Why did Ontario borrow more short term during the pandemic year?
Chapter 4 of the 2021 Ontario Budget is about borrowing and debt management. This topic rarely gets political attention, but it deserves attention nonetheless.
We know that Ontario will be running a budget deficit this year and for many years to come. It matters how we borrow, how much interest we pay, and what interest rate risk we take because those interest payments come from the same pot that pays for other things the province needs.
First of all, we have borrowed more money this year than ever before:
As you can see, borrowing by the Ontario government has jumped from about $40b to $60b a year and is projected in the budget to remain at that level for at least several years. This number is a combination of the yearly budget deficit, plus government debt which matures and needs to be refinanced. It means that every year, for the next few years, we will have to borrow $50-$60 billion and pay whatever the prevailing interest rate is.
Fortunately, interest rates were at historic lows this past year. As you can see, Ontario could lock in long term interest rates between 1.2% and 1.4% for much of the pandemic year.
The Ontario budget also showed what the average term of government borrowing was. Here I was intrigued by the fact that the term decreased. That means that the Ontario treasury decided to borrow more short term instead of long term. I’m not saying that was the wrong decision. After all short term interest rates in Canada went down below 0.2% for much of the year. Clearly Ontario saved money up front by borrowing short term. But I think what is important for people to realize is that we are taking more refinancing risk. When those short term borrowings mature, you may find that interest rates are higher, and you end up paying more interest.
Sure enough, in early 2021, long term interest rates went up. You can imagine a pension fund manager saying, well, now that vaccines are coming and we can see the end of the pandemic, if central banks are all targeting 2% inflation or more, why should I be stuck getting 1% interest for 10-30 years?
My question is, couldn’t the finance ministry have anticipated, before the end of 2020, that there would be years of borrowing to come and asked the treasury to increase the average term of borrowing to lock in more funding at long term interest rates?
The budget actually gives a prediction of average borrowing rates we expect to pay in the coming years. As you can see, the government is expecting the interest rates it pays to go up substantially, from 1.6% in 2020-21 to 3.2% in 2023-24:
And, quoting the budget again,
“A one percentage point change in interest rates, either up or down, from the current forecast is estimated to have a corresponding change in Ontario’s interest costs by over $750 million in the first full year.”
That’s $750m for just the first year, from the same pot that we pay for housing, long term care, or schools. It’s the same pot of money that pays for child care, hospitals or public health.
Granted, it’s not an easy decision to make - trading off short term gain for long term risk.
But the federal government in its April 2021 budget decided to significantly lengthen the average term to maturity of its new debt issuance including re-opening the ultra-long 50 year bond. Why didn’t the Ontario government do the same?
Unfortunately, just before long term interest rates started heading back up in January and February of 2021, a new finance minister was only just settling in. Premier Doug Ford’s previous finance minister had to resign suddenly after he was discovered to be vacationing in the Carribean, undermining the government’s message to avoid travel during the second wave of COVID. In the wake of that unforced error, I expect the government couldn’t move to make a multi-million dollar adjustment to our debt refinancing risk. Or, to be generous, maybe the brand new minister just didn’t think of asking the question. Ontario will likely be borrowing some more money at higher interest rates.
Financing is not top of mind, politically, but getting good financing terms matters enough that politicians and voters should care. So my question to Premier Ford is, why did the average term of Ontario government debt decrease in 2020?