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The Government of Canada’s “Economic and Fiscal Snapshot” released today reveals a much larger deficit in 2020 than what was anticipated by many economists. The federal deficit estimate at $343.2 billion for this fiscal year is more than ten times the deficit last year and significantly more than the $250 to $300 billion economists were expecting. The deficit is 15.9% of GDP and reflects the combination of measures taken to combat the fallout of the pandemic ($212 billion) and the loss of revenues from the recession ($71 billion). Financial markets did not respond to the larger-than-anticipated deficit (in fact the Canadian dollar strengthened slightly) suggesting that it was not shocked by the news given the enormous uncertainty at the moment and likely also reflecting the fact that Canada’s fiscal situation is still better than many of its international peers—including the United States.
The latest fiscal estimates are based on economic assumptions provided by the consensus of private sector forecasters, which is for a 6.8% contraction in GDP in 2020 and only a 5.5% recovery in 2021. This is arguably the worst economic downturn since the Great Depression, and there is scope that the performance of the economy might be worse than projected if the health risks intensify in the months ahead. Given this situation, there is no disputing that massive fiscal stimulus was required to limit the economic contraction and the loss of jobs and income. Moreover, even with the fiscal measures taken to date, the consensus expectation is for a very slow recovery warranting continued fiscal and monetary policy support.
The natural question is whether Canada can afford such a large deficit, which is pushing federal government debt to beyond $1 trillion for the first time. The answer is a conditional ‘yes’.
It is affordable if the deficit is only so large for one year. Today’s announcement puts the federal government gross debt-to-GDP ratio at 49.1% for 2020-21 relative to the 31.1% in the year before. The government cannot afford to have the debt burden continue to rise at its current pace.
The good news is that many of the recent stimulus measures come with a limited time horizon, so the deficit should collapse as they are wound down. But, there is enormous uncertainty about the evolution of the health risks and the prospects for the economy. The deficit will be larger if the recovery is more protracted.
Despite the alarming fiscal deterioration, Finance Minister Morneau said Canada will continue to hold its low debt advantage. While the federal government can crow about its favourable fiscal position compared to other countries, it should be noted that Canada’s fiscal position is much worse when one includes provincial debt. Before the pandemic, aggregate provincial debt-to-GDP was around 30%. So, the combined federal and provincial debt to GDP ratio is now above 80%—we don’t have an exact number because the provinces have not done fiscal updates, but their debt levels are rising. This means government debt is much larger than just the federal fiscal position, but the combined federal and provincial debt-to-GDP ratio will likely still be lower than the ratios in most other G7 nations.
In my mind, the main reason Canada’s fiscal position is manageable is the low rate environment. The drop in interest rates in response to the global downturn have resulted in lower debt-service costs. Canada’s public debt charges are sitting around 1% of GDP. In comparison, when Canada was trying to manage high debts in the 1990s, the public debt charges were close to 6% of GDP. In fact, the government expects the cost of servicing debt to go even lower by the end of 2020, anticipating that the total public debt charges will be $4bn lower than forecasted last fall. The good news is that given the depth of the global downturn, the outlook is for a sustained low interest rate environment for several years.
This fiscal snapshot was quite long, at 168 pages, reflecting the vast number of policy announcements this year. However, there was little new beyond the fiscal tracking. There were no tax policy changes. In today’s press conference, Prime Minister Trudeau said that increasing taxes or cutting services would be “the worst option” to help the economy recover at this time. However, programs like the CERB and the wage subsidy programs won’t be able to last forever, and Minister Morneau declined to speak to the long-term plan for these programs.
From my perspective, the large fiscal response has been the right one. The federal government had to address the income shock on households as well as the cash flow and balance sheet impact on businesses. I think the real debate is going to be on the following:
First, how effective was the response? Time will tell. The government will need to wind down their support programs as the reopening proceeds. There are significant questions about how to transition workers off of the CERB income support program, which some businesses have indicated is deterring individuals from returning to work. The take up of the rental relief program and the wage subsidy has been weak. It may be that other measures to support businesses will be needed.
Second, how much more will the government need to do to stimulate the economy? So far the bulk of the response has been to address the income shock to household and businesses, but the government will want to help spur economic growth during the reopening and recovery. Increased infrastructure investment or measures to encourage spending and investment will be needed. So while the deficit today is massive, I think the final deficit number for fiscal year 2020-21 will be much larger.
Third, what is the road ahead? There is no road map or fiscal framework as to how the government will manage its fiscal balances in the years ahead. The government was clear that today’s announcement would only be a snapshot for the current year, but eventually a plan of how to get out of the fiscal chasm will be needed. There is bound to be expenditure restraint and future tax changes, but the massive amount of debt will only be manageable if the economy recovers. Indeed, the priority will be to implement policies aimed at accelerating growth—and this could include regulatory changes, incentives for private investment, and infrastructure investment.
So, what should we look for in the months ahead? While we now have a ‘fiscal snapshot’ of the country’s finances, Canadian citizens and businesses can reasonably expect their government will tell us what it plans to do next to efficiently and effectively govern in a post-pandemic country; a dramatically different country with radically changed priorities since COVID-19. Keep an eye out for the following events, which we anticipate the federal government may leverage to tell us what it plans to do next: Parliament is currently due to resume on September 21, despite pressure from the political opposition to resume sooner. When parliament does come back, the Liberal government could decide to issue a new Speech from the Throne, where they’ll outline all of their new policy priorities for the months and years after. Prime Minister Trudeau could also shuffle his cabinet to eject the pandemic’s poor performers and elevate or maintain his strongest ministers to help steer the country forward. If this happens, we can expect to see new mandate letters for each minister that will also lay out priorities and aspirations for cabinet’s policy direction. Eventually a full budget will also be drafted and released that will tell us how much the government plans to spend over the following months and years, and on what. Finance Canada has issued a call for public consultations on a future budget, signaling that we may see the finished product at the end of 2020 or early 2021. Finally—and this is just rumour at this point—Prime Minister Trudeau could consider calling an early federal election to ask voters for a new mandate, and try to win more seats in the House of Commons so he has a powerful majority government. The Liberal government currently enjoys majority-level favour from the Canadian public, but the minority government is working reasonably well, so calling an election would be a calculated risk.
So, the bottom line is that the federal government estimate of the deficit for the current fiscal year is larger than expected, and I suspect will get larger before the year is over. The fiscal policy response has done a lot to limit the economic fallout from the pandemic, but the path forward is unclear. The health and economic risks remain elevated, so the economic and fiscal outlook is fraught with uncertainty. Today’s limited fiscal snapshot reflects these uncertain times. There are still a lot of questions to be answered.