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Canada Becomes First to Lose AAA Status at Fitch on Virus Woes

Esteban Duarte

(Bloomberg) -- Fitch Ratings stripped Canada of its AAA status amid a spike in emergency spending for Covid-19, making it the first top-rated country to be downgraded by the ratings agency during the pandemic.

The country is expected to run a bigger government deficit this year and emerge from the recession with much higher public debt ratios, Fitch said Wednesday. It cut the country’s rating one notch to AA+.

Canada still has a AAA rating with S&P Global Ratings, making it only one of two countries left in the Group of Seven to hold that status; Germany is the other. Moody’s Investors Service also gives Canada its highest rating.

“The question is what took so long. Canada’s excessively leveraged national balance sheet has looked a lot like China, Italy and Greece for quite a while,” said David Rosenberg, founder of Rosenberg Research and Associates and former chief North American economist at Merrill Lynch & Co. “This won’t be the last ratings cut, I can assure you.” He had predicted the downgrade in an April research note that said the “Great Canadian Debt Surge has come home to roost.”

Canada’s national government is on track to post its largest deficit on record in the 2020-2021 fiscal year. The shortfall may reach about 12% of gross domestic product compared with 1.1% last year, according to the Parliamentary Budget Officer.

“Canada continues to be in a stronger financial position than many other countries in the G-7 and G-20,” Finance Minister Bill Morneau said in a statement. “We will continue to be fiscally responsible while acting to protect our country and its economy.”

Fitch expects the coronavirus response to raise Canada’s consolidated gross general government debt to 115.1% of GDP in 2020, up from 88.3% last year. “The higher deficit is largely driven by public spending to counteract a sharp fall in output as parts of the economy were shuttered to contain the spread of the coronavirus,” the company said in the report.

Indifferent

The Canadian dollar briefly weakened to a session low, hitting C$1.36 per U.S. dollar, before rebounding.

Bank of Montreal’s Chief Executive Officer Darryl White shrugged off the news.

“The Government of Canada will still have a AAA credit rating by other agencies, I think one of only two G-7 countries that can say that, and there’s plenty of access to capital and the cost of capital relative to other countries and relative to history is very, very low,” he said in an interview on BNN Bloomberg.

Derek Holt concurs. “Markets don’t seem to care, rightly so in my view,” said the economist at Bank of Nova Scotia. “Every sovereign is under the same pressure. Ratings are a relative game and even at that there is a long list of more dominant market factors. It’s one agency that stripped Canada of some political bragging rights, but the tangible impact is scant to non-existent.”

For Bipan Rai, head of foreign exchange strategy at Canadian Imperial Bank of Commerce, things may get volatile for the loonie if another agency follows. “The question is who’s next to downgrade? If it’s Moody’s, then there is a risk of portfolio outflows,” he added, noting that Canada’s current account deficit is financed heavily by foreign fund inflows.

The North American economy is set to contract 7.1% in 2020 compared to 1.6% growth last year, according to median consensus of analysts compiled by Bloomberg. Canada’s government is rolling out a plan of more than C$230 billion ($169 billion) of subsidies, grants and tax deferrals in a bid to offset the impact of the pandemic.

Gradually improving global trade, commerce and domestic labor market conditions may allow Canada’s economy to grow 3.9% in 2021, according to Fitch projections. Nonetheless, Canada’s medium-term growth prospects “are limited by structural investment challenges and are below many developed markets peers,” the ratings company said.

Who’s Next?

“It will take Canada approximately 6-12 months longer to return to 2019 GDP levels than the U.S. or several other developed markets,” said Alexandra Gorewicz, portfolio manager and head of rates at CI Investment. “Fitch partly alluded to this structural issue in their release by highlighting that prior to the pandemic.”

The downgrade raises concerns that other top-rated countries such as Australia, which was put on negative outlook by Fitch, may follow suit. After today’s rating action, Fitch has kept its AAA rating for ten countries, of which the U.S. and Germany are part of the Group of Seven economies.

“Covid-19 impact on G-7 economies has been quite similar to each other while monetary and fiscal stimulus have also been quite similar and proportionate,” said Imran Chaudhry, a senior portfolio manager at Fiera Capital Corp. “It’ll be interesting to see what Fitch does for other sovereign names such as Australia, Germany and most importantly the U.S.”

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