Thursday, October 29, 2009

Canada Not as Financially Sound as We'd Like to Think

As much as the Reform Conservatives like to brag that Canada is in much better shape than the rest of the world, they may be exaggerating things a bit. Aside from the fact that the Canadian taxpayer is now the largest sub-prime mortgage lender in the world, economists have been crunching the numbers, and the Harper government is going to have to do something soon.

One of the biggest problems is that our revenue has been greatly reduced with tax cuts, and with the ref-Cons still talking Republican, they may not be able to put off the inevitable. They are going to have to raise taxes or else.

I was glad in this article that they also mentioned the problems we are facing with an aging population. Baby Boomers are retiring and will soon be drawing on services they once propped up.

Canada may need to cool bragging
By Paul Vieira,
Financial Post
October 29, 2009

OTTAWA -- Policy makers have reminded us ad nauseam about how well positioned Canada is, vis-à-vis its industrialized peers, in dealing with the global economic downturn because of this country’s sound fiscal framework.

But the country may be reaching a point at which the bragging needs to cool down.

Sure, Canada’s record on public finance looks better than the United States and Europe, measured on a debt-to-GDP basis. Still, some analysts are beginning to wonder whether this fiscal advantage is at risk as budget balances, at the federal level and in some provinces, have deteriorated faster than expected.

The impact is already being felt, with Standard & Poor’s Rating Services cutting Ontario’s credit rating one notch, based on the “sharp deterioration” in that province’s fiscal framework. As a result, Ontario -- set to post nearly $72-billion in deficits over the next four years -- will face higher borrowing costs to finance its growing debt.

Perhaps the advantage is not as big as many had thought just a few months ago,” said Derek Burleton, senior economist at Toronto-Dominion Bank, who has written about the pending fiscal restraint Canada faces.

Aveny Shenfeld, chief economist at CIBC World Markets, said policy makers might be overstating the so-called fiscal advantage over the United States, which is now recording annual deficits in the trillion-dollar range -- which, at face value, makes the federal deficit this fiscal year of $56-billion and the combined federal-provincial shortfall of roughly $100-billion sound like a rounding error.

“While we are doing better than the U.S., it is not like we have no problem ahead of us in terms of wrestling the budget balance back into a more sustainable level,” he said. “And like the U.S., we have to remember while the economy is going to be [driven] by stimulus now, it will have to get through a period of restraint ahead.”

Analysts such as Mr. Burleton note that relative to GDP, the overall deficit (at 6%) and debt (64%) for this fiscal year -- fuelled by the recession and stimulus spending -- will still fall short of levels hit in the mid-1990s, or 9% and 102% respectively.

“And we are a long way off from anything the U.S. is facing,” Mr. Burleton added, noting the U.S. debt-to-GDP ratio is set to surpass the 100% level in the next few years.

But as Mr. Burleton has written, governments face tough choices once their stimulus programs come to an end. Mark Carney, the Bank of Canada governor, said this week legislators face “difficult decisions,” as governments will need healthier cash flows to meet the demands of an ageing population -- which will ultimately demand more health care and the old-age benefits they believe they are entitled to.

Of concern to analysts such as Mr. Shenfeld is the hit Canada has taken to nominal GDP, which is essentially the tax base from which governments get revenue. As of the second quarter, nominal GDP was down 7.4% in Canada, as opposed to 2.7% in the United States. Meanwhile, in terms of real GDP, which is adjusted for inflation, the peak-to-trough drop was 3.8% in the United States, compared with an estimate of 3.3% for Canada. (August GDP for Canada is set for release Friday morning, whereas U.S. GDP grew in the third quarter an estimated 3.5%, marking an official end to its recession.)

Canada’s nominal GDP growth skyrocketed prior to the crisis based on the great upswing in commodity prices. Mr. Shenfeld warned it could take years to recover to such highs.

“Progress could take some time, given how high those commodity peaks were. And we may have set government spending [in motion] based on the view that kind of money would roll in forever. In the interim, we have a large hole to fill.”

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