Transcript of a Conference Call on the Staff Report for the 2011 Article IV Consulation with Canada
December 22, 2011IMF Mission Chief Gian Maria Milesi-Ferretti and Deputy Division Chief Oya Celasun
Washington, December 22, 2011
MS. BECKMAN: Good morning. I am Jennifer Beckman with External Relations and this morning we’ll be talking about the Staff Report for the 2011 Article IV Consultations with Canada. Oya Celasun will start off the call. She’s the deputy division chief for the North America Division in the Western Hemisphere Department, and later we’ll be joined by Gian Maria Milesi-Ferretti, who is the Assistant Director in the Western Hemisphere Department. He’s a little delayed but he will join us as we’re in progress.
Oya is going to make some brief introductory comments and then we will take your questions.
MS. CELASUN: Thank you. The recovery of the Canadian economy is well advanced. The economy grew strongly in 2010 above its potential rate of growth. This good performance reflected a decisive policy response and a relatively resilient financial sector.
The challenge going forward is to accept the appropriate pace of normalization for macroeconomic policies.
The outlook for Canada is favorable but we recognize that the external risks are elevated from Europe and from the response of the rest of the world to the situation in Europe. So, the key question that we addressed to the authorities in this consultation was, at what pace they should normalize macroeconomic policies?
We think that if the authorities focus on shifting towards fiscal consolidation, it is appropriate given the stage of the recovery and given the outlook for fiscal balances going forward. But downside risks are elevated, so it’s our view that Canada has the scope to respond flexibly to changes in the external environment and its own outlook, including by allowing the deficit to automatically widen if the economy weakens, or consider some stimulus if there’s a very adverse scenario.
Another topic that we focused on was the outlook for household debt and house prices. Again, our recommendation is that if there are continued further sustained increases in household debt going forward, the authorities could consider further macroprudential measures.
Other than that, we found the financial sector to be in a solid position and is in a good position to weather volatility and the authorities have the appropriate tools for providing liquidity support if the external environment worsens.
Happy to take any further questions.
QUESTION: Couple of questions. I noticed that there was talk about exercising vigilance over the housing market and household debt, and that maybe stronger or more oversight was required of the CMHC, or Canada Mortgage Housing Corp. What concerns might there be about the CMHC and the increased levels of personal debt, much of it of the mortgage variety?
MS. CELASUN: Thank you. I think you’re highlighting two slightly separate concerns. One of them is the outlook for household debt. The elevated level of debt, the relatively historic norms for Canada, poses a vulnerability. If Canada is hit by an external shock, the fact that household debt levels are high could amplify the adverse effect of the external shock and lead to some deleveraging of the household sector.
So, it’s our view that, going forward, the authorities should remain vigilant, as they have, they are closely watching these risks, but we believe that if household debt continues to rise going forward in a sustained way, further macro-prudential measures could be introduced.
Then you had a question on the oversight of the CMHC?
QUESTION: Yeah, what exactly is the concern there, in other words, specifically about oversight on the CMHC?
MS. CELASUN: The issue there is that the CMHC is a large financial institution, it plays an important role in the Canadian mortgage sector. From that perspective our recommendation is to enhance its supervision and oversight. It wasn’t linked to any particular concern, but we believe, given its important role, the supervision and oversight could be enhanced.
QUESTION: Okay. Okay, that’s great. And one last question. You also mentioned the Canadian provincial governments need to exercise some fiscal consolidation plans. Is there a concern that the state of some of the provincial governments’ public finances may be in worse shape than the federal government’s?
MS. CELASUN: All levels of government are moving toward fiscal consolidation and the provinces have stated their aim to return to balanced budgets over the medium term. Further specificity of measures will be helpful.
QUESTION: Yes, a couple of things I know have cropped up here in Canada, one is the idea of the mortgage / rental ratio. That is getting quite close to the housing collapse of the early ’90s and I’m wondering if this is something that you noted.
And the second thing is, obviously, with Canada being so resource-based there are some economists noting that -- concerning Quebec and Ontario, that there is probably a case of Dutch Disease happening in the rest of the economy. Do you actually have any comments on these issues?
MR. MILESI-FERRETTI: It is true that the house-price-to-rent ratio in Canada has been rising quite steeply and we’ve been arguing that there are a number of indicators that projected the housing market is very buoyant and that this is why we’ve devoted so much attention to it.
Again, we think that the overall infrastructure of the mortgage market in Canada is very different from the infrastructure of the mortgage market in the U.S. pre-crisis, for example, and that you have a set of clear rules with a clear government backstop through the CMHC, so I don’t think it is a structure that is as vulnerable as the U.S. was, but I think it is legitimate to monitor closely what is happening to household debt and house prices precisely because you’re in an environment in which low interest rate incentives are to increase borrowing.
And yet, we know that at some point interest rates are going to increase and at some point house prices may actually decline, and you need to be prepared for that and consumers and households need to be prepared for that.
Let me then move on to your other question. You’re certainly right that the Canadian dollar has been moving quite strongly in tandem with commodity prices and that this particular link has put strain on sectors of the economy that are more reliant on manufacturing activity like, as you mentioned, Ontario and Quebec.
In part, it has been a global shift in relative prices that has created incentives for increasing the allocation of resources to the commodity sector. And given the pace of growth in emerging markets, I’m not thinking so much about the cyclical base of growth, but more about the structural increase in the importance in the global economy of these countries, it is conceivable that the commodity sector is going to be quite resilient. In that sense, an allocation of resources towards that sector is not necessarily a bad thing.
On the manufacturing side, you’re absolutely right, that it would suffer from a strong exchange rate. I would also note, though, that these sectors have also been penalized by the situation in the United States, so there are two factors that basically affect their economic outlook based on exports. One is the prices, of course, but the other is, what is external demand going to be, and Canada was particularly exposed to U.S. sectors that experienced a particularly severe downturn.
With the U.S. economy recovered, that aspect should gradually go away and that, together with productivity increases, would provide some momentum to Canadian manufacturing as well.
QUESTION: I have two questions. First, the IMF, in the past, has made the point of criticizing Canada’s securities regulatory system, citing the fact that the country doesn’t have a unified national regulator. That quest, or the quest to create one, has received a blow today from the Supreme Court. So, I wondered if I could get you to comment on this issue again just in context of that decision and just the impact on Canada’s financial system of having this bifurcated regulatory system for securities.
And then secondly, back to CMHC, could I get you to talk about the government’s response to your suggestion that the CMHC needs enhanced regulation and just what your specific proposals might be to better regulate CMHC.
MR. MILESI-FERRETTI: Okay, we got the news of the decision of the Supreme Court just this morning. All I can say is what we say in the Staff Report, just reiterate our longstanding view, that we, of course, are, you know, economists and experts on economic grounds. We think there is a case to be made to have a securities regulator on a national basis, and that is the case that we made in the Staff Report, and it is a case that was made by Canadian authorities as well.
Again, we are talking about strictly about economic grounds and we are clearly not in a position to comment about the legal infrastructure.
If I can briefly touch on the CMHC. So, our point is primarily that the boom in house prices, increasing household debt, having played basically a more central role for the Canadian Mortgage and Housing Corporation, than it used to have, so it is not really a criticism of the behavior of the Canadian Mortgage and Housing Corporation, which has a number of mandates, of course, and not just the provision of insurance. But we are just noting that we are in an environment in which de facto the CMHC is one of the largest financial institutions in Canada, and has clearly a particularly important role in the overall financial sector stability.
And from that broad perspective, in our view, it would make sense to have a system of sort of stress testing, of supervision, that relates a little bit more closely to this very important financial sector role. And what I can say is that in our dialogue with the Canadian authorities that there is clearly very much an awareness of the situation, very much an awareness of the fact that -- of the very important role played by this institution, and that is in a sense, it was a commonality of views in that sense, that it is an institution with a particularly important presence in financial markets.
And I think the Canadian authorities have tightened mortgage regulations and have clearly indicated that they are watching what is happening on housing market quite closely.
QUESTION: Two quick questions. One on your scenario on the declining house prices, the 15 percent decline. I just wanted to see whether the impact on the declining private consumption was a decline in percentage points of the growth rate of consumption or if it was an overall 1.5 percent decline in consumption.
And my second question, the measures that the IMF staff suggested to maybe tighten the rules to lending, are there some specific ones that the authorities agreed to? Because, you know, you mentioned that they are ready, perhaps, to do more, but not in details, and you also mentioned that they’re not ready to look into different roles in different provinces. So, is there anything concrete that they are considering? Thank you.
MS. CELASUN: Yes. On the question on how a house price decline would affect consumption, we have a chapter on this. There’s some background work there. We looked at a 10 percent hypothetical reduction in house prices. Our estimates pointed to 1 percent, slightly more than 1 percent decline in the level of consumption over time corresponding to half a percentage power lower real GDP level.
Again, that was just to highlight the sensitivity of consumption to the house prices.
On your question on the policy dialogue, on macroprudential measures , our suggestion is that, again, as I mentioned earlier, if there are further sustained drivers in household debt, then we are of the view that the authorities can consider some further type of measures and our particular suggestions in that area were to potentially, if needed, further tighten, further raise down payment requirements for house purchases and to set lower limits for debt service costs for households.
QUESTION: But do the authorities agree with that?
MS. CELASUN: They are watching the market closely. They have already taken these types of measures. I think these are some of the tools that would be available to them.
MR. MILESI-FERRETTI: Yeah, as we indicated in the report, we provided some suggestions and I think, again, the authorities have indicated that they’re watching things closely. They clearly want to see what is the outcome of the measures that have been taken just a few months back. So, let a few months go by to see, you know, is there a more sustained slowing of the growth rate in household debt. And, of course, watch the international environment quite carefully.
You may have very severe hits to consumer confidence because of a very unsettled global environment, so there are other factors that could affect households’ propensity to borrow other than the low level of interest rates.
So, all these things bear watching. Our point was just that should the pace of household debt increases exceed in a material way the increase in disposable income over a sustained period of time, then of course one would want to keep in the arsenal of measures that could be deployed a further tightening of mortgage insurance regulation.
QUESTION: My question is about Europe and how much of a threat is the European debt crisis to Canada’s growth prospects? And, more specifically, what are the chances that the growth forecast will need to be cut further in Canada?
MR. MILESI-FERRETTI: Clearly, there would be an impact. Canada has the direct trade linkages with Europe. They’re not very large, so we would not expect a very large impact from a decline in European demand for Canadian products.
More of concern are the potential global financial market repercussions of turmoil in Europe and there is a lot of uncertainty about that. So, again, we see those threats not so much coming from direction of say direct exposures of Canadian banks to euro area financial institutions, for example, but more through the impact that this global financial market turmoil would have more generally.
For example, you know, increased demand for liquidity, higher cost of short-term borrowing for banks, declines in consumer business confidence and in stock market valuations, and all those collateral factors could take a much heavier toll than we think the direct linkages from the euro area economy to Canada.
So, clearly, we see the impact on Canada as being very tightly linked to the impact on the global environment and should the impact on the global financial markets and the global environment be more severe, Canada being a very open economy, very integrated in the global economy, we would clearly see a stronger impact on Canada.
Again, our views are, as we state in the Staff Report, that we think Canada starts from a strong position, you know, a resilient financial system. It has dealt very well with a very severe crisis just next door, so I don’t want to underplay the global risks from turmoil in Europe. I just want to state that I don’t think that Canada, certainly not the financial system, comes at this stage in a vulnerable position. That’s not the case.
QUESTION: But what is your base case scenario for how the financial market turmoil developed from here?
MR. MILESI-FERRETTI: Well, you know, the institution is in the process of elaborating updates on our global outlook and I think those would be available in late January, so it’s clearly very high in our thinking process how the material impact of the global environment is going to effect, you know, individual economies, but that is the stage at which we are.
QUESTION: The report also talks about the need to contain healthcare costs in light of an aging population. The provinces -- well, I guess, the federal government sort of outlined to the provinces its approach for healthcare transfers for the medium-term. Just wondering if that plan -- what the IMF’s thoughts are of that plan and does that go to -- is this a starting point? Just your thoughts in general.
MR. MILESI-FERRETTI: We think this is clearly an important medium-term challenge for Canada and we think the review of the transfers, that is going to have to take place by 2014-15, will be a good opportunity to devise a strategy between the federal government and the provinces to address this issue.
As you are well aware, the amount of the federal government transfer to the provinces covers only a fraction of total provincial healthcare spending. So, there is clearly an issue between the federal government and the provinces on how the structure of transfers is going to be designed going forward, but we think there is a general government issue, something that affects the overall Canadian economy, which is how do you get to contain the rate of growth in healthcare costs in the aggregate? That is clearly an important -- another important element in the agenda.
We understand it is very important, of course, to discuss how the financing works and what is the relative role of the federal government versus the provinces, but we think there is also clearly a very important point to devise strategies that help contain health costs over time.
Canada is clearly not alone in this big issue, as you know for the United States, and not just for the United States, so by it’s no means an easy challenge, but that is clearly something that warrants attention, I think in the medium-term, is one of the big issues.