1995 BUDGET REPORTS

SUMMARY (1)

The Need for a Debt Management Plan

Debt financing plays an important role in making our economy work. It allows businesses to make key investments in plant and equipment, investments that serve new customers and generate increased sales. It allows consumers to buy durable goods like houses, automobiles, and appliances, paying for them over their useful lives. However, debt can play a negative role. Debt that is not affordable and cannot be repaid causes bankruptcy for both business and consumers.

The same is true of government. Debt can play a positive role in financing the infrastructure necessary for continued economic growth. But consistent borrowing to finance government deficits can lead to the accumulation of debt, with more tax dollars going to banks to pay interest, and less to provide services for people.

Public awareness of federal and provincial debt levels has increased significantly over the last several years. Canadians are concerned about escalating debt at both the federal and provincial levels, and are looking to their governments for action.

British Columbia has the best debt position of any province in Canada. Data compiled by the bond rating agency, Moody's Investors Service, show that the province has the lowest debt as a per cent of provincial gross domestic product (GDP) as well as the lowest debt interest cost as a per cent of government revenue. However, like other provinces, British Columbia's debt has risen in recent years.

In its 1994 budget, the British Columbia government put forward a fiscal plan that focussed on the first essential step -- eliminating the provincial deficit. The government committed to eliminate the budget deficit by 1996/97 while freezing taxes for three years.

The 1995 budget achieves this goal one year ahead of schedule. With the deficit eliminated, a longer-term plan is needed to pay down accumulated direct debt and control the growth of total taxpayer-supported debt.

British Columbia Debt Trends

As of March 31, 1995, the total debt owed or guaranteed by the Government of British Columbia, including BC 21, stands at $26.9 billion. This debt can be broken down into two types, debt incurred by commercial Crown corporations and taxpayer-supported debt.

Commercial Debt

Commercial debt represents amounts owed by commercial Crown corporations which operate without government subsidy -- B.C. Hydro and BC Rail. This debt is guaranteed by government. However, the Crown corporations cover debt servicing and repayment requirements from revenues gained from the sale of their services, not from tax dollars.

Commercial Crown corporation debt totalled $8.1 billion as of March 31, 1995, accounting for 30.1 per cent of total provincial debt. The debt of B.C. Hydro and BC Rail has grown at about 2 per cent per year over the last four years -- well below growth in the British Columbia economy. Like any private corporation, this debt has been used to expand plant and equipment to meet the growth in demand for the Crown corporations' services.

Taxpayer-Supported Debt

The second key component of debt is called taxpayer-supported debt because interest and principal repayments are made, at least in part, with tax dollars. Bond rating agencies usually assess and compare government debt on this basis. As of March 31, 1995, British Columbia's taxpayer-supported debt totalled $18.8 billion.

There are two types of taxpayer-supported debt -- debt to fund operating deficits and debt to fund provincial infrastructure.

Debt Management Principles

The government believes that a long-term plan to manage debt should be based on the following principles:

Summary of the Debt Management Plan

The Debt Management Plan represents a major government commitment to repay the province's direct debt and to cap and reduce the overall cost of debt.

It follows extensive consultations with British Columbians. The Premier's Forum on Jobs and Investment identified a general lack of understanding of the province's financial situation, and the need for a longer-term fiscal plan. The Premier's Summit on the Economy recommended the adoption of objective and easily understood benchmarks to measure the province's fiscal and debt situation. Follow-up meetings achieved consensus on these benchmarks and the consensus is reflected in this plan.

The Debt Management Plan adopts four key goals. Based on the recommendations of the Premier's Summit participants, it also establishes specific benchmarks against which progress in achieving these goals can be measured over time.

Goals and Benchmarks

Reporting on the Province's Debt Position

The government is committed to full disclosure of the province's debt situation. Each year the provincial government will issue a provincial Debt Management Progress Report. It will update the plan annually and record progress made in meeting each of its goals. If progress is not being made, it will identify the reasons and identify actions that are needed to put the plan back on track.

The Auditor General will be requested to review the annual Debt Management Progress Report, and provide an opinion to the Legislative Assembly on its completeness and accuracy.


TABLE S1
DEBT MANAGEMENT PLAN
SUMMARY OF KEY BENCHMARKS

Year Ending March 31
Goal/Benchmark                                         1996      2000     2005     2010     2015

Maintain B.C. Credit Rating
  Credit Rating Relative to Other Provinces......... Highest   Highest   Highest   Highest  Highest
Repayment of Direct Debt
  Debt at Year End ($ billions).....................     9.8       8.9       5.9       2.9      0.0
Taxpayer-Supported Debt
  Debt as a Per Cent of Provincial GDP..............    18.8      18.1      15.2      12.5     10.2
Debt Interest Bite
  Interest Expense per Dollar of Revenue (cents)...      7.4       7.9       7.0       6.0      5.0

Note: The plan is based on certain underlying economic assumptions set out in Appendix E2.
The plan commits the government to achieve these benchmarks, regardless of actual economic performance. 

TABLE S2
DEBT MANAGEMENT PLAN
SUMMARY OF MEDIUM-TERM PROJECTIONS

Year                                                   1995/96     1996/97     1997/98     1998/99     1999/2000
                                                       ------- ($ millions, unless otherwise indicated) --------

Revenue before Federal Funding Cuts..................   20,353      20,750      21,410      21,810      22,690
Expenditures.........................................   20,186      20,210      20,510      20,820      21,330
Budget Surplus before Federal Funding Cuts(1)........      167         540         900         990       1,360
Budget Surplus after Federal Funding Cuts............      114          25          40         125         500
Debt Repayment from Investments(2)...................      300         200           0           0           0
Total Direct Debt Repayment..........................      414         225          40         125         500
Total Taxpayer-Supported Debt as a Per Cent of GDP...     18.8        18.7        18.7        18.6        18.1
Interest Bite (cents)................................      7.4         7.6         7.9         8.0         7.9

(1) Only federal cuts announced in 1994 and 1995 are counted here. These are on top of significant federal
    offloading that took place beginning in 1982.
(2) Includes sale of British Columbia Endowment Fund assets and cash management transactions.

DEBT MANAGEMENT PLAN

Introduction

Canadians have become increasingly concerned about government debt. Canada's total public-sector debt now exceeds $700 billion (73 per cent of which is owed by the federal government). This amount is equivalent to Canada's annual gross domestic product (GDP). Canada's debt position is 60 per cent higher than the United States, and is the second highest of any member of the G7 group of industrialized countries.

British Columbia's debt position is the best of any jurisdiction in Canada. Data compiled by the bond rating agency, Moody's Investors Service, shows that the province has by far the lowest debt as a percentage of provincial gross domestic product (see Chart E7) and the lowest debt service cost. British Columbia's debt service cost is 7 cents of every dollar of revenue compared to 13 cents for Alberta and 34 cents for the federal government. However, like other provinces, British Columbia's debt has risen in recent years.

Canada's growing government debt creates a number of problems. As debt accumulates, interest on debt becomes an ever larger share of government spending. Every year, less money is available for programs and more goes to banks and investors.

A growing public sector debt also makes Canada more reliant on foreign investment and reduces the country's economic sovereignty. In addition, debt incurred to finance the day-to-day operations of government shifts the bill away from today's consumer of government services and on to future generations.

What is the Deficit?

A government runs a deficit when its spending exceeds the revenue it takes in from taxes and other sources in any one year. A surplus occurs when a government spends less than the revenue it takes in. When a deficit is incurred, it becomes a debt owed by the government. Interest on this debt must then be budgeted each year until it is repaid. Repayment can only occur if the government collects more revenue than it spends in a subsequent year. If the government continues to run deficits over a number of years, government debt will continue to increase.

In British Columbia, reporting of revenues, expenditures, and deficits is done in two ways. The first method, called the Consolidated Revenue Fund (CRF), covers all expenditures made directly by government and all revenues collected to fund them.

The provincial government's budget surplus or deficit has been reported on a CRF basis since Confederation.

The second method, called the Summary Financial Statements, covers both direct government financial operations and the financial results of all agencies and enterprises owned by the provincial government.

The government's public accounts report financial results on both a CRF and Summary Financial Statements basis. As shown in Chart E1, the choice of reporting method does not markedly alter the surplus/deficit position.

[ Chart E1 -- B.C. Deficit/Surplus ]

What is Government Debt?

Government debt is the total amount of money owed by government to those who have lent it money. It includes both amounts borrowed directly by government and amounts borrowed by other entities but guaranteed by government. As of March 31, 1995, the total debt owed or guaranteed by the Government of British Columbia stood at $26.9 billion.

British Columbia's public sector debt can be broken down into two types, commercial debt and taxpayer-supported debt (see Chart E2).

[ Chart E2 -- Categories of Debt ]

Commercial Debt

Commercial debt represents amounts owed by commercial Crown corporations that operate without government subsidy -- B.C. Hydro and BC Rail. This debt is borrowed on behalf of or guaranteed by government. However, these Crown corporations cover servicing and repayment requirements from revenues gained from the sale of their services, not from tax dollars.

The debt of commercial Crown corporations totalled $8.1 billion as of March 31, 1995, accounting for 30 per cent of total provincial debt.

Taxpayer-Supported Debt

The second key component of debt is called taxpayer-supported debt because interest and principal repayments are made, at least in part, with tax dollars. Bond rating agencies usually assess and compare government debt on this basis. As of March 31, 1995, taxpayer-supported debt totalled $18.8 billion.

There are two types of taxpayer-supported debt:

Public Sector Assets

Much of British Columbia's government debt is offset by two types of assets -- physical assets and financial assets.

Physical assets include the value of such things as roads, buildings, plant and equipment, and other public facilities. These assets are owned either by government directly or by its Crown corporations and other agencies. As shown in Table E1, British Columbia public-sector physical assets have a book value of $32 billion and a replacement value of $62 billion.

The government will review the potential sale of assets, the proceeds of which could be used to reduce debt.


TABLE E1
VALUE OF PROVINCIAL ASSETS, 1994

                                                                    Estimated
                                                         Net       Replacement
                                                      Book Value       Cost
                                                      ----- ($ billions) -----

Value of Provincial Government Assets...............       8           16
Value of Crown Corporation Assets....................     14           26
Value of Assets of Institutions (includes schools,
   universities, hospitals)..........................     10*          20
                                                         ---          ---
Total...............................................      32           62
                                                         ===          ===

* Current value of depreciated capital stock from Statistics Canada.
Source: Province of British Columbia, 1993/94 Public Accounts; Statistics Canada,
Investment and Capital Stock Division; and Ministry of Finance and Corporate Relations estimates.

Financial assets are instruments which could be converted to cash -- bank balances, accounts receivable, mortgages, stocks and bonds, and investments in Crown enterprises on the province's Summary Financial Statements. As of March 31, 1994, $26 billion in government liabilities were offset by $14 billion in financial assets for a net liability of $12 billion.

British Columbia's Debt Trends

Overall government debt levels have shown a cyclical pattern over the last 15 years. Chart E3 shows the trend in total government debt since 1981 as a share of the total British Columbia economy. Debt levels rose sharply in the 1980s, peaking at just over 30 per cent of GDP in 1986. Debt levels declined to just over 20 per cent in 1990 before climbing again to just under 30 per cent in 1994.

[ Chart E3 -- Total Debt as a Per Cent of GDP ]

Commercial Debt

While the debt of commercial Crown corporations represents a significant share of British Columbia's total debt, this debt has grown relatively slowly over last four years. The annual increase in debt for B.C. Hydro and BC Rail has averaged under 2 per cent -- well below growth in the economy. Like any private corporation, this debt has been used to expand plant and equipment to meet the growth in demand for the Crown corporations' services.

Taxpayer-Supported Debt to Fund Operating Deficits

Chart E1 shows that British Columbia has recorded budget deficits in all but two of the last 14 years. As shown in Chart E4, continuous operating deficits following the recession of the 1980s led to a rapid build-up of debt. Debt was reduced as the economy improved in the late 1980s and budget surpluses were recorded. However, an economic slowdown in the early 1990s, and budget surpluses were recorded. However, an economic slowdown in the early 1990s, combined with high spending growth between 1989 and 1991 led to a return to deficit financing.

This trend was aggravated by the federal government's offloading of its responsibilities for health, post-secondary education and social services on to the provinces. Between 1991/92 and 1994/95 federal government offloading cost British Columbia $6.5 billion, accounting for more than the $3.6 billion increase in direct debt during that period.

Between 1991/92 and 1994/95, the province's operating deficit was brought down from $2.4 billion to under $400 million. In 1995/96 the province will run an operating surplus of $114 million. With this operating surplus and the sale of British Columbia Endowment Fund assets, the direct debt will fall by $414 million by the end of the 1995/96 fiscal year. Further progress in reducing direct debt will be made as budget surpluses are recorded in future years.

[ Chart E4 -- B.C. Taxpayer-Supported Debt ]

Taxpayer-Supported Debt to Fund Provincial Infrastructure

This debt represents amounts borrowed by government agencies and subsidized Crown corporations to build capital facilities such as schools, health facilities, colleges and transportation networks. The provincial government either borrows directly, or guarantees the borrowing of other agencies. The resulting interest and principal repayments are recorded as provincial expenditures.

The practice of funding infrastructure investments by long-term borrowing has been followed in British Columbia for nearly 30 years. It is not new. Successive governments have decided that the cost of such assets should be spread over their useful life, rather than paid for in advance. The issue is one of fairness. If the benefits of public assets occur over several decades, it is appropriate that the costs be evenly spread among all those who benefit over that period.

This policy of borrowing to finance major investments has also been influenced by the rapid growth of the British Columbia economy and a high population growth rate. Paying in advance for capital investment would place a large burden on the current population and make it difficult to provide basic facilities to support new businesses and new residents.

Making a distinction between day-to-day operating expenses and large up-front capital investments is common practice in the private sector. While the former are recorded as they occur, the costs of the latter are spread over the useful life of the asset. Similarly, using long-term borrowing to finance large new investments in plant and equipment is common in the private sector.

In 1993, the government added highway capital construction to the list of infrastructure amortized. Previously highways represented the only major long-term capital spending still expensed. This change was made to ensure consistency with other types of transportation funding and provide for better capital planning to meet growing transportation needs. It also provided for the use of dedicated revenue sources to finance highway capital construction.

Some have argued that government should not incur any debt at all, regardless of what it is used for. All debt is bad and all capital investments should be made on a pay-as-you-go basis. If British Columbia were to follow this approach, the entire cost of building capital facilities for the future would be borne by today's taxpayers. This added burden on taxpayers would likely lead to lower rates of public investments and increased backlogs in key areas like education and transportation.

Again, the private sector is a useful comparison. Most businesses could not operate this way. Without debt financing, businesses would find it much more difficult to finance inventory or make the new investments in plant and equipment necessary to expand their operations.

British Columbia's infrastructure debt increased rapidly in the early 1980s, reflecting provincial population and economic growth. Fiscal pressure in the mid-1980s resulted in sharply lower levels of capital investment and infrastructure debt dropped. Renewed growth and population inflow resulted in a resumption of debt growth in the 1990s.

British Columbia's infrastructure debt has increased by $2.7 billion over the last three years.(3) As shown in Chart E5, new transportation investments accounted for 41 per cent of this increase, health and educational facilities for 38 per cent, and municipal infrastructure (roads, sewers and water) for 12 per cent.

The growth of infrastructure debt during the 1990s has been due to two factors.

[ Chart E5 -- Borrowing to Fund Long-Term Investments Three Years 1992/93 to 1994/95 ]

Between 1985 and 1995, British Columbia's population grew at an average annual rate of 2.2 per cent per year, much faster than Canada as a whole. This rapid growth added 700,000 people to British Columbia's population, creating new demands for public facilities. New ferries and buses had to be added, roads became congested, new schools had to be built, and new housing development created the need for new water and sewer lines.

The growth of British Columbia's economy and population began to accelerate at a time of greatly reduced capital funding. As shown in Chart E6, capital budgets were cut sharply in the mid-1980s to control debt growth, and significant backlogs emerged. Therefore, during the 1990s the provincial government was faced with both providing for the needs of current growth and catching up with past growth.

Some of this backlog has been now been addressed by increased capital spending over the last four years, but pressures for new investments remain strong. For example:

[ Chart E6 -- Infrastructure Spending as a Per Cent of GDP ]

Despite these pressures, debt to finance new capital needs cannot grow indefinitely at the rates of the last four years. Therefore, capital spending allocations will be cut over the next four years, and spending will be targeted to areas where backlogs remain a serious problem.

For the longer term, the provincial government is investigating new, innovative ways of meeting the growing demand for public infrastructure. One approach is to increase the use of existing public buildings. For example, the government recently introduced a year-round schooling pilot project which will help make more effective use of our school buildings. Other options include cutting costs through more effective building designs, and entering into financing arrangements with private-sector partners. However, difficult trade-offs must continue to be made to balance investment requirements with the need to keep infrastructure debt affordable.


HOW MUCH DEBT IS AFFORDABLE?

There is no universally accepted method for determining whether any given level of government debt is affordable, and opinions differ. Bond rating agencies and investors assess the ability of borrowers to repay debts when making credit rating and investment decisions. Taxpayers ultimately communicate their views on affordability at the ballot box.

A number of key indicators have been used to put debt levels into perspective, make comparisons among jurisdictions, and help make judgements about affordability. Indicators recommended by British Columbia's Auditor General include:

Historical data on these and other indicators is contained in Appendix E1.

One way of assessing affordability of debt is to compare it to other jurisdictions using the above indicators. As shown in Chart E7, British Columbia has the lowest debt to GDP ratio in Canada. It also has the lowest interest bite on its outstanding debt.

Ultimately, the best means of assessing affordability is to look at the relative credit ratings given by major bond rating agencies. A high credit rating means that rating agencies consider a jurisdiction's debt to be relatively affordable with a low probability of default. As shown in Chart E8, British Columbia has the highest credit rating of any Canadian province.

[ Chart E7 -- Provincial Taxpayer-Supported Net Debt at March 31, 1995 ]


The Need for a Debt Management Plan

Debt financing plays an important role in making our economy work. It allows businesses to make key investments in plant and equipment, investments that serve new customers and generate increased sales. It allows consumers to buy durable goods like houses, automobiles, and appliances, paying for them over their useful lives. However, debt can play a negative role. Debt that is not affordable and cannot be repaid causes bankruptcy for both business and consumers.

The same is true of government. Debt can play a positive role in financing the infrastructure necessary for continued economic growth. But consistent borrowing to finance government deficits can lead to the accumulation of debt, with more tax dollars going to banks to pay interest, and less to provide services for people.

Over the last several years, public awareness of federal and provincial debt levels has increased significantly. Canadians are concerned about the escalation of debt at both the federal and provincial levels, and are looking to their governments for action.

In response to these concerns, a number of provinces have introduced balanced budget requirements, either in the form of policy commitments or as legislation. Some provinces have achieved, or are close to achieving, a balanced budget, and have put forward plans to repay accumulated debt.

In its 1994 budget, the British Columbia government put forward a fiscal plan which focussed on the first essential step -- eliminating the provincial deficit. The government committed to eliminate the budget deficit by 1996/97 while freezing taxes for three years. The 1995 budget achieves this goal one year ahead of schedule. With the deficit eliminated, a longer term plan is needed to pay down accumulated direct debt and control the growth of total taxpayer-supported debt.

Debt Management Principles

The government believes that a long-term plan to manage debt should be based on the following principles:

Summary of the Debt Management Plan

The Debt Management Plan represents a major government commitment to repay the province's direct debt and to cap and reduce the overall cost of debt.

It follows extensive consultations with British Columbians. The Premier's Forum on Jobs and Investment identified a general lack of understanding of the province's financial situation, and the need for a longer-term fiscal plan. The Premier's Summit on the Economy recommended the adoption of objective and easily understood benchmarks to measure the province's fiscal and debt situation. Follow up meetings achieved consensus on these benchmarks and the consensus is reflected in this plan.

The Debt Management Plan adopts four key goals. Based on the recommendations of the Premier's Summit participants, it also establishes specific benchmarks against which progress in achieving these goals can be measured over time.

Goals and Benchmarks

Table E2 summarizes the specific benchmarks established for every five-year period over the life of the plan.


TABLE E2
DEBT MANAGEMENT PLAN
SUMMARY OF KEY BENCHMARKS

                                                               Year Ending March 31
Goal/Benchmark                                       1996     2000     2005     2010     2015

Maintain B.C. Credit Rating
  Credit Rating Relative to Other Provinces.....    Highest  Highest  Highest  Highest  Highest
Repayment of Direct Debt
  Debt at Year End ($ billions).................      9.8      8.9      5.9      2.9      0.0
Taxpayer-Supported Debt
  Debt as a Per Cent of Provincial GDP..........     18.8     18.1     15.2     12.5     10.2
Debt Interest Bite
  Interest Expense per Dollar of Revenue (cents)      7.4      7.9      7.0      6.0      5.0

Table E3 shows projected targets for the medium term -- the first five-year period of the Debt Management Plan.

The economic and financial assumptions underlying Tables E2 and E3 are presented in Appendix E2.


TABLE E3
DEBT MANAGEMENT PLAN
SUMMARY OF MEDIUM-TERM PROJECTIONS

Year                                                  1995/96     1996/97     1997/98     1998/99     1999/2000
                                                      -------- ($ millions, unless otherwise indicated) -------

Revenue before Federal Funding Cuts................      20,353      20,750      21,410      21,810      22,690
Expenditures.......................................      20,186      20,210      20,510      20,820      21,330
Budget Surplus before Federal Funding Cuts(1)......         167         540         900         990       1,360
Budget Surplus after Federal Funding Cuts..........         114          25          40         125         500
Debt Repayment from Investments(2).................         300         200           0           0           0
Total Direct Debt Repayment........................         414         225          40         125         500
Total Taxpayer-Supported Debt as a Per Cent of GDP         18.8        18.7        18.7        18.5        18.1
Interest Bite (cents)..............................         7.4         7.6         7.9         8.0         7.9

(1) Only federal cuts announced in 1994 and 1995 are counted here. These are on top of significant federal
    offloading that took place beginning in 1982.
(2) Includes sale of British Columbia Endowment Fund assets and cash management transactions.

1. Maintaining British Columbia's High Credit Rating

As shown in Chart E8, British Columbia currently enjoys the highest credit rating of any province in Canada. This high credit rating allows the provincial government and its agencies to borrow at lower interest rates, thereby reducing debt servicing costs.

The Government of British Columbia is committed to maintaining its credit rating relative to other provinces, and has established this benchmark as a key component of the Debt Repayment Plan.

2. Paying Down Debt From Previous Deficits

With the elimination of the budget deficit, the government can begin to pay down the debt accumulated to fund previous deficits. A combination of operating surpluses and assets from the British Columbia Endowment Fund will allow repayment of $414 million in 1995/96.

The Columbia River downstream benefits to the province will total over $5 billion over the next 30 years. The government recently announced a Columbia Basin Accord, which includes an investment in the region of $1 billion over the next decade. The remainder of the downstream benefits will be fully allocated to debt reduction.

[ Chart E8 -- Provincial Credit Ratings, 1995 ]

The Debt Management Plan commits the government to repaying, over a 20-year period, $10.2 billion in outstanding direct debt. The repayment schedule is summarized in Table E4. It is based on four five-year periods commencing April 1, 1995. It should be noted that government is required to do significantly better than simply balancing the budget over each five-year period. The debt repayment requirements mean that it must also take in significantly more money than it spends.


TABLE E4
20-YEAR DIRECT DEBT REPAYMENT SCHEDULE

Five-Year Period                                     1996-2000   2001-2005   2006-2010   2011-2015
                                                     --------------- ($ millions) ----------------

Average Debt Repayment.......................              260         600         600         580
Total Five-Year Repayment....................            1,300       3,000       3,000       2,900
Total Direct Debt at End of Period...........            8,900       5,900       2,900           0

Table E4 is based on average values for five-year intervals over the 20-year life of the plan. Year-to-year values will fluctuate with movements in factors such as interest rates over the economic cycle.

Over the last two years real per capita spending by the provincial government has been declining. If the above targets for debt repayment are to be met without increasing taxes, the level of real per capita spending must continue to decline.

The federal government's recent decision to offload the costs of health and education programs increases the pressure to reduce the cost of government. Two years from now, the provincial government will see its revenues reduced $860 million or 4 per cent. Therefore, the government will continue to cut spending in real per capita terms and to reduce the size of the provincial government relative to the economy as a whole.

3. Reducing Taxpayer-Supported Debt Relative to the Provincial Economy

Meeting the debt repayment targets set out in this plan will lead to an overall reduction of total taxpayer-supported debt as a share of economic activity. The Debt Management Plan sets out benchmarks for reducing this debt relative to provincial GDP. As shown in Table E2, the debt to GDP ratio will fall from 18.8 per cent in 1995/96 (the lowest in Canada) to 15.2 per cent in 2004/05, to 10.2 per cent in 2014/15.

4. Capping Debt Interest Costs

Interest payments on taxpayer-supported debt now account for 7.4 cents of every dollar of revenue collected from taxpayers -- the lowest level in Canada. (The direct debt accounts for 4.8 cents of this amount.) The Debt Management Plan caps interest payments to ensure that they remain below 8.5 cents per dollar of revenue. By the end of 20 years, it is forecast that interest payments on taxpayer-supported debt will fall to 5 cents.

As shown in Tables E2 and E3, debt interest costs do not rise above 8 cents per dollar of revenue over the period of the plan. The 8.5-cent ceiling is adopted to account for uncontrollable factors such as interest rates.

Interest costs will also be contained through effective debt management (see Appendix E3).

Reporting on the Province's Debt Position

The government is committed to a full disclosure of the province's debt situation. The regular reporting of reliable information is essential to determine whether targets are being met.

Each year, the provincial government will issue a provincial Debt Management Progress Report. It will update the medium-term plan shown in Table E3, and record progress made in meeting each of the five-year targets set out in Table E2. If progress is not being made, it will identify the reasons and identify actions that are needed to put the plan back on track.

The Debt Management Progress Report will cover not only the four key benchmarks set out above, but will bring together, in one document, a comprehensive picture of the province's debt situation. It will include the debt indicators recommended by the Auditor General in his review of the 1993/94 Public Accounts. These indicators include:

The Auditor General will be requested to review the annual Debt Management Progress Report and provide an opinion to the Legislative Assembly on its completeness and accuracy. The first report will be released in conjunction with the 1994/95 Public Accounts.

APPENDIX E1

KEY DEBT INDICATORS

The Auditor General recommended in his 1993/94 report that at a minimum, 10 measures and indicators relating to debt be disclosed in the Public Accounts. This table provides an historical summary of the financial indicators. Unless noted otherwise, debt indicators refer to taxpayer-supported debt, which excludes the debt of B.C. Hydro, BC Rail, WLC Developments Ltd. and B.C. Lottery Corporation.


                                                    1991/92  1992/93  1993/94  1994/95  1995/96

Debt to Revenue(1) (per cent)................         73.0     85.3     87.7     84.3     83.2
Debt per Capita ($)..........................        3,713    4,569    5,031    5,126    5,187
Interest Bite (cents per dollar of revenue)
  -- Taxpayer-Supported Debt.................          6.4      6.9      7.0      7.2      7.4     
  -- Total Debt(2)...........................          7.7      8.8      8.5      8.6      8.6
Total Cost of Borrowing(3) ($ million).......        1,096    1,293    1,437    1,609    1,740
Debt to GDP (per cent).......................         15.4     18.4     19.5     19.1     18.8
Debt at Year End ($ billion)
  -- Taxpayer-Supported......................         12.5     15.9     18.0     18.8     19.5     
  -- Total Provincial........................         20.0     23.4     25.9     26.9     27.9
Interest rate (per cent)
  -- On Taxpayer-Supported Debt..............         10.4      9.7      9.4      8.9      9.0
Background Information:
 Revenue ($ billion).........................         17.2     18.6     20.5     22.3     23.5     
 Nominal GDP ($ billions)....................         81.3     86.3     92.1     98.7    103.7     
 Population (thousands)......................        3,380    3,479    3,574    3,668    3,765

(1) Includes revenue of the CRF plus revenue of the government agencies whose debt is taxpayer-supported.
(2) As calculated by the Auditor General for 1991/92 to 1993/94; 1994/95 and 1995/96 are Ministry of Finance and Corporate Relations estimates.
(3) For taxpayer-supported debt.

APPENDIX E2

KEY ECONOMIC AND FINANCIAL ASSUMPTIONS

It is difficult to predict economic and financial conditions on a year-by-year basis over 20 years. However, reasonable assumptions can be made about the values of key variables, on average, based on historical trends and forecasts of the Ministry of Finance and Corporate Relations.

These assumptions should, therefore, be seen as mid-points in a range of possible outcomes. The Debt Management Plan commits the government to achieving the stated benchmarks, notwithstanding potential variability in the underlying economic and financial assumptions.

1. Nominal Economic Growth
Ministry forecast of 5.1 per cent in 1995 and an average of 4.2 per cent from 1996 to 1999 -- followed by a 4 per cent nominal growth projection for the rest of the period (2 per cent real, 2 per cent inflation). This base case is lower than historical experience.

2. Revenue
Ministry forecast to 1999/2000, then 3 per cent annually, based on revenue growth at three-quarters the growth of nominal GDP. This relationship is consistent with historical experience.

3. Expenditures
Expenditure growth is held below revenue growth, generating increasing surpluses which are capped at approximately 3 per cent of revenue.

4. Interest Rates
An average interest rate of 8.5 per cent is assumed over 20 years.


APPENDIX E3

EFFECTIVE DEBT MANAGEMENT

Prudent and effective management of the province's debt portfolio depends, significantly, on being able to readily and cost-effectively source funds from domestic and international investors. This task is complicated by a market environment that is subject to often volatile interest rate and currency fluctuations over which the province has little or no control. Further, the province is in direct competition for limited funds with other major Canadian and international issuers.

The challenges posed by the market environment require the province's debt management program to be streamlined, efficient and sufficiently flexible to respond to the lowest-cost financing opportunities afforded by the domestic and international capital markets. It also entails instituting policies and controls which establish the appropriate framework for undertaking debt management in the province.

The primary objective of the province's debt management program is to achieve the lowest cost financing at an acceptable level of risk. The province accepts only low levels of risk which are judged appropriate for a risk-averse public-sector borrower.

The province's debt management program is operated centrally by Provincial Treasury of the Ministry of Finance and Corporate Relations, on behalf of the government, Crown corporations and agencies. As fiscal agent, the government borrows directly in the financial markets and relends the proceeds to Crown corporations and agencies. This centralized borrowing program provides lower-cost financing to Crown corporations by taking maximum cost advantage of the province's superior credit rating (AA+ with Standard & Poor's Corporation and Aa1 with Moody's Investors Service). The province is also able to respond in a timely way to changes in market conditions without risk of market competition from its own agencies. Further, a centralized debt management function eliminates duplication among treasury departments in Crown corporations and agencies.

Provincial Treasury's implementation of the debt management program is subject to control by the ministry's senior executive risk committee. The committee sets risk and policy parameters, ensures compliance within these parameters, and approves the annual debt management strategy and quarterly updates.

The following discussion reviews the key risk and policy parameters which form the framework for conducting debt management in the province.

Avoid having to fund under unfavourable market conditions

Provincial Treasury will typically manage its funding program ahead of actual requirements, thus mitigating against the risk of having to finance when interest rates are high or market conditions are not receptive to new financings. While Provincial Treasury relies on its outlook for interest rates and foreign exchange to guide timing decisions for financings, the general bias is to lock-in fixed rate debt costs by "averaging-in" over the course of a year. It is judged imprudent to risk financing a large annual borrowing requirement strictly in accordance with a market outlook which may prove to be incorrect.

In 1994/95, the government instituted prudent measures to help safeguard against the possibility of severe financial market volatility impairing the province's financing ability. These measures included:

Minimize risk of refinancing maturing debt

The orderly retirement of future debt obligations without incurring undue refinancing risk is important for minimizing interest rate costs. To this end, the province relies on the following policies:

As a result of these policies, the province's refinancing schedule is well-balanced, with an average level of annual net maturities over the next 10 years of $1.2 billion.

Diversify funding sources to reduce debt costs

Provincial Treasury actively diversifies its borrowing sources to cultivate strong domestic and international investor demand for British Columbia debt securities; strong demand helps minimize financing costs for the province. A broad investor base is also important, given the increased competition for funding and the need for multiple funding sources in the face of sometimes difficult and volatile capital markets.

On May 10, 1994, the province launched its Euro-debt issuance program (EDIP), which allows the province to gain more efficient and cost-effective access to European financial markets. EDIP has raised about $1.6 billion to date, all of which was in the form of yen-denominated notes fully converted back to Canadian dollar obligations by use of financial products. Compared to the cost of borrowing these funds domestically, EDIP saved the province $1.7 million.

The province also actively diversifies its financing program in Canada by attracting investors who are looking for alternatives to domestic public bond issues:

Foreign currency exposure is managed within conservative limits

From time to time the province borrows by issuing debt denominated in foreign currencies. The cost of repaying and servicing foreign currency denominated debt varies, in Canadian dollar terms, with the changes in the value of the Canadian dollar vis-a-vis these other currencies. Appreciation of the Canadian dollar vis-a-vis the U.S. dollar, for example, decreases the cost, in Canadian dollar terms, of repaying and servicing U.S. dollar obligations, whereas depreciation of tar increases such costs. The exposure of the province's debt portfolio to changes in the value of the Canadian dollar can be effectively offset and reduced to conservative levels through various hedging vehicles, including currency swaps.

Neither the government nor its Crown corporations has debt exposure to currencies other than U.S. or Canadian dollars.

The ministry's risk committee has set the maximum allowable U.S. dollar exposure for the government, excluding Crown corporations, at 10 per cent of net debt. U.S. dollar exposure was approximately 5 per cent as at February 28, 1995, or U.S. $554 million.

Among the Crown corporations, only British Columbia Hydro and Power Authority (B.C. Hydro) carries U.S. dollar debt exposure. B.C. Hydro's U.S. dollar debt obligations are largely hedged through B.C. Hydro's U.S. dollar revenue inflows, as well as through other financial hedges entered into over the past few years. B.C. Hydro's unhedged U.S. dollar debt exposure was 25.1 per cent of its gross debt as at February 28, 1995, or U.S. $1.7 billion, well within B.C. Hydro's 30 per cent authorized limit.

Prudent use of financial products

Subject to risk parameters set by the ministry's risk committee, Provincial Treasury uses financial products for hedging interest rate and currency risks associated with the existing debt portfolio and new borrowings. These financial products, or financial derivatives,(4) are not used in a speculative manner, but rather are matched against specific debt obligations to balance the overall mixes of fixed- and floating-rate debt and currency exposure for the debt portfolios. In this manner, Provincial Treasury affords itself a sufficient degree of flexibility for raising financing, while ensuring that variation in the annual costs of debt servicing and repayment is maintained within a tolerable range.

The ability to offset or hedge exposures through the use of financial products lends flexibility to the funding program by:

The province is subject to risk of default by the counterparty under the terms of a financial products transaction. For this reason, the ministry risk committee sets restrictive and high credit criteria for qualifying acceptable counterparties.

Looking ahead

The province will continue to take measures that ensure the best possible management of new and existing debt. These initiatives include:

Further, as a new initiative, the Ministry of Finance and Corporate Relations will consult with the Office of the Auditor General, credit rating agencies and investment banking firms on the contents of the annual Debt Management Progress Report to be produced in conjunction with the 1994/95 Public Accounts. The purpose of the report will be to improve the public's understanding of the province's debt and how it is managed. The report will consolidate all pertinent information on debt and debt management.


(1) The full Debt Management Plan begins on p. 45.

(2) A further $1.7 billion in infrastructure was financed over this period from operating deficits.

(3) A further $1.7 billion in infrastructure was financed over the period from operating deficits.

(4) Derivatives are financial agreements whose returns are linked to, or derived from, the performance of some underlying asset, such as bonds, currencies or commodities.


Budget '95 (Province of B.C.)

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