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

While it's unlikely that Canada would lose its AAA rating with this year's federal budget, the country shouldn't be complacent about threats to long-term prosperity, writes Charles St-Arnaud. Photo by Peter J. Thompson/National Post/Postmedia files

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Canada is part of the highly select club of 10 countries that hold AAA sovereign credit ratings from both S&P 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.

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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.

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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?

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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.

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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.

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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.

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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.

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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.