Provincial Debt

The provincial government along with its Crown corporations and agencies provides services and capital infrastructure to support the social and economic programs needed for maintaining and enhancing the quality of life in British Columbia. Funding for these programs is mainly derived from government revenue. When revenues are not sufficient to offset the cost of its initiatives, government obtains financing from outside sources mainly through debt issuances that are to be repaid on future dates.

Borrowing for operations is required to finance deficits and to meet other working capital requirements such as loans and advances or changes in accounts receivable/payable. This type of debt (government direct operating debt) grows during periods of deficits, but declines with surpluses. There is not a dollar for dollar relationship between changes in direct operating debt and the surplus or deficit because of changes in other balance sheet items, such as cash balances, loan receivables and other accounts receivables/payables.

Borrowing for capital projects finances the building of schools, hospitals, roads and other social and economic assets. As these investments provide essential services over several years, the government, like the private sector, borrows to fund these projects and amortizes the costs over the assets' useful life.

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Provincial debt is reported using two basic classifications (see Chart 1):

• Taxpayer-supported debt includes government direct debt, which is incurred for operating and capital purposes, and the debt of those Crown corporations and agencies that require an operating or debt service subsidy from the provincial government or that are fully consolidated in the summary financial statements. The SUCH sector – school districts, universities, colleges and institutes, and health-care organizations – is also included in this category.
• Self-supported¹ debt mainly includes commercial Crown corporations and agencies that generate sufficient revenues to cover interest costs and make principal repayments, and may pay dividends to the province. As a result commercial Crown corporation debt is acquired primarily to finance capital projects.

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Chart 2 shows that debt levels have risen sharply over the past decade mainly to finance deficits and capital spending. Beginning in 2004/05 the government is now forecasting operating surpluses that can be used to offset borrowing requirements – however, absolute debt levels will rise to finance capital projects through March 31, 2008.

1	Also includes the warehouse program that is used to take advantage of borrowing opportunities in advance of requirements. These funds are invested at market rates until they are allocated to the province or its Crown corporations and agencies

Calculating provincial debt forecasts

Numerous factors are taken into consideration when calculating provincial debt forecasts including:

• Operating results on a cash basis – the operating statement forecast is adjusted to back out non-cash items included in the surplus, for example annual non-cash amortization expenses.
• Capital spending – Capital projects may be funded through surpluses, contributions from outside of the government reporting entity (eg federal government), working capital, public-private partnership agreements, or direct borrowing. Some public-private partnerships may result in a liability included in the debt forecast, although it is not a market borrowing. For direct borrowings, the debt forecast reflects the actual cash requirements to fund capital investment.
• Working capital and financing transactions – cash flows and thus debt forecasts are affected by other transactions that are not included in the operating statement. These include debt refinancing; loans and investments; borrowing in advance of requirements; and changes in accounts receivable/payable. Debt also includes debt guarantees (which are not borrowings and do not pay interest), such as third party loan guarantees provided by the Homeowner Protection Office, to more closely match the reporting definitions used by the rating agencies.
• Debt forecast allowance – total provincial debt includes a forecast allowance to mirror the operating statement forecast allowance.

Reconciliation of Surplus to Change in Debt

In general, the change in debt will not equal the surplus as debt is required to finance capital spending in excess of non-cash amortization costs included in the surplus, and due to other working capital sources/requirements which are changes in balance sheet items such as cash balances, loan receivables and other accounts receivables/payables and do not form part of the surplus.

Table 1 provides a reconciliation of the surplus versus the change in debt. In 2004/05, the forecast reduction in debt exceeds the forecast surplus mainly due to:

• other working capital sources including the early repayment of the BC Ferry Services loan receivable; and
• lower commercial crown corporation debt resulting from the pay-down of BC Rail debt;
• partially offset by the impact of capital spending in excess of amortization.

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In the updated fiscal plan, debt increases despite expected surpluses mainly due to the impacts of capital spending in excess of amortization, and higher commercial crown debt incurred for capital investments.

Debt remains affordable

With the surplus in 2004/05, and forecast surpluses over the next three years, government direct operating debt, the debt resulting from cumulative historical deficits, is forecast to decline by $1.5 billion and will steadily decline over the next three years resulting in a further cumulative reduction of $1.4 billion by 2007/08.

To meet the transportation, health and education infrastructure needs of a growing economy and replace and upgrade existing infrastructure in the health and education sectors, significant capital investments are planned over the coming years. These investments will result in additional debt, however they also fit within the overall government strategic objective of lowering the taxpayer-supported debt-to-GDP ratio each year. This ensures that the necessary investments are made in an affordable, sustainable manner. Chart 3 shows that the government direct operating debt, taxpayer-supported debt and total provincial debt-to-GDP ratios decline over the three-year plan and that the debt burden remains affordable.

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Bond rating agencies

Bond rating agencies provide independent and globally consistent opinions about the credit quality of individual debt instruments or of an issuer's general credit worthiness. The rating assigned to an entity measures the risk of default over the life of a debt issuance.

Each year, BC's financial outlook, fiscal policy and debt position is evaluated by three separate rating agencies – Moody's Investors Service, Standard and Poor's and Dominion Bond Rating Service. Each agency assigns a rating to the province following their evaluation. A credit rating affects the borrower's debt servicing costs and the investor's rate of return since an investor will demand a higher interest rate on a higher-risk, lower-rated security.

Table 2 shows the relative inter-provincial credit ratings. Since Budget 2004, Standard & Poor's upgraded BC's credit rating to AA from AA- and Moody's Investor Service and Dominion Bond Rating Service have improved the debt rating outlook to positive from stable recognizing the improved fiscal outlook, BC's record for meeting annual budget targets and the low taxpayer-supported debt burden relative to other provincial jurisdictions.

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Looking forward

Government intends to continue its focus on effective and affordable debt management through the following measures:

• use surpluses to continue paying down government direct operating debt;
• continued use of forecast allowances and the contingency vote to help ensure fiscal targets are met;
• review management of cash balances; and
• through on-going review and diligent management of capital spending, ensure the appropriate utilization of capital resources; and a sustainable relationship between operating and capital budgets.