring the resource hit As previewed in the lead up to the budget, there’s been a nearly one billion dollar drop in the non-renewable resource revenue outlook. That’s the gap between today’s forecast for 2016-17 and what had originally been planned for 2015-16. The true year-on-year decline in resource revenue will be more like $350 million or down some 19%. The royalty outlook for both oil and potash has softened notably, as has expected returns from the resource surcharge, proceeds from crown land sales and other resource revenues (which includes uranium, coal and other minerals). As a result, resource revenue is expected to account for a notably smaller share of total revenue: down from 18.6% in 2014-15 to 10.6% this fiscal year. Looked at another way, resource revenue would be equivalent to 2.0% of GDP in 2016-17, the lowest ratio in a quarter century. For reference, the budget assumes that WTI will average US$44.9/bbl in 2016-17, little changed compared to the average level for fiscal 2015-16 (although crude was on somewhat of a rollercoaster over the course of those 12

months). A slight improvement/narrowing in the light-heavy differential is anticipated, while a modestly cheaper C$ (yearover-year) could also help when translating US$ proceeds back into loonies. Oil production is expected to once again move lower, reflecting in part a drop-off in drilling activity. While still a very attractive jurisdiction for mining investment, a weaker profile for oil investment and production helps to explain the second straight contraction in real GDP that has been forecast for 2016. Some additional colour on the economic outlook will follow. As for potash, the budget is based on an average price of US$207/KCl tonne—more than 20% below 2015-16. Cushioning the blow somewhat, potash sales volumes are seen rising nearly 5% year-on-year. Overall, the province terms its commodity price assumptions “prudent”. Official sensitivity analysis suggests that each US$1/bbl increase in WTI would add $18 million to oil royalties, while a US$10/KCl tonne swing on realized potash prices would be worth just over $60 million in related royalties. As economists are fond of saying, that assumes “all else is equal”. However, as noted above, the exchange rate can materially blunt/counteract a surprise move in commodity prices. To wit, each one cent drop in the loonie adds $30 million to resource revenue for a given WTI price/differential.

Partial revenue offsets While there are no new taxes or tax increases, resource revenue weakness is being partly offset by gains in certain own-source revenue sources. Personal income tax revenue is slated for better than 5% growth (credit a “prior-year reconciliation adjustment”). Net proceeds from agricultural land sales are expected to step up smartly to $165 million, as the province reduces its ownership of farmland. Meanwhile, another solid year of net income at government business enterprises is also foreseen (even if it’s technically down vs the prior year). Finally, federal transfers are due to jump noticeably, buoyed by compensation linked to the transfer of federal dams to the province and also from extra federal P3 funding for the Regina Bypass project. (Federal health/social transfers will also continue to grow, as per the current legislated formulas.) In much the same way the government has sworn off tax increases, Saskatchewan won’t be pursuing severe spending cuts. On a budget-over-budget basis, total spending is expected to climb 2.0% in 2016-17. The province aims to hold the growth in the health care budget to an even slower 1.5%, although that would still leave health care comprising roughly 40% of the total spending envelop, with education a distant second at ~25% of total expenses.

Some context and a look ahead It remains to be seen how rating agencies will react to this updated deficit outlook for 2016-17. We’d note that S&P

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SASKATCHEWAN • 2016 BUDGET placed the province’s ‘AAA’ long-term rating on negative outlook back in October 2015, on “expectations that Saskatchewan’s budgetary performance could weaken in the next two years as a result of the deterioration in oil prices.” For S&P, returning the outlook to “stable” would in part require the budgetary performance to first stabilize, then improve, taking the operating surplus >5% of operating revenues. At this point, Moody’s also rates Saskatchewan ‘Aaa’ (in this case with a stable outlook), whereas DBRS has assigned the province an ‘AA’ rating (also currently stable). While rating agency verdicts bear watching, it’s useful to put the budget shortfall into a broader context. Without trivializing a $434 million deficit or the erosion relative to earlier projections, Saskatchewan’s budget shortfall, equivalent to 0.6% of GDP, remains fairly modest. The province deems it “manageable”, and we’re inclined to agree. If you fancy relative comparisons, Saskatchewan’s shortfall is a fraction of the red ink being run in two other oil-levered provinces (Alberta and Newfoundland and Labrador) and is also proportionately smaller than the deficits in Manitoba, New Brunswick or at the federal level for that matter. Moreover, Saskatchewan has a stated commitment to return to balance sooner than many. Although there’s work to be done, the budget repeated an earlier pledge to erase the deficit by 2017-18 (i.e., by next fiscal year). While details are somewhat limited, 2017-18’s modest $6 million surplus is the resulting by-product of 3.1% headline revenue growth and a perfectly flat spending profile (i.e., no change in spending year-on-year). In other words, getting back to balance requires an improving economy and some substantial restraint on the spending side. As the budget concedes, there are difficult decisions to be made. When it comes to the economy, a second consecutive decline in real GDP in 2016 (down 0.6% after 2015’s 1.4% contraction) is set to give way to a 2.5% expansion in 2017. Nominal output has understandably swung much more wildly, and after a couple of tough years is seen rebounding by 6.8% in 2017. That’s the result of strengthening real growth and further gains in key commodity prices, as WTI is expected to average US$53/bbl in 2017-18, en route to US$70 come 2019-20. When you look at the out-years of the fiscal plan then, you’ll see modest surpluses projected for 2018-19 ($55 million) and 2019-20 ($97 million). Unlike 2017-18, these out-year forecasts do allow for (admittedly modest) spending growth, averaging 1.7%/year, and also incorporate contingencies of $50 million and 75 million respectively. Note that there are no such contingencies set aside for this fiscal year or next. In general, restoring fiscal balance appears to rest on a looming “transformational change” in how Saskatchewan operates. Consider this the new hallmark of a recently reelected government. Through this new lens, Saskatchewan

will explore what programs/services the government should really be delivering, will seek opportunities to combine/amalgamate similar programs/bodies (e.g., regional health authorities) and will also seek administrative savings through different governance models. Transformation change is meant to extend to the revenue side of the equation as well, but retaining a competitive tax system is a stated priority.

Debt burden provides fiscal flexibility While relatively small as a percent of GDP, Saskatchewan’s budget deficits (in 2015-16 and 2016-17) are made perhaps even more manageable by the fact that the province’s core government debt burden is relatively light. True, the level of public debt has climbed in recent years, rising from $8.5 billion as recently as 2011-12 to $13.5 billion for the fiscal year that just ended. A further increase to $14.8 billion is planned for 2016-17, bringing the corresponding public debt-to-GDP ratio up to 19.9% vs last year’s 17.6%. That’s a snick below the level observed back in 2008. Going forward, smaller planned increases in the public debt, combined with a recovery in nominal GDP growth, would be expected to put this debt ratio on a downward trajectory. Saskatchewan continues to draw a notable distinction between its different types of public debt. For instance, debt traced back to the operation of the General Revenue Fund has been broadly unchanged since 2010—and is projected to be similarly unmoved in future years. True, there’s growing debt tied to the Saskatchewan Builds Capital Plan, which is focused on high priority infrastructure investments. Consider this a “borrow to build” strategy which has been endorsed in other provinces and at the federal level. But really, the majority of Saskatchewan’s public debt reflects amounts borrowed by or on behalf of government business enterprises, obligations that are fully expected to be repaid from cash flows generated by each given enterprise. Overall then, the debt burden can be deemed low (second only to Alberta), with the interest bite very manageable, contingent liabilities fairly limited, liquidity very healthy and budget flexibility/taxing room available (should it ultimately be required). These are all plusses when it comes to supporting the credit rating, to say nothing of the favourable “institutional framework” that Saskatchewan, like all provinces, operates within.

On borrowing Consider the impact the province’s Saskatchewan Builds Capital Plan and Crown requirements on the borrowing program. Last year, in 2015-16, the government’s infrastructure plan and Crown needs jointly accounted for over $1.5 billion (or roughly 70%) of the province’s $2.3 billion gross funding requirement. The bulk of that funding, nearly $2 billion, ended up being sourced from the domestic bond

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SASKATCHEWAN • 2016 BUDGET market, although a larger prom-note program did pick up some slack. Notwithstanding a similarly scaled budget deficit, gross funding needs are set to ease to just over $2 billion in 201617. Once again, requirements for the capital plan (up to $1 billion) and for Crowns ($745 million for SaskPower, SaskTel and SaskEnergy) make up the lion’s share of this year’s gross funding needs.

For 2016-17, Saskatchewan is telegraphing a smaller gross bond program compared to the prior year—$1.7 billion to be precise. The province also aims to increase its promissory note program by a further $256 million (on top of the $320 million increase carried out in 2015-16). In general, expect the domestic market to serve as Saskatchewan’s primary source of funding.

Warren Lovely & Marc Pinsonneault

Saskatchewan Budget 2015-16

$000 000

Forecast 2015-16

Budget 2015-16

2017-18

Plan 2018-19

2019-20

14,023.9 6,860.9 1,484.9 1,084.4 2,088.9 2,504.8

14,464.0

14,780.0

15,141.0

14,458.1 14,160.9 5,588.1 3,688.4 4,884.4 297.2 (434.2)

14,458.0

14,675.0

14,968.0

6.0

50.0 55.0

75.0 97.0

Consolidated Budget Total revenues Taxes Non-renewable resources Net income from Government Business Enterprises Other revenue Transfers from the Government of Canada

14,288.0 6,791.4 2,453.2 904.9 1,908.3 2,230.2

13,867.9 6,703.7 1,836.4 1,139.3 1,959.9 2,228.6

Total spending

14,181.2 14,295.1 13,876.1 14,004.2 5,507.0 5,587.0 3,661.0 3,619.3 4,708.1 4,797.9 305.1 290.9 Surplus (deficit) * 106.8 (427.2) * Before adjustment to account for pension costs on an accrual basis (see net debt) Program expenditure As of Health As of Education AS of Other Debt servicing Contingency

Public debt (end of year - net of sinking funds) General Revenue Fund and Gov. Service organizations Government Business Enterprises Total: Public Debt As a % of GDP

5,101.4 8,081.2 13,182.6 16.7%

5,433.9 8,114.2 13,548.1 17.6%

6,389.7 8,383.2 14,772.9 19.9%

6,400.0 8,700.0 15,100.0 19.0%

6,200.0 9,200.0 15,400.0 18.3%

6,200.0 9,700.0 15,900.0 18.0%

Beginning of year Summary surplus Acquisition of Government Service Organization Capital Assets Amorization, disposal and adjustments Adjustment to account for pension costs on an accrual basis End of year

5,551.9 (106.8) 1,449.2 (550.7) 820.8 7,164.4

5,551.9 427.2 1,390.0 (553.5) 834.1 7,649.7

7,649.7 434.2 1,789.0 (609.4) (130.1) 9,133.4

9,133.4 (6.0)

(55.0)

(97.0)

Borrowing requirements

2,073.4 933.4 440.0 700.0

2,285.2 845.2 740.0 700.0

2,045.1 745.1 300.0 1,000.0

7,077.1 820.8 7,897.9

7,077.1 834.1 7,911.2

7,911.2 (130.1) 7,781.1

Net Debt

For Crown Corporations For Government - operating For Government - Capital Plan

Pension liabilities Beginning of year Adjustment to account for pension costs on an accrual basis End of year Source: Budget documents, Saskatchewan Ministry of Finance.

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SASKATCHEWAN • 2016 BUDGET ECONOMICS AND STRATEGY Montreal Office 514-879-2529

Toronto Office 416-869-8598

Stéfane Marion

Marc Pinsonneault

Warren Lovely

Chief Economist & Strategist

Senior Economist

MD, Public Sector Research and Strategy

[email protected]

[email protected]

[email protected]

Paul-André Pinsonnault

Matthieu Arseneau

Senior Fixed Income Economist

Senior Economist

[email protected]

[email protected]

Krishen Rangasamy

Angelo Katsoras

Senior Economist

Geopolitical Associate Analyst

[email protected]

[email protected]

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