On Wednesday, the Fitch credit ratings agency downgraded Canada’s triple-A rating to AA+, citing the “deterioration” of the country’s finances resulting from the fight against COVID-19. The move came as a surprise to some, but David Rosenberg, founder of independent research firm Rosenberg Research & Associates Inc., saw the trouble brewing earlier this year. The following note, outlining his concern that a downgrade might be in the offing, was published in the firm’s Breakfast With Dave Newsletter on April 24, under the headline, ‘Will Canada get a credit downgrade?’

There is a very good chance that the need for more massive federal assistance for the provinces, for households, for the business sector, will trigger a downgrade at some point soon. ‎It may be true that the federal government went into this mess with a seemingly well contained 31 per cent debt-to-GDP ratio, but for the entire economy, at all public and private sector levels, that ratio is an unprecedented 350 per cent.

So Canada in aggregate doesn’t have a AAA-rated balance sheet to begin with and now Ottawa has to somehow shoulder a good chunk of these liabilities.

In the end, it doesn’t matter what the rating agencies do, in any event, as we saw with the inconsequential U.S. debt downgrade in the summer of 2011. It has to be remembered that, prior to 2002, the Canadian federal government was frequently rated as an AA-credit by at least one of the major agencies. I’m not sure anyone cared or even noticed… as much as it may be a source of national pride. Remember that in 2002, when the Canadian government was an AA-credit, the all-in debt-to-GDP ratio was more than 100 percentage points lower than it is today. And we also have to keep in mind, especially now that Ottawa is being forced to backstop everyone, that the national balance sheet really is Ottawa’s balance sheet when crises emerge.

Ireland is a classic case in point. In several stages in the Great Financial Crisis, the federal government felt compelled to bail out the banking sector which, when all the sector liabilities were included, meant that the government debt-to-ratio ballooned from 21 per cent prior to the GFC to 110 per cent within four years’ time (actually, it was really north of 300% when all the guarantees were factored in). Prior to the Great Recession, Ireland, like Canada today, possessed a AAA-rated federal government balance sheet. By 2011, all three major agencies had downgraded the sovereign credit ranking to BBB. So… Canada may end up being lucky if all it ends up seeing is a cut to AA. It likely will be facing a series of downgrades, and frankly speaking, the national balance in aggregate is already barely investment grade because it is shameful to have been incurring such a massive debt load at the peak of the cycle and at or near full employment.

It’s not just the debt, either, but the denominator, which is national income, which threatens to take the ratio of liabilities to GDP further into the stratosphere. Yes, interest rates are close to 0 per cent, but they won’t be there forever and there is this other not-so-little thing called the principal that still has to get repaid. It will be interesting to see how a central bank that does not govern over the world’s reserve currency and a country with a massive balance-of-payments deficit will be able to have all of this largesse find its way onto the BoC balance sheet — and the rampant money supply growth this will engender — without jeopardizing global investor confidence in the relative value of the Canadian dollar, which I believe will not end up bottoming until it hits 60 cents (U.S.). And as bold as that sounds, it may end up proving to be a conservative forecast.

Canada’s 350 per cent total debt-to-GDP ratio compares to 330 per cent in the U.S. — the latter having the most powerful army in the world and the world’s reserve currency which means the Fed has the largest printing press of all and it gets its ink for free. Italy’s debt ratio is 360 per cent and its credit rating is BBB. Greece is 340 per cent and it is rated BB-. Spain’s debt ratio is 360 per cent and it has a BBB- ranking. And China is at 290 per cent and has an A+ rating by S&P. So Canada, even as it stands, deserves a AAA sovereign rating based exactly on what criteria? Again, as the Ireland situation showed us, a country’s debt really comes under central government’s purview, when push comes to shove — and all the more so when the alternative is a default and delinquency wave from the provincial, business and household sectors. We are all one unhappy family at the moment, and the obligations merely now get transferred to the entity that has the balance sheet and ultimately taxing power to absorb these liabilities.

A little history here may be worth noting. For those wondering, Canada has experienced a provincial debt default in the past and it was Alberta back in the Great Depression (on a $62-million bond payment) — but it was ultimately bailed out by the federal government. In fact, nearly half of the provinces in the 1930s received some form of bailout from Ottawa as their debts proved to be unsustainable. Go back to 1993, and you will see that Saskatchewan talked openly about a possible debt default and its rating was downgraded to the very outer fringe of investment grade status (there is other documentation at the time that Newfoundland was also on the precipice of a debt default). I doubt that we will ever see this happen, as in a provincial default, because there is no way the federal government will every let that happen from a pure political standpoint. But the reality is that Ottawa is now having to bail out everybody, and while the BoC will act as a backstop and repository, this is still a federal government debt obligation.

Back to the provinces. Only one has a AAA balance sheet and that is British Columbia. Four are in the AA region and the rest are around A-rated credits. Insofar as Ottawa ends up having to guarantee the provincial liabilities (and it may not end there), we should keep in mind that the median provincial debt rating is AA-/A+. Then we have the consumer debt-to-income ratio at 175 per cent and the ratio of nonfinancial corporate debt-to-GDP ratio is which identical. The Great Canadian Debt Surge has come home to roost, and that home is going to be in the nation’s capital.

David Rosenberg is founder of independent research firm Rosenberg Research & Associates Inc. You can sign up for a free, one-month trial on his website.