Moody's threat to downgrade Ontario's debt rating will likely spur the Canadian province to take bolder moves to rein in its C$16 billion ($15.4 billion) deficit.
Analysts said the credit rating agency's move, similar to the downgrade threats facing many euro zone nations, will give Ontario's minority Liberal government cover to implement unpopular moves like deeper spending cuts or tax increases.
It's not easy for a government to take on a prolonged period of austerity and I think this will serve to awaken the public to the move on this all-difficult challenge, along with other rating agencies that have already spoken, said Derek Burleton, deputy chief economist at Toronto-Dominion Bank.
Moody's lowered its outlook on Ontario's debt rating to negative to reflect the province's growing debt burden as growth in the region slows down.
The move follows earlier ratings downgrades by Standard & Poor's and DBRS in the fall of 2009, after the province announced a record deficit in the wake of the global economic downturn, and a similar outlook downgrade by Fitch this past May.
The Moody's news only slightly hit Ontario government bond prices, with the 10-year bond yield 92 basis points above its Canadian government counterpart, up from 90 basis points on Thursday. The spread was just 60 basis points in February.
Burleton noted that Moody's was one of the last ratings agencies to respond to Ontario's fiscal challenges, which limited the market impact.
Unlike governments in other jurisdictions, Ontario's Liberals have said they will not introduce sweeping austerity measures. Returned to power with a minority this fall, they pledged to go ahead with increased - albeit curbed - spending in healthcare and education, as well as an ambitious green energy program and promised tax cuts.
Canada's most populous province hired former Toronto-Dominion Bank chief economist Don Drummond to examine where spending could be cut, with those recommendations due in January, in time to evaluate them for the spring budget.
They will have to announce tougher measures in the next budget, said Eric Beauchemin, managing director of public finance at ratings agency DBRS, a rival of Moody's.
It will involve definitely more negotiation to have some tough measures implemented ... they need to build consensus.
Nelson Wiseman, a politics professor at the University of Toronto, said the Moody's report lends support to difficult budget decisions in a minority government environment, despite his view that credit rating agencies having lost credibility since the global financial collapse.
This gives ammunition to the finance minister (Dwight Duncan) in terms of dealing with his caucus and in terms of shaping the budget, Wiseman said.
Politically, there just isn't any appetite in the province for an election and the opposition parties are not going to bring down the government unless the polls go so badly against the Liberals that they feel their own partisans will hold it against them for propping them up.
Ontario, which was hit harder than other Canadian provinces by the 2008 recession, was also the only one downgraded by DBRS during the slowdown. The province's long-term credit rating is investment-grade AA low at DBRS and AA- at S&P, all between one and three notches below the top rating that the federal government enjoys.
The Aa1 rating by Moody's on the province is still higher than those of S&P and DBRS, and affects approximately C$190 billion in securities issued by Ontario, which issues the most debt of any province.
It's positive that officials will get a sense that they have to address the situation, said Hosen Marjaee, senior managing director at Manulife Asset Management, whose fixed income team is underweight Ontario bonds. It's going to be difficult to meet the deficit target. It's possible that they will not.