February 10, 2016
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.
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.
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).
Federal planning assumptions vs NBF (annual averages)
% 2015 2016 2017 2018 2019
Nominal GDP growth
Apr-2015 budget
Nov-2015 fiscal update
Feb-2016 NBF forecast
Real GDP growth
Apr-2015 budget
Nov-2015 fiscal update
Feb-2016 NBF forecast
3-month treasury bill rate
Apr-2015 budget
Nov-2015 fiscal update
Feb-2016 NBF forecast
10-year government bond rate
Apr-2015 budget
Nov-2015 fiscal update
Feb-2016 NBF forecast
1.6
0.9
0.6
2.0
1.2
1.2
0.6
0.5
0.5
1.7
1.5
1.5
4.9
4.1
1.6
2.2
2.0
0.9
1.0
0.6
0.5
2.5
2.1
1.2
4.7
4.6
3.7
2.3
2.2
1.7
2.0
1.3
0.6
3.2
2.8
1.8
4.3
4.4
3.5
2.2
2.2
1.5
2.7
2.1
1.1
3.7
3.3
2.2
4.2
4.2
3.5
2.0
2.0
1.5
3.0
2.7
1.6
3.9
3.6
2.5
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). T hat’s exactly how we see things playing out through 2019-20.
1

GOVERNMENT CREDIT
Canadian nominal GDP: Federal planning assumptions vs NBF
2450
2400
2350
2300
2250
2200
2150
2100
2050
2000
1950
$bln
2015 2016 2017
Apr budget
Nov update
Nov update w/ risk adj
NBF
2018 2019
Source: NBF, federal government
After making a series of other necessary adjustments
1
, we estimate that Ottawa’s underlying fiscal position for 2016-17 has deteriorated by $15 billion since April’s budget and $9 billion since November (Table 2). The size of the fiscal miss versus earlier official forecasts gets bigger the further out you go.
Evolution of federal budget balance, incorporating NBF adjustments
C$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
Nov-2015 fiscal update B -3.9
-2.4
-1.4
4.8
1.7
11.7
-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
Lower interest rates
D
E
-2.9
0.4
-3.2
1.5
-2.7
3.3
-2.9
5.5
-11.8
10.8
Other adjustments
Sub-total
F
G: Sum C-F
-1.5
-9.3
-1.7
-11.5
-1.3
-12.5
-1.1
-13.0
-5.5
-46.3
Revised balance (incl. NBF adjustments & pledged stimulus for illustrative purposes)
Underlying fiscal balance H: B+G -13.2
-13.9
-13.9
-11.3
-52.3
Liberal platform stimulus*
Post-stimulus balance?
I
J: H+I
-10.5
-23.7
-11.7
-25.6
-9.1
-23.0
-6.6
-17.9
-37.9
-90.2
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).
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.
Evolution of federal budget balance (after adjustment for risk)
5
$bln
0
-5
-10
-15
-20
-25
Apr budget Nov update NBF eco outlook NBF w/ election stimulus
-30
2016-17
Source: NBF, federal government
2017-18
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.
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 keep the debt-to-GDP ratio on a downward trajectory
2 ? It’s increasingly coming into play. As of 2015-16, the federal debt-to-
GDP 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 obj ective needn’t be restrictive. But the corollary also holds.
The slower nominal GDP growth becomes, the smaller the
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, w e’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 $30-35 billion
(something like 1½% of GDP) for a few years isn’t going to erode Ottawa’s long-term fiscal sustainability. Yes, deficits of that magnitude in an environment of slower nominal growth might technically add a couple percentage points to the government
’s debt burden. But given past success in wrestling
Managing Director,
Head of Public Sector Research and Strategy warren.lovely@nbc.ca
Federal debt-to-GDP ratio in 2019-20 under different deficit/growth combinations (ratio estimated at 31.1% as of 2015-16)
0 5 10
Average annual deficit: 2016-17 to 2019-20 (C$bln)
15 20 25 30 35
6.0
5.5
5.0
4.5
4.0
3.5
3.0
2.0
1.0
0.0
24.6
25.1
25.6
26.0
26.6
27.1
27.6
28.7
29.8
31.1
25.4
25.9
26.4
26.9
27.4
27.9
28.5
29.6
30.8
32.1
26.2
26.7
27.2
27.7
28.3
28.8
29.4
30.6
31.8
33.1
27.0
27.5
28.0
28.6
29.1
29.7
30.3
31.5
32.8
34.1
27.8
28.3
28.9
29.4
30.0
30.6
31.2
32.4
33.7
35.1
28.6
29.1
29.7
30.3
30.9
31.5
32.1
33.3
34.7
36.1
29.4
30.0
30.5
31.1
31.7
32.3
33.0
34.3
35.7
37.1
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
30.2
30.8
31.4
32.0
32.6
33.2
33.9
35.2
36.6
38.1
40
31.0
31.6
32.2
32.8
33.4
34.1
34.8
36.1
37.6
39.1
45
31.8
32.4
33.0
33.7
34.3
35.0
35.7
37.1
38.6
40.1
50
32.6
33.2
33.8
34.5
35.2
35.8
36.5
38.0
39.5
41.1
3

GOVERNMENT CREDIT
514-879-2529
416-869-8598
Chief Economist & Strategist Senior Economist MD, Public Sector Research and Strategy stefane.marion@nbc.ca marc.pinsonneault@nbc.ca warren.lovely@nbc.ca
Senior Fixed Income Economist Senior Economist paulandre.pinsonnault@nbc.ca matthieu.arseneau@nbc.ca
Senior Economist Geopolitical Associate Analyst krishen.rangasamy@nbc.ca angelo.katsoras@nbc.ca
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