Fitch Affirms Province of Quebec at 'AA-'; Outlook Revised to Stable

NEW YORK--()--Fitch Ratings has affirmed the Long-Term Issuer-Default Ratings (IDR) of the Province of Quebec, Canada and Financement-Quebec (FQ) at

'AA-'. Fitch has also affirmed the Short-Term IDR on the Province and FQ at 'F1+'.

In addition, Fitch has affirmed the 'AA-' ratings on debt linked to the Province and FQ's IDRs. A complete list of ratings follows at the end of this release.

The Rating Outlook has been revised to Stable from Negative.

SECURITY

Senior unsecured obligations are direct and unconditional obligations of the Province of Quebec to which its full faith and credit is pledged. Commercial paper notes are promissory notes ranking equally with Quebec's other unsubordinated and unsecured indebtedness.

For Financement-Quebec, payment of debt service is unconditionally guaranteed by the Province from the consolidated revenue fund.

KEY RATING DRIVERS

STABLE OUTLOOK BASED ON BALANCED OPERATIONS: The Outlook revision to Stable on Quebec's Long-Term IDR reflects the Province's return to fiscal balance beginning in fiscal 2015 and the likely continuation of balanced operations through the forecast horizon. Steady, albeit slow, economic and revenue gains, combined with disciplined spending growth control have contributed to fiscal consolidation.

HIGH DEBT: Debt is high relative to resources and caps the rating at the current level. Debt management is strong and centralized, debt service is manageable and the Province maintains ample access to liquidity for both operations and debt service requirements, supporting the Short-Term 'F1+'rating.

FISCAL FLEXIBILITY PRESENT: The Province's unlimited control of tax revenues and an extensive ability to determine spending priorities provide notable, though not unlimited, fiscal flexibility in the absence of sizable annual and reserve balances. Tax rate increases implemented since the consolidation program began in 2010 may limit the Province's ability to raise rates further without affecting collections. The Province has successfully reduced the pace of spending growth, although its ability to maintain limited growth over time may prove difficult. Federal transfers support about one-fifth of spending needs.

DIVERSE ECONOMY: The economy is large and diverse, but historically slower growing and less wealthy than the Canadian average. Moderate growth continues, boosted by exchange rate trends and favorable U.S. economic conditions. Vulnerabilities include global trade links and the ongoing competitiveness of key sectors.

FINANCEMENT-QUEBEC'S RATING LINKED TO PROVINCE: The rating for Financement-Quebec reflects the credit strength of the Province given its unconditional guarantee.

RATING SENSITIVITIES

FISCAL UNDERPERFORMANCE: Unexpected near-term fiscal deterioration or an inability to attain currently forecast operating targets could result in a rating downgrade.

REDUCED DEBT BURDEN: The Stable Outlook at the current rating level assumes the Province returns to its past focus on debt reduction. The resumption of significant borrowing to support operating deficits would result in a downgrade.

CREDIT PROFILE

The affirmation of Quebec's 'AA-' IDR and Outlook revision is based on the Province's success in achieving fiscal consolidation beginning in fiscal 2015 and the likelihood of continued stronger operating performance through the plan period. Economic and revenue gains, although slow, combined with extensive efforts to slow spending growth have positioned the Province to continue achieving near-term surpluses on a consolidated budget basis.

The Province's ability to maintain improved fiscal operations and refocus on the larger challenge of lowering its high debt burden will depend on several factors, including continued economic gains and success in resisting demands for faster spending growth.

Fitch views Quebec's debt burden as elevated for the current rating category, a factor offset by its consistently solid fiscal and debt management and its past success in lowering debt ratios. The Stable Outlook assumes that the Province will now resume its longer-term debt reduction goal. Fitch cautions that future rating action could result if unexpected economic or fiscal reversals derail currently solid trends and lead to additional significant borrowing.

DEBT BURDEN WILL REMAIN HIGH

Outstanding gross debt, which includes debt of consolidated entities and pension liabilities, stood at C$207.7 billion in fiscal 2016, equal to 55.2% of GDP. Debt service, at C$10.1 billion in fiscal 2016, consumed 10.1% of consolidated revenues, a high but manageable level. Much of the current debt burden stems from accumulated deficits from prior decades and in the years since the 2008 - 2009 recession, estimated at C$119.7 billion in fiscal 2016 or 31.8% of GDP. Total public sector debt, at C$276.2 billion, equals 73.4% of GDP.

Fitch expects the Province's debt burden to remain relatively high, although a return to consistently balanced operations provides it with a window of opportunity to resume debt reduction. The Province forecasts that debt relative to GDP peaked in fiscal 2016 (which ended on March 31) and will decline going forward assuming it achieves forecast targets; the ratio of accumulated deficit to GDP has already begun declining. The Province has longstanding statutory target, in fiscal 2026, of gross debt-to-GDP at 45%, and an accumulated deficit to GDP at 17%. Debt figures are net of the Generations Fund balance, a reserve for debt reduction, which is funded at about C$8.5 billion in fiscal 2016.

The Province is a sophisticated debt manager and has demonstrated broad market access for current liquidity, new borrowing and debt refunding. Liquidity is ample, and the Province has established a reserve for prudential liquidity intended to cover a share of annual financing requirements in the event of market disruption. About 22% of total public sector debt is self-supporting, mainly for the Province's large water power utility, Hydro-Quebec (rated 'AA-' by Fitch).

ECONOMIC GROWTH STEADY THOUGH SLOW

Quebec's economy is diverse, mature and generally more slow-growing than Canadian averages. Similar to other Canadian provinces, it has significant exposure to U.S. economic performance, the primary destination for many of its exports, including from its important manufacturing sector. A globally significant transportation equipment sector is one of the Province's key economic anchors.

Economic performance during the current expansion has generally been positive, albeit less robust than past expansions given the slow global recovery. Lower oil price trends in place since late 2014 and a more favorable exchange rate environment have provided additional economic lift.

Real GDP growth was slow at 1.1% in 2015 and is estimated to grow 1.5% in 2016. Steady household consumption growth has provided a baseline for recent gains, boosted by recent export strength. Business investment has been a drag on growth but is forecast to return to growth over the forecast period. The Province forecasts real GDP rising 1.6% in 2017, with growth averaging about 1.5% through the 2020 forecast period.

Labor market conditions in Quebec historically were weaker than Canadian averages but have largely closed that gap over time; average annual employment growth in the Province was 1% during 2005 - 2015, just below the 1.1% Canadian rate, while average unemployment during the same period was 7.8%, compared to 7.1% for Canada as a whole. Recent trends have generally been positive, though gains have been only gradual. The Province's economic forecast assumes unemployment at 7.5% for 2016, and 7.2% in 2017.

FORECAST BALANCE ACHIEVED

As with many Canadian provinces, Quebec responds to recessionary conditions with stimulus spending and multi-year consolidation programs. Quebec's 2010 consolidation plan initially targeted returning to surpluses in fiscal 2014. An unsteady recovery and the challenge of meeting its spending targets led it, in 2013, to temporarily delay its fiscal consolidation target by two years, but ultimately the Province reported a small surplus on a consolidated basis in fiscal 2015. On a consolidated basis before Generations Fund deposits, the Province is estimating a surplus of C$1.4 billion in fiscal 2016 and forecasting a surplus of C$2 billion in fiscal 2017; these surpluses will be directed to the Generations Fund.

The Province has been very successful in recent years in curbing spending growth as part of its consolidation program. Recent policy actions have sought to slow growth across a range of spending categories, including employee remuneration, health care delivery and education. Health care and education consume two-thirds of program spending in Quebec.

Fitch continues to view spending growth targets to be achievable albeit politically challenging, particularly as a wide range of public services are affected over a longer timeframe. Program spending rose a low 1.4% in fiscal 2015, and is estimated to have risen only 2.5% in fiscal 2016; the budget for fiscal 2017 projects growth of 2.4%. This growth pace, well below the reported 5.6% average annual pace recorded from fiscal 2007-2010, assumes continued realization of a range of measures, including constrained salary increases, reduced staffing and efficiency improvements.

The Province's revenue forecast appears reasonable, although Fitch notes the persistent uncertainty that has been a hallmark of the current economic cycle in Quebec and elsewhere. The Province estimates consolidated own-source revenues rose 3.8% in fiscal 2016, slower than expected when the budget was tabled. Fiscal 2017 own-source revenues are forecast to rise 2.6%.

The Province also projects a 5.7% gain in federal transfers in fiscal 2017, driven thus far by formula factors for equalization and health transfers. Fitch expects the 2015 change in government at the federal level to likely lead to expanded federal transfers for provincial operations and capital, although such changes and their resulting impact on provincial finances are likely to emerge only gradually.

Fitch has affirmed the following rating:

Province of Quebec:

--Senior unsecured debt at 'AA-';

--Long-Term Foreign- and Local-Currency IDR at 'AA-';

--Short-Term IDR at 'F1+';

--Commercial Paper Rating at 'F1+'.

Financement-Quebec:

--Senior unsecured debt at 'AA-';

--Long-Term Foreign- and Local-Currency IDR at 'AA-';

--Short-Term IDR at 'F1+'.

The Rating Outlook has been revised to Stable from Negative.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria

International Local and Regional Governments Rating Criteria - Outside the United States (pub. 18 Apr 2016)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=878660

Rating of Public-Sector Entities - Outside the United States (pub. 22 Feb 2016)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=877128

Additional Disclosures

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1006064

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

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Contacts

Fitch Ratings
Primary Analyst
Douglas Offerman, +1-212-908-0889
Senior Director
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Secondary Analyst
Karen Krop, +1-212-908-0661
Senior Director
or
Committee Chairperson
Marcy Block, +1-212-908-0239
Senior Director
or
Media Relations, New York
Sandro Scenga, +1-212-908-0278
sandro.scenga@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Douglas Offerman, +1-212-908-0889
Senior Director
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Secondary Analyst
Karen Krop, +1-212-908-0661
Senior Director
or
Committee Chairperson
Marcy Block, +1-212-908-0239
Senior Director
or
Media Relations, New York
Sandro Scenga, +1-212-908-0278
sandro.scenga@fitchratings.com