How Canada Lost and Regained its Top Credit Rating

By Mike Hornbrook

Markets around the world were roiled this week after Standard and Poor’s downgraded the United States debt.

But the US isn’t the only country ever to lose its AAA rating. A little under two decades ago, America’s northern neighbor was in the same boat. In April 1993, a bond-rating agency dropped Canada’s debt from a AAA to a AA plus rating, for failing to follow through on reducing its deficits.

At first, politicians challenged the credit downgrade, saying that it was based on “erroneous information.”

But the downgrade shocked Canadians into taking a hard look at their books, according to Canadian economist Jack Mintz.

“Our foreign indebtedness was pushing close to 45 percent of GDP, which was very high at that time,” said Mintz. “The problem is similar for the United States today.”

It wasn’t just the downgrade, though. Canadians were stung when the American media began likening Canada to a developing nation, said Craig Alexander, the chief economist of Canada’s TD Bank.

“One of the most marvelous catalysts to change public attitudes was when the Wall Street Journal ran an article talking about Canada turning into an emerging market economy,” Alexander said.”¨”They talked about the Canadian dollar being the ‘peso of the north’. Now that story really resonated.”

He said it was such an embarrassment that public polls began to show government debt as the number one issue, above health care and education.

The Canadian government began slashing spending – an average of 20 percent across the board. Canada’s finance minister at the time, Paul Martin said the attack on the deficit was irrevocable and irreversible. “Let there be no doubt about that. We will balance the books.”

The government earlier had imposed a national sales tax – seven-percent on goods and services. At first Canadians complained, but given the severity of the country’s budget woes, they ultimately went along.

Economist Jack Mintz said there is a lesson there for Democrats and Republicans: The US government is going to have to do some real tax reform. He suggested special tax preferences would be a good place to start.

“The number one item is the mortgage interest deductible, which I think is a very harmful policy but reflects the psyche in US policy of trying to push home ownership in the country, Mintz said.

Canada has no such tax deduction, but it has a higher rate of home ownership than the US

Another reason Canada was able to take action and pay down its debts, said TD Bank’s Craig Alexander, is that the Liberal government in power at the time had a majority in Canada’s parliament.

“A majority means the government of the day can do whatever it wants and go back to see the electorate several years later.”

In contrast the US government is sharply divided, which Alexander noted fundamentally impairs the ability of the US to deal with its growing debt problem.