Dominion Bond Rating Service notes that the Government of Canada’s Economic and Fiscal Update confirms that the country is a sound fiscal position, but some of its debt reduction targets may prove too ambitious.

DBRS notes that the update indicates that results are tracking ahead of original budget estimates, with the surpluses now anticipated for 2006-07 and 2007-08 revised upward by $3.6 billion and $2.9 billion to $7.2 billion and $7.3 billion, respectively, despite modest weakening of the economic outlook.

Revenue forecasts have been boosted by personal income tax and GST collections, which outweighed a reduction in corporate taxes. The government did not implement any notable policy changes in this update, it notes, however it did reiterate its intention to pay down debt by $3 billion annually and announced a plan to use interest savings to reduce personal income taxes. It also proposes to cut the GST rate to 5% by 2011 and reduce corporate taxes.

“Adherence to these initiatives will support further improvement in the already solid credit profile of the government, although benefits will take years to materialize,” the credit rating agency says.

It also notes that the government announced a target of eliminating total government (federal, provincial and CPP/QPP) net debt by 2021, which DBRS believes to be optimistic. “To reach this target, the government projects that it will have to reduce its net debt-to-GDP ratio to 10% from 35.1% at March 31, 2006, which appears aggressive,” it cautions.

“Using the government’s assumptions for net debt and nominal GDP for 2006-07 to 2011-12 and assuming conservative nominal growth of 5% and annual reductions in net debt of $3 billion for the remaining period results in a net debt-to-GDP ratio of just over 15%. Reaching the 10% target would require additional reductions in net debt of about $10 billion annually over 15 years, or nominal GDP growth averaging 8% annually over 15 years, a level exceeded only six times in the past 24 years,” it calculates.

“Nevertheless, the overall outlook for the government’s fiscal position remains very sound and DBRS believes that debt and tax reductions are likely to result in further credit improvement if implemented,” it concludes. “However, pressure on transfers to provinces as they continue to cope with rising health care costs and infrastructure needs and expectations of more moderate economic growth in the years ahead are likely to make some of the targets set out difficult to achieve.”