Canada is in a small club of countries with a AAA credit rating. How long can it last?

Canada is part of the highly select club of 10 countries that hold

AAA sovereign credit ratings from both SP and Moody’s, a mark of outstanding fiscal credibility and near-zero default risk. However, it has not always been the case. Canada only regained its pristine credit rating in the early 2000s, after losing it in the early 1990s due to persistent, sizable fiscal deficits and ballooning debt levels.

The upcoming federal budget is likely to show bigger fiscal deficits, at their highest levels in recent memory outside of recessions and the pandemic, persisting for some years to come. As a result, the federal government’s debt burden is likely to increase.

The deterioration in the country’s fiscal situation in recent years and the fiscal outlook raises an important question: Does Canada still deserve its

AAA sovereign rating ? There are five key factors that rating agencies take into consideration when deciding on a rating: 1) institutional and governance strength; 2) economic strength; 3) fiscal strength; 4) susceptibility to shocks; and 5) monetary and financial strength. Moreover, countries are not evaluated in isolation; they are compared with peers with similar ratings to see whether they belong to the same group.

Canada continues to earn top marks in its institutions and governance, with a high respect for the rule of law, which should be expected from a mature democracy. Similarly, the country earns high scores for its solid financial and banking sectors, its deep financial markets and the credibility of the Bank of Canada, in part due to its independence and inflation-targeting framework.

When it comes to its economic strength, Canada’s high income per capita and diversified economy, with a strong resources sector, advanced services and good trade links, are viewed positively. However, weak productivity growth and underperformance in GDP per capita growth in recent years relative to other advanced economies, especially highly rated countries, are likely to be a source of concern for rating agencies. The economic vulnerabilities arising from high household debt and housing are also worrisome.

Similarly, while Canada’s susceptibility to shocks from, for example, commodity price volatility, global economic cycles and provincial contingent liabilities, has not changed, the recent trade tensions with the U.S. are a reminder that Canada’s heavy economic dependence on its neighbour could be viewed negatively or at least as a greater risk to Canada’s rating.

It’s in fiscal strength that Canada has seen the most deterioration in recent years. According to Desjardins, once all the announcements to increase spending, especially on defence, infrastructure, housing and tariffs-impacted industries and workers, are taken into account, the

deficit for fiscal year 2025-26 is likely to be almost 2.3 per cent of GDP; the highest since 2010, when the economy was still recovering from the global financial crisis. This would also be the biggest deficit for a AAA-rated country, with the Netherlands close second at 2.1 per cent.

With Canada expected to run fiscal deficits for the foreseeable future, its debt level will increase. Already, Canada has

one of the highest levels of gross debt-to-GDP amongst AAA-rated countries, at about 114 per cent of GDP, second only to Singapore at 176 per cent of GDP.

Nevertheless, compared with other advanced economies, Canada’s situation is relatively favourable . Using net debt, Canada’s debt level is much lower at 14 per cent of GDP, a level comparable to the average of other AAA-rated countries.

However, with deficits expected to remain significant over the next five years, it is very likely that the country’s debt level will no longer be expected to ease and could even increase slightly. Already, Canada’s gross and net debt-to-GDP ratios have deteriorated the most among AAA-rated countries in recent years.

As a result of higher debt levels and rising interest rates over the past few years, Canada’s net interest payments on public debt — 1.8 per cent of GDP — are the highest among AAA-rated countries. However, when compared to countries rated just below AAA, Canada is in a better situation. With debt levels expected to continue increasing in the coming years, this indicator is likely to deteriorate further.

Based on these measures, it is evident that Canada is one of the weakest of the AAA-rated countries, especially in its fiscal position. However, the country remains stronger than those rated just below AAA. Hence, a downgrade solely due to the recent development seems unlikely and could also depend on whether rating agencies differentiate between capital-driven vs operation-driven increases in deficits.  In addition, compared to the early 1990s, when Canada lost its AAA rating, the fiscal situation is much more sustainable; the deficit was 6.9 per cent of GDP in 1994, net debt-to-GDP was 66 per cent, and interest payments were 5.6 per cent of GDP.

While we view it as unlikely that Canada would lose its AAA rating with this year’s budget, the country shouldn’t be complacent. The federal government will need to recommit to a credible fiscal path, including smaller deficits and a return to gradual debt reduction. This will mean confronting the country’s structural issues of weak business investment and anemic productivity growth, both of which threaten its long-term economic prosperity.

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