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February 10, 2016
Anatomy of Ottawa’s fiscal
transformation
We’re a little more than a month removed from a crucial federal
budget. There’s now a growing chorus echoing our longstanding view that material fiscal stimulus is needed to breathe
life into a struggling Canadian economy. Indeed, the Liberal
government has made it abundantly clear that it’s not a question
of whether the budget will deliver fiscal stimulus; rather, we’re
debating how big, in what form and over what timeframe fiscal
support will flow.
The answers to these questions hinge critically on the underlying
economic outlook, but in more ways that you might think.
Clearly, the health (or lack thereof) of the Canada economy
informs how much of a fiscal push is needed—few would argue
the point. Increasingly, however, the economy risks capping how
much room Ottawa has to dish up stimulus, unless the
government opts to further relax its longer-term fiscal
commitments. The irony is that the more real and nominal
growth falters, the more the federal government ties its own
hands by committing itself to an arbitrary debt burden target.
Make no mistake; this is hardly a theoretical discussion. More
likely sooner than later, something’s going to have to give.
From surplus to deficit, lickety-split
It was only ten months ago, in an April 2015 budget, that the
federal government proudly proclaimed a renewed era of federal
surpluses for Canada. No sooner had the budget landed than
the economy soured, taking Ottawa’s finances with it. By the
time a new Liberal government had been sworn in and a
November 2015 fiscal update released, those surpluses had
been transformed into modest deficits (before allowing for any
fiscal stimulus).
We haven’t exactly staunched the bleeding; if anything, it’s
continuing to pool up. As we’re seeing in Alberta, Saskatchewan
and most notably Newfoundland and Labrador, commodity price
declines (particularly for oil) and associated weakness in real
GDP growth are a nasty one-two punch, fiscally speaking. The
federal government may not levy royalties on non-renewable
resources the way provinces do, but repeated downgrades to
the national growth outlook have nonetheless dealt a heavy blow
to the federal budget balance.
Quantifying the fiscal hit
We detail Canada’s evolving economic outlook in Table 1. You’ll
see that for each and every year from 2016 to 2019, National
Bank anticipates weaker real GDP growth and slower GDP
inflation than what was outlined in the government’s November
update. Over time, a yawning gap opens up between the level of
economic activity that had been telegraphed in April and where
we see Canada headed (Chart 1, page 2). Consistent with our
more tepid growth forecast, we also maintain a relatively more
dovish interest rate outlook (i.e., much lower short- and longterm interest rates than those envisioned in November).
Table 1: Key economic assumptions
Federal planning assumptions vs NBF (annual averages)
%
2015
2016
2017
2018
2019
Apr-2015 budget
1.6
4.9
4.7
4.3
4.2
Nov-2015 fiscal update
0.9
4.1
4.6
4.4
4.2
Feb-2016 NBF forecast
0.6
1.6
3.7
3.5
3.5
Apr-2015 budget
2.0
2.2
2.3
2.2
2.0
Nov-2015 fiscal update
1.2
2.0
2.2
2.2
2.0
Feb-2016 NBF forecast
1.2
0.9
1.7
1.5
1.5
Apr-2015 budget
0.6
1.0
2.0
2.7
3.0
Nov-2015 fiscal update
0.5
0.6
1.3
2.1
2.7
Feb-2016 NBF forecast
0.5
0.5
0.6
1.1
1.6
Apr-2015 budget
1.7
2.5
3.2
3.7
3.9
Nov-2015 fiscal update
1.5
2.1
2.8
3.3
3.6
Feb-2016 NBF forecast
1.5
1.2
1.8
2.2
2.5
Nominal GDP growth
Real GDP growth
3-month treasury bill rate
10-year government bond rate
Source: NBF, federal gov't | Note: NBF figures for 2018-2019 presented for planning purposes
Utilizing official federal government sensitivities, our weaker
real/nominal GDP growth profile, should it come to pass, would
rob Ottawa of $50 billion of revenue over the coming four fiscal
years. Granted, the impact of lower-than-planned interest rates
softens the blow…a bit.
Whether you’re a finance minister, corporate treasurer or heavily
indebted household, low rates are the gift that keeps on giving.
But you want to be careful what you wish for. As a general rule,
the weaker growth that attends lower interest rates is a net
losing proposition for senior levels of government (i.e., lost
revenue trumps interest savings). That’s exactly how we see
things playing out through 2019-20.
1
GOVERNMENT CREDIT
Chart 1: Weaker trajectory for economy
Chart 2: Surplus turns into $25bln deficit?
Canadian nominal GDP: Federal planning assumptions vs NBF
Evolution of federal budget balance (after adjustment for risk)
2450
5
$bln
2400
$bln
0
2350
2300
-5
2250
-10
2200
-15
2150
2100
-20
Apr budget
Nov update
Nov update w/ risk adj
NBF
2050
2000
1950
2015
2016
2017
2018
-25
Apr budget
2016-17
2019
Source: NBF, federal government
Nov update
NBF eco outlook
NBF w/ election stimulus
-30
2017-18
Source: NBF, federal government
1
After making a series of other necessary adjustments , we
estimate that Ottawa’s underlying fiscal position for 2016-17 has
deteriorated by $15 billion since April’s budget and $9 billion
since November (Table 2). The size of the fiscal miss versus
earlier official forecasts gets bigger the further out you go.
The combined impact of a weaker underlying economy and
pledged stimulus could, all else equal, produce a cumulative
deficit of $90 billion over this government’s four-year mandate.
That represents a net erosion of $100 billion relative to a budget
plan presented not quite 10 months ago.
Table 2: Detailed fiscal adjustments
Debt ratio target could unnecessarily tie
government’s hands
Evolution of federal budget balance, incorporating NBF adjustments
C$bln
2016-17 2017-18 2018-19 2019-20 4Y Sum
Official budget balance projections (after adjustment for risk)
Apr-2015 budget
A
1.7
2.6
2.6
4.8
11.7
Nov-2015 fiscal update
B
-3.9
-2.4
-1.4
1.7
-6.0
NBF economic adjustments (relative to Nov-2015 assumptions; see Table 1 for details)
Weaker real GDP growth
C
-5.3
-8.1
-11.8
-14.5
-39.7
Slower GDP inflation
D
-2.9
-3.2
-2.7
-2.9
-11.8
Lower interest rates
E
0.4
1.5
3.3
5.5
10.8
Other adjustments
F
-1.5
-1.7
-1.3
-1.1
-5.5
G: Sum C-F
-9.3
-11.5
-12.5
-13.0
-46.3
Sub-total
Revised balance (incl. NBF adjustments & pledged stimulus for illustrative purposes)
Underlying fiscal balance
H: B+G
-13.2
-13.9
-13.9
-11.3
Liberal platform stimulus*
I
-10.5
-11.7
-9.1
-6.6
-37.9
J: H+I
-23.7
-25.6
-23.0
-17.9
-90.2
Post-stimulus balance?
-52.3
Source: NBF, federal gov't | Notes: Revised balances include risk adjustment of $3bln/year;
Liberal platform stimulus represents difference in "new investment" and "new revenue"
It’s important to note that these prospective deficit figures do not
incorporate fiscal stimulus. What do we know of planned
stimulus? On the campaign trail, the Liberal party outlined $38
billion of net new spending over four years. Factoring in the
weaker underlying budget position, adding this pledged stimulus
would leave the resulting federal deficit at ~$25 billion in each of
2016-17 and 2017-18, or 1.2% of GDP/year (Chart 2).
Little wonder then that the government has de-emphasized
earlier pledges to limit the deficit to $10 billion a year and return
to balance by the end of its mandate. Given our economic
forecast, achieving such arbitrary fiscal objectives would entail
more than just putting off stimulus, but actually require higher
taxes and/or reduced spending in the years’ ahead. And tighter
federal fiscal policy is about the last thing a moribund Canadian
economy needs right now.
What of the new government’s remaining fiscal commitment to
2
keep the debt-to-GDP ratio on a downward trajectory ? It’s
increasingly coming into play. As of 2015-16, the federal debt-toGDP ratio was estimated at just over 31%. We’ve run a number
of scenarios to quantify how much red ink the government can
run for a given nominal GDP growth rate while leaving the debt
burden in 2019-20 no higher than it is today. We summarize
findings in Table 3 (page 3).
For instance, at 5% average annual nominal GDP growth—the
long-term trend prior to the global financial crisis—Ottawa would
be able to run annual deficits in excess of $30 billion and still
keep its debt-to-GDP ratio marching lower. In other words, take
a rosy enough view of medium-term growth and a declining debt
ratio objective needn’t be restrictive. But the corollary also holds.
The slower nominal GDP growth becomes, the smaller the
1
Adjustments include: revenue loss from recent personal income tax
changes; impact of extra net debt on interest charges; adjustments to
certain federal transfers due to slower nominal GDP growth.
2
The Liberal platform pledged to reduce the federal debt-to-GDP ratio to
27% by 2019-20, where debt represents the accumulated deficit.
2
GOVERNMENT CREDIT
annual deficit has to be in order to hold the debt burden in
check. Should growth average something closer to 3% from
2016 to 2019—more in line with NBF’s current thinking—holding
the line on the debt burden would mean limiting the average
annual deficit through 2019-20 to less than $20 billion.
the federal debt-to-GDP ratio down to size (and given rock
bottom interest rates fundamentally bolster debt affordability now
and into the future) Canada needs to ask itself: do we need the
federal debt burden to keep falling forever and ever until the end
of time? Probably not.
And there’s the rub. If our economic forecasts are on the mark,
keeping the debt-to-GDP ratio moving lower might force the
federal government to provide less not more stimulus than what
was promised on the campaign trail. If you think that would be
an unsavory outcome for the Canadian economy, we’d tend to
agree with you.
To be clear, we’re not advocating a wholesale abandonment of
responsible fiscal management. But Ottawa might want to
consider further relaxing its medium-term debt target in order to
enhance flexibility to offer up an enlarged and/or accelerated
fiscal stimulus package—support that a slumping Canadian
economy increasingly needs.
When it comes right down to it, running deficits of $30-35 billion
(something like 1½% of GDP) for a few years isn’t going to
erode Ottawa’s long-term fiscal sustainability. Yes, deficits of
that magnitude in an environment of slower nominal growth
might technically add a couple percentage points to the
government’s debt burden. But given past success in wrestling
Warren Lovely
Managing Director,
Head of Public Sector Research and Strategy
[email protected]
Table 3: Where’s the federal debt-to-GDP ratio headed…a few scenarios
Federal debt-to-GDP ratio in 2019-20 under different deficit/growth combinations (ratio estimated at 31.1% as of 2015-16)
Average annual deficit: 2016-17 to 2019-20 (C$bln)
growth: 2016-2019 (%)
Avg annual nominal GDP
0
5
10
15
20
25
30
35
40
45
50
6.0
24.6
25.4
26.2
27.0
27.8
28.6
29.4
30.2
31.0
31.8
32.6
5.5
25.1
25.9
26.7
27.5
28.3
29.1
30.0
30.8
31.6
32.4
33.2
5.0
25.6
26.4
27.2
28.0
28.9
29.7
30.5
31.4
32.2
33.0
33.8
4.5
26.0
26.9
27.7
28.6
29.4
30.3
31.1
32.0
32.8
33.7
34.5
4.0
26.6
27.4
28.3
29.1
30.0
30.9
31.7
32.6
33.4
34.3
35.2
3.5
27.1
27.9
28.8
29.7
30.6
31.5
32.3
33.2
34.1
35.0
35.8
3.0
27.6
28.5
29.4
30.3
31.2
32.1
33.0
33.9
34.8
35.7
36.5
2.0
28.7
29.6
30.6
31.5
32.4
33.3
34.3
35.2
36.1
37.1
38.0
1.0
29.8
30.8
31.8
32.8
33.7
34.7
35.7
36.6
37.6
38.6
39.5
0.0
31.1
32.1
33.1
34.1
35.1
36.1
37.1
38.1
39.1
40.1
41.1
Source: NBF | Note: Figures in above table represent resulting debt-to-GDP ratio in 2019-20; red shading denotes
average annual GDP growth/average annual deficit combinations that produce no net increase in debt-to-GDP ratio by 2019-20
3
GOVERNMENT CREDIT
ECONOMICS AND STRATEGY
Montreal Office
514-879-2529
Toronto Office
416-869-8598
Stéfane Marion
Marc Pinsonneault
Warren Lovely
Chief Economist & Strategist
Senior Economist
MD, Public Sector Research and Strategy
[email protected]
[email protected]
[email protected]
Paul-André Pinsonnault
Matthieu Arseneau
Senior Fixed Income Economist
Senior Economist
[email protected]
[email protected]
Krishen Rangasamy
Angelo Katsoras
Senior Economist
Geopolitical Associate Analyst
[email protected]
[email protected]
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