Fitch Affirms Canada at 'AAA'; Outlook Stable

NEW YORK--()--Fitch Ratings has affirmed Canada's ratings as follows:

--Long-term foreign and local currency IDRs at 'AAA';

--Senior unsecured foreign- and local-currency bonds at 'AAA';

--Country ceiling at 'AAA';

--Short-term foreign-currency IDR at 'F1+'.

The Rating Outlook is Stable.

KEY RATING DRIVERS

Canada's 'AAA' rating draws support from its advanced, well diversified and high-income economy. Its political stability, strong governance and institutional strengths support the rating. Its overall policy framework remains strong and has delivered steady growth and low inflation.

A sharp fall in the price of oil since 2H14 has hit investment in the oil sector, reduced nominal GDP, and has likely placed the overall economy in a mild recession in H1. Canada is the second most commodity-dependent 'AAA'-rated economy after Australia, with oil and gas accounting for one quarter of merchandise exports and up to 10% of GDP when allied sectors are included.

Two policy rate cuts by the Bank of Canada in 2015 illustrate the sovereign's monetary policy flexibility. The Canadian dollar has depreciated sharply against that of the U.S., its main trading partner. Improved competitiveness should help exports, which Fitch expects to contribute to a recovery in 2H15, taking overall growth to 1% in 2015. Fitch expects growth of over 2% in 2016, supported by growth in the U.S.

Fitch believes that high levels of household debt (which has stabilised at around 165% of disposable income) and pockets of real estate overvaluation pose risks to the Canadian economy, but without a broad-based shock to employment or a sharp rise in interest rates, the risks are manageable.

Only a severe economic shock resulting in higher interest rates and much higher unemployment could trigger direct contingent liabilities for the sovereign from the financial sector. The state-owned Canada Mortgage and Housing Corporation (CMHC), a Crown Corporation, insures mortgages worth around 27% of GDP (and falling) and has its own capital buffers. Macroprudential measures have had some impact on credit growth although a cut in interest rates could encourage continued growth.

Gross general government debt of 88% of GDP is exceeded only by the U.S. among AAA sovereigns, but there are a number of mitigants. Almost two-thirds of general government debt is at the provincial level, while the federal government is close to a balanced budget and is reducing its debt ratio. The general government has sizeable assets, largely in pension funds, which reduce net debt to 36% of GDP (Fitch's narrower net general government debt measure takes into account only deposits and is 81% of GDP). Canada's unfunded state pension liability, which Fitch subtracts from Canada's debt figures for comparability, is also well below that of peers.

The debt ratio has risen in 2015 partly because falling oil prices have affected nominal GDP. With the overall general government deficit contained at 1.7% of GDP in 2014, Fitch expects GGGD to resume its fall from 2016. A forecast fall in the debt ratio is consistent with Canada retaining a 'AAA' rating, and contrasts with sustained forecast rises in sovereigns that have lost 'AAA' status such as Austria and the United Kingdom.

Falling oil prices and a shock to gross domestic income may prevent the federal government from achieving its cherished goal of a fiscal surplus in FY2015-2016 but without jeopardising the downward trend. A new balanced budget law could entrench fiscal responsibility at the federal level. Provinces are gradually narrowing deficits.

RATING SENSITIVITIES

The following factors would be negative for the rating:

--Financial sector stress that leads to the crystallisation of contingent liabilities for the sovereign and results in economic and fiscal underperformance;

--Fiscal deterioration as well as lower than expected growth, leading to persistent increases in the government debt burden.

KEY ASSUMPTIONS

Fitch assumes that Brent averages USD65/b in 2015, USD75/b in 2016 and USD80/b in 2017. Risks to these assumptions are largely on the downside.

Fitch estimates that residential property prices are 20% overvalued relative to fundamentals but assumes that the Canadian housing market will achieve a soft landing and that the government will remain proactive and pragmatic in its approach to address macroeconomic and banking sector vulnerabilities.

Fitch expects no major change in economic policy following the general election on October 19th. All three main parties have pledged to balance the federal government budget.

Additional information is available on www.fitchratings.com

Applicable Criteria

Country Ceilings (pub. 28 Aug 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=752194

Sovereign Rating Criteria (pub. 12 Aug 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=754428

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=989609

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=989609

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst
Charles Seville
Senior Director
+1-212-908-0277
Fitch Ratings Ltd.
33 Whitehall Street
New York 10004
or
Secondary Analyst
Todd Martinez
Associate Director
+1-212-908-0897
or
Committee Chairperson
Douglas Renwick
Senior Director
+44 20 3530 1045
or
Media Relations:
Sandro Scenga, New York, +1 212-908-0278
Email: sandro.scenga@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Charles Seville
Senior Director
+1-212-908-0277
Fitch Ratings Ltd.
33 Whitehall Street
New York 10004
or
Secondary Analyst
Todd Martinez
Associate Director
+1-212-908-0897
or
Committee Chairperson
Douglas Renwick
Senior Director
+44 20 3530 1045
or
Media Relations:
Sandro Scenga, New York, +1 212-908-0278
Email: sandro.scenga@fitchratings.com