Walter Schroeder is the founder of the Schroeder Policy Group. Mr. Schroeder is founder of DBRS and has 40 years of experience examining debt and provincial finances. Bob Hallett is on the Advisory Board to the Schroeder Policy group and has had an accomplished career as a writer, musician and producer.
Newfoundland and Labrador needs Ottawa’s help, and very soon, or it will be subjected to insolvency when the level of its fiscal problems becomes known – and that day is getting closer.
Today, the net direct debt carried by Newfoundland is $13.8-billion. Newfoundland’s entire gross domestic product (GDP) is only $35.2-billion. This means the province’s debt is a hefty 39 per cent of total GDP.
Newfoundland’s long-term prospects are much less favourable than any other province. Its economy is not strong enough to support this level of debt, and it is already borrowing a billion dollars a year just to pay the interest. Newfoundland is borrowing money to pay the interest on existing loans, which is the financial equivalent of taking out new credit cards to cover the interest on the old ones.
Even without the coming write-down of the Muskrat Falls investment, Newfoundland’s debt load is formidable. Unfortunately, Muskrat Falls puts Newfoundland over the top, adding $9.4-billion to its debt.
The province has discussed various plans to contain electricity rates, but they all depend on government revenue that does not exist. Right now, the only option being seriously considered is for the province to raise taxes. As far as the financial analysts are concerned, the Muskrat Falls debts will become dependent on tax revenue, and would raise the province’s total debt to $27.4-billion, or a terrifying 83 per cent of GDP.
That is two-to-three times the debt load of a typical Canadian province. Plus, a tax hike of this magnitude would be almost impossible to justify politically.
The second alternative for Newfoundland is to just raise electricity rates to a point where it can cover the costs of Muskrat Falls. To do this would require electricity rates to double to 24 cents a kilowatt-hour (kWh) versus a current 12 cents per kWh. This would be devastating to the Newfoundland economy.
Currently, 50 per cent of electricity in the province is used for heating, and most people cannot afford to pay twice as much for this essential service. Their alternative is to reduce heat, something almost impossible with the province’s extreme weather conditions. Additionally, about 35 per cent of electricity is currently used by industrial users – forcing them to raise prices, causing further strain on the province’s economy.
Newfoundland cannot solve this problem by itself. The solution to this is immediate action by Ottawa to help Newfoundland by using the “dignified” alternative. This involves giving Newfoundland $1.4-billion annually until the year 2041, when the Churchill Falls deal expires. After, the province can take over and repay the principal and interest on all its outstanding debt from Churchill Falls profits.
Alternatively, there is the “nuclear” option: Newfoundland voluntarily defaults on all interest owing on the $8-billion in debt issued through the Muskrat Falls/Labrador Transmission Assets Funding Trust and Labrador-Island Link Funding Trust. The principal and interest on this are unconditionally guaranteed by the federal government, who will have five days (by covenants in the trust) to make good on the interest.
It is true that Newfoundland is obligated to repay Ottawa, but it is clear that it does not have the capacity to do so. The federal government cannot take administrative control over the province, and the consequences would be minimal.
Regardless, crunch time is coming for Newfoundland, with an ongoing structural deficit of $1-billion to fund, $500-million in capital expenditure to finance, and a record $930-million in provincial direct debt maturing.
There is no way Newfoundland will be able to finance this, and the world’s bankers will not allow the province to maintain this fiscal fantasy. This has happened before – in 1993, Saskatchewan came to the very edge of insolvency. If the Conservative government of Brian Mulroney that year was able to give Saskatchewan $1-billion to avert insolvency, why can’t a Liberal government in Ottawa give $1.4-billion annually to a provincial Liberal government in Newfoundland, a province that consistently votes Liberal?
The day of reckoning is close at hand.
Correction: A previous version of this column said Newfoundland and Labrador’s net debt was $18 billion, with a debt-to-GDP ratio of 53%. The correct net debt figure is $13.8 billion, with a debt-to-GDP ratio of 39%.