## _cr05118 — Executive Summary

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### Macroeconomic performance and outlook
- Since the mid-1990s, Canada achieved the fastest growth rate among major industrial countries supported by inflation targeting, a federal fiscal objective of balanced budgets or better, and structural reforms.
- Real GDP growth averaged 3½ percent a year since 1995—2½ percent on a per capita basis.
- Net debt ratio fell by about 35 percentage points of GDP since 1995, moving Canada’s net debt ratio from second highest to the lowest within the G-7.
- Recent indicators and developments:
  - Real final domestic demand has grown at an annual rate of around 3½ percent since early 2002.
  - Corporate profits rose 20 percent year-on-year in the third quarter of 2004.
  - Residential mortgage loans have increased at an annual rate of 9 percent since mid-2003.
  - House prices have increased by around 7 percent per year.
  - Household saving rate has dropped to zero and household debt has risen to over 100 percent of disposable income.
  - Export volumes rebounded strongly from early 2003 but began retreating in the third quarter of 2004; the trade surplus remains well above 5 percent of GDP.
  - The Canadian dollar strengthened by almost 20 percent in real effective terms in 2003 and has appreciated further since mid-2004.
  - Staff estimates: output gap about ½ percent of GDP; potential output growth around 3 percent a year.
  - Unemployment rate is now at 7 percent—the staff’s estimate of the NAIRU.
  - Year-on-year inflation: rose to 2¼ percent (overall) and 2 percent (core) in July; the core rate fell to 1½ percent in November.
  - Staff estimate the real exchange rate is now essentially consistent with underlying fundamentals.

### Monetary policy
- Bank of Canada actions and stance:
  - Began withdrawing stimulus with 25 basis point increases in the target overnight rate in September and October, bringing the target to 2½ percent.
  - Bank suggested further rate hikes would be needed to keep core inflation to 2 percent at end-2005 but paused in December, citing concerns about the exchange rate’s impact on activity.
- Assessment and guidance:
  - Bank appears to have room to maintain a patient and measured approach to withdrawing stimulus.
  - Further interest rate hikes likely to be needed, but absence of wage pressures, anchored inflation expectations, and risks to the outlook warrant a cautious and pragmatic approach.
  - Markets expect the pause to continue through the first half of next year.
- Inflation-targeting framework:
  - Aim: keep 12-month change in the CPI in the middle of a 1–3 percent target band over an 18–24 month horizon.
  - Review of the regime scheduled to be completed by end-2006; early focus likely on definition of core inflation, forecasting horizon, and the role of asset prices.

### Fiscal policy and public finances
- Fiscal outcomes and framework:
  - Fiscal surpluses maintained and debt continues to fall.
  - Federal budget surplus in FY 2003–04 (April to March) reached ¾ percent of GDP, despite post-budget spending measures of ¼ percent of GDP.
  - Provincial finances deteriorated slightly but budgets in aggregate remained close to balance; general government recorded a significant surplus.
  - New objective: lower the federal debt-to-GDP ratio to 25 percent within ten years.
- Constraints and policy implications:
  - Recent agreements with provinces have all but removed room for fiscal maneuver.
  - Given very limited room, authorities should weigh carefully merits of spending programs versus further reducing the relatively high tax burden.
  - The two-year rolling commitment to budget balance or better and prudence elements (C$3 billion contingency reserve; economic prudence factor rising by C$1 billion each year) underpin the fiscal framework.
- Federal Budget: Staff Projections (In percent of GDP)
  - Revenue: 2004/05 15.0; 2005/06 14.6; 2006/07 14.6; 2007/08 14.6; 2008/09 14.6
  - Outlays: 2004/05 14.4; 2005/06 14.3; 2006/07 14.2; 2007/08 14.1; 2008/09 13.8
    - Of which: New commitments: 0.3; 0.4; 0.4; 0.4; 0.4
  - Operating balance: 2004/05 0.6; 2005/06 0.3; 2006/07 0.4; 2007/08 0.5; 2008/09 0.8
  - Contingency Reserves: 0.2; 0.2; 0.2; 0.2; 0.2
  - Prudence factor: -; 0.1; 0.1; 0.2; 0.2
  - Planning balance: 0.4; 0.0; 0.1; 0.1; 0.4
  - Net debt (in percent of GDP): 2004/05 38.1; 2005/06 35.8; 2006/07 33.6; 2007/08 31.5; 2008/09 29.2

### Health care and structural policies
- Sustainability and efficiency challenges:
  - Health care spending rising at an unsustainable pace due to increased utilization, population aging, and rapid technological innovation.
  - Major challenge: improve system efficiency by strengthening incentives for both providers and consumers.
  - Responsibility largely lies with provinces; encourage diversity of provincial strategies to control costs and reform public systems.
- Broader structural reform needs:
  - Raise underlying labor productivity growth and economic flexibility.
  - Policies to lower the tax burden, minimize disincentives from social transfers, and reduce barriers to trade and competition.
  - Specific proposals: fund social-assistance components through general revenues to reinforce insurance principle; reduce incentives for early retirement; address low “welfare walls.”

### Financial sector and regulatory reforms
- Banking sector soundness and indicators:
  - Banks’ return on equity rose to 14¾ percent in FY 2002–03 from 9¼ percent the previous year.
  - Banks boosted capital ratios to 13½ percent.
- Reform options to promote flexibility:
  - Clarify regulatory framework governing bank mergers, including the “public interest” criterion.
  - Adopt a single national securities regulator to reduce compliance and administrative costs.
  - Harmonize regulation of defined benefit pension plans and consider enhancing incentives for funding.
- Regulatory developments and areas of limited progress:
  - Five-year revision to financial services regulation to begin; streamlining agency roles could be considered.
  - FINTRAC implementing anti-money-laundering legislation.
  - Progress on securities regulation coordination underway but resistance to full unification remains.

### Risks and priorities
- Principal risks to outlook:
  - External shocks, exchange rate appreciation, uncertainty about net exports, and commodity price volatility for an open, U.S.-oriented, commodity-intensive economy.
  - External demand uncertainty: 85 percent of Canadian exports destined for the United States; higher oil prices could cool U.S. growth; U.S. monetary tightening could weigh on Canadian manufacturing and lumber exports.
- Important short- and medium-term priorities:
  - Continue cautious monetary withdrawal while monitoring slack and wage pressures.
  - Preserve fiscal surpluses and advance credible debt reduction toward the 25 percent federal debt-to-GDP target within ten years.
  - Pursue structural reforms to raise productivity, improve health care efficiency, and liberalize competition and trade.
  - Advance targeted financial sector reforms to maintain a sound and flexible regulatory environment.

### Growth outlook and projections
- Staff expectation: growth to remain close to potential over the next year-and-a-half.
- 2005 projections and drivers:
  - Domestic demand: real consumer demand and investment growing at around 3 percent and 5 percent in 2005, respectively.
  - Aggregate projection: Growth expected to be 3 percent in 2005.
  - External drag: appreciation of the Canadian dollar and weaker external demand expected to depress exports.
- Medium-Term Projections (In percent change from previous period)
  - Real GDP: 2002 3.4; 2003 2.0; 2004 2.7; 2005 2.9; 2006 3.0; 2007 3.2; 2008 3.0; 2009 2.9
  - Final domestic demand: 2002 3.1; 2003 3.6; 2004 3.6; 2005 3.3; 2006 3.2; 2007 2.8; 2008 2.9; 2009 2.8
  - Private consumption: 2002 3.4; 2003 3.1; 2004 3.2; 2005 2.7; 2006 2.8; 2007 2.4; 2008 2.6; 2009 2.6
  - Private fixed investment: 2002 1.4; 2003 4.6; 2004 6.0; 2005 4.8; 2006 4.1; 2007 4.0; 2008 4.0; 2009 4.0
  - Net exports (contribution): 2002 -0.1; 2003 -2.4; 2004 -0.7; 2005 -0.6; 2006 0.2; 2007 0.3; 2008 0.2; 2009 0.2
  - Unemployment rate (percent): 2002 7.7; 2003 7.6; 2004 7.3; 2005 7.2; 2006 7.1; 2007 6.9; 2008 6.9; 2009 6.8
  - Consumer price index: 2002 2.3; 2003 2.7; 2004 1.8; 2005 2.3; 2006 2.1; 2007 2.0; 2008 2.0; 2009 2.0
  - Federal fiscal balance/GDP: 2002 0.6; 2003 0.7; 2004 0.6; 2005 0.3; 2006 0.4; 2007 0.5; 2008 0.8; 2009 0.8
  - Current account balance/GDP: 2002 2.0; 2003 2.0; 2004 2.8; 2005 1.8; 2006 1.9; 2007 2.2; 2008 2.4; 2009 2.6
- Memorandum projections:
  - Partner country growth: 2002 1.9; 2003 3.0; 2004 4.4; 2005 3.7; 2006 3.6; 2007 3.6; 2008 3.3; 2009 3.2
  - Oil prices ($/Barrel): 2002 25.0; 2003 28.9; 2004 37.8; 2005 40.5; 2006 38.0; 2007 36.0; 2008 35.0; 2009 34.5

### External-sector analyses and scenarios
- Exchange rate risk and passthrough:
  - Officials and private analysts identified the exchange rate as the principal risk.
  - Unusual vigor of net exports in early 2004 despite strong exchange rate appreciation in 2003 could reflect increased flexibility/efficiency or delayed adjustment.
  - Staff queried whether a fall or delay in exchange rate passthrough complicates impacts on output and prices.
- Box 2 — Oil price effects (GEM simulations):
  - A sustained 25 percent increase in oil prices would lower output by up to ¼ percent after a year.
  - A sustained 25 percent increase in oil prices could raise real GDP by ½ percent after five years, with terms of trade benefits allowing domestic spending to increase by more.
  - Regional effects: benefits to the resource-rich west (Alberta) and costs to central provinces (Ontario and Quebec).
- External projections and balance of payments (selected)
  - Current account balance (in percent of GDP): 2002 2.0; 2003 2.0; 2004 2.8; 2005 1.8; 2006 1.9; 2007 2.2; 2008 2.4; 2009 2.6
  - Net external investment position (selected, in billions): 2002 -202; 2003 -218; 2004 -159; 2005 -135; 2006 -108; 2007 -75; 2008 -38; 2009 5

### Fiscal planning horizon, risks, and transparency
- Budget horizon and uncertainty:
  - Discussion on merits of extending budget projections beyond current two-year presentation; mission agreed but cautioned against placing undue weight on planning surpluses expected to re-emerge from FY 2007/08.
  - Quantitative finding: standard deviation around a fiscal forecast is estimated at ¾ of a percent of GDP in the first year, rising to 2¼ percent of GDP by the fifth year.
  - Impulse response: a shortfall in real GDP growth of one percent per annum reduces the fiscal balance by about ¼ percent of GDP in the first year.
- Federal-provincial agreements:
  - Ten-Year Plan for Health Care: federal commitment to boost health care transfers by C$41 billion (3 percent of 2004 GDP) over the next 10 years; includes 25 percent increase to Canada Health Transfers in FY 2005–06 and a 6 percent subsequent escalator.
  - Equalization and TFF: increase support by $33 billion over next 10 years; minimum federal funding floor of C$10.9 billion for Equalization and C$2 billion for TFF for next two years, followed by 3½ percent growth in base through FY 2009–10.
- Debt management and transparency:
  - Overshoots of projected federal surpluses raised questions about credibility of fiscal framework and constrained debate over allocations.
  - Efforts to enhance fiscal transparency: reestablishment of the Office of the Comptroller General; Fiscal Update added detail on forecast conversions.

### Staff appraisal and recommendations (selected)
- Macro assessment:
  - Canada’s macroeconomic performance enviable; inflation targeting and commitment to budget balance contributed to fastest growth in the G-7 since 1995.
  - Growth expected around 3 percent into 2005; Canadian dollar appreciation broadly consistent with fundamentals.
- Policy recommendations (selected):
  - Monetary: continue measured withdrawal of stimulus; further tightening likely needed but proceed cautiously given anchored expectations and risks.
  - Fiscal: preserve surpluses, advance credible debt reduction toward 25 percent federal debt-to-GDP target within ten years; limited room for new initiatives.
  - Health care: curb cost increases, improve delivery efficiency, strengthen incentives for providers and consumers, permit diversity of provincial strategies.
  - Structural: lower tax burden where feasible, reduce barriers to trade and competition, reform EI and social-transfer interactions to boost labor utilization.
  - Financial sector: clarify bank merger regulatory framework; adopt a single national securities regulator; continue harmonization of defined benefit pension regulation.
- Next consultation:
  - It is recommended that the next consultation occur on the usual 12-month cycle.

*IMF staff report (text of content unit).*

### Executive Summary ......................................................................................................

### Executive Summary

### Macroeconomic performance and outlook
- Since the mid-1990s, Canada achieved the fastest growth rate among major industrial countries supported by inflation targeting, a federal fiscal objective of balanced budgets or better, and structural reforms.
- Real GDP growth averaged 3½ percent a year since 1995—2½ percent on a per capita basis.
- Net debt ratio fell by about 35 percentage points of GDP since 1995, moving Canada’s net debt ratio from second highest to the lowest within the G-7.
- After shocks in 2003, the economy rebounded over the last year and indicators point to a sustained expansion in 2005, but external developments create significant uncertainties.
- Key recent developments and statistics:
  - Real final domestic demand has grown at an annual rate of around 3½ percent since early 2002.
  - Corporate profits rose 20 percent year-on-year in the third quarter of 2004.
  - Residential mortgage loans have increased at an annual rate of 9 percent since mid-2003.
  - House prices have increased by around 7 percent per year.
  - The household saving rate has dropped to zero and household debt has risen to over 100 percent of disposable income.
  - Export volumes rebounded strongly from early 2003 but began retreating in the third quarter of 2004; the trade surplus remains well above 5 percent of GDP.
  - The Canadian dollar strengthened by almost 20 percent in real effective terms in 2003 and has appreciated further since mid-2004.
  - Staff estimates indicate the output gap is about ½ percent of GDP and potential output growth is around 3 percent a year.
  - The unemployment rate is now at 7 percent—the staff’s estimate of the NAIRU.
  - Year-on-year inflation: rose to 2¼ percent (overall) and 2 percent (core) in July; the core rate fell to 1½ percent in November.
  - Staff estimate the real exchange rate is now essentially consistent with underlying fundamentals.

### Monetary policy
- The Bank of Canada began withdrawing monetary stimulus with 25 basis point increases in the target overnight rate in September and October, bringing the target to 2½ percent.
- The Bank suggested further rate hikes would be needed to keep core inflation to 2 percent at end-2005 but paused in December, citing concerns about the exchange rate’s impact on activity.
- Assessment and guidance:
  - The Bank appears to have room to maintain a patient and measured approach to withdrawing stimulus.
  - Further interest rate hikes will likely be needed, but the absence of wage pressures, anchored inflation expectations, and risks to the outlook warrant a cautious and pragmatic approach to tightening.
  - Markets expect the pause to continue through the first half of next year.

### Fiscal policy and public finances
- Fiscal surpluses have been maintained and debt continues to fall.
- Federal budget surplus in FY 2003–04 (April to March) reached ¾ percent of GDP, well above earlier estimates despite post-budget spending measures of ¼ percent of GDP.
- Provincial finances deteriorated slightly but budgets in aggregate remained close to balance; general government recorded a significant surplus.
- Recent agreements with the provinces have all but removed room for fiscal maneuver.
- Policy implications:
  - Given very limited room, authorities should weigh carefully the merits of spending programs versus further reducing the relatively high tax burden.
  - The new objective of lowering the federal debt-to-GDP ratio to 25 percent within ten years provides a welcome anchor to the fiscal framework to help prepare for aging-related fiscal challenges.

### Health care and structural policies
- The sustainability and efficiency of the health care system require more action.
- Major challenge: improve system efficiency by strengthening incentives for both providers and consumers.
- Responsibility largely lies with provinces; it is important to encourage a diversity of provincial strategies to control costs and reform public systems.
- Broader structural reform needs:
  - Further measures to raise underlying labor productivity growth and economic flexibility.
  - Policies to lower the tax burden, minimize disincentives from social transfers, and reduce barriers to trade and competition.

### Financial sector and regulatory reforms
- The banking sector remains sound, supported by the recovery and buoyant financial markets.
- Key financial indicators:
  - Banks’ return on equity rose to 14¾ percent in FY 2002–03 from 9¼ percent the previous year.
  - Banks boosted capital ratios to 13½ percent.
- Reform options to promote flexibility:
  - Clarify the regulatory framework governing bank mergers.
  - Adopt a single national securities regulator.
  - Harmonize regulation of defined benefit pension plans.

### Risks and priorities
- External shocks, exchange rate appreciation, uncertainty about net exports, and commodity price volatility are key risks to the outlook for this open, U.S.-oriented, commodity-intensive economy.
- Important short- and medium-term priorities:
  - Continue cautious monetary withdrawal while monitoring slack and wage pressures.
  - Preserve fiscal surpluses and advance credible debt reduction toward the 25 percent federal debt-to-GDP target within ten years.
  - Pursue structural reforms to raise productivity, improve health care efficiency, and liberalize competition and trade.
  - Advance targeted financial sector reforms to maintain a sound and flexible regulatory environment.

*IMF Country Report — Executive Summary*

### 16. The staff expects growth to remain close to potential over the next year-and-a-half.

### 16. The staff expects growth to remain close to potential over the next year-and-a-half.

### Growth outlook and projections
- Staff expectation: growth to remain close to potential over the next year-and-a-half.
- Domestic demand: real consumer demand and investment growing at around 3 percent and 5 percent in 2005, respectively.
- Drivers:
  - Relatively easy financial conditions supporting consumption and investment.
  - Business investment spurred by increasing capacity constraints and lower prices of imported machinery and equipment.
- External sector drag:
  - Appreciation of the Canadian dollar and weaker external demand expected to continue to depress exports.
- Aggregate projection: Growth is expected to be 3 percent in 2005, broadly consistent with private sector and official projections.

- Medium-Term Projections (In percent change from previous period; unless otherwise indicated) — Projections 2002 2003 2004 2005 2006 2007 2008 2009
  - Real GDP: 3.4 2.0 2.7 2.9 3.0 3.2 3.0 2.9
  - Final domestic demand: 3.1 3.6 3.6 3.3 3.2 2.8 2.9 2.8
  - Private consumption: 3.4 3.1 3.2 2.7 2.8 2.4 2.6 2.6
  - Private fixed investment: 1.4 4.6 6.0 4.8 4.1 4.0 4.0 4.0
  - Net exports (contribution): -0.1 -2.4 -0.7 -0.6 0.2 0.3 0.2 0.2
  - Inventories (contribution): 0.6 0.9 -0.1 0.4 -0.2 0.1 0.0 0.0
  - Unemployment rate (percent): 7.7 7.6 7.3 7.2 7.1 6.9 6.9 6.8
  - Consumer price index: 2.3 2.7 1.8 2.3 2.1 2.0 2.0 2.0
  - Federal fiscal balance/GDP: 0.6 0.7 0.6 0.3 0.4 0.5 0.8 0.8
  - Current account balance/GDP: 2.0 2.0 2.8 1.8 1.9 2.2 2.4 2.6

- Memorandum items:
  - Partner country growth: 1.9 3.0 4.4 3.7 3.6 3.6 3.3 3.2
  - Oil prices ($/Barrel): 25.0 28.9 37.8 40.5 38.0 36.0 35.0 34.5

Sources: Haver Analytics; and Fund staff estimates.

### Risks and external-sector considerations
- Exchange rate risk:
  - Officials and private analysts identified the exchange rate as the principal risk for the outlook.
  - Noted the unusual vigor of net exports in the first half of 2004 despite strong exchange rate appreciation in 2003—possible interpretations: increased flexibility/efficiency or delayed adjustment.
  - Bank of Canada analysis suggested the pickup in exports partly reflected a recovery to equilibrium; since imports remain below levels suggested by long-term fundamentals, there is a risk net exports could weigh heavily in the period ahead.
- Exchange rate passthrough:
  - Staff queried whether an apparent fall in exchange rate passthrough complicated the impact of exchange rate movements on output and prices.
  - Slower or limited passthrough could reduce the responsiveness of net exports to changes in real exchange rates.
  - Officials noted it was not clear-cut that passthrough had fallen; some indicators suggested passthrough might simply have been delayed.
- External demand uncertainty:
  - Global demand conditions viewed as a major source of uncertainty, especially given that 85 percent of Canadian exports were destined for the United States.
  - Key risks: higher oil prices cooling U.S. growth; U.S. monetary tightening weighing on auto and housing markets and, in turn, Canadian manufacturing and lumber exports.
  - China and India increasingly relevant through global commodity markets and third-country channels despite modest direct trade links.

### Domestic demand, households, and investment risks
- Domestic impact of high oil prices characterized as broadly neutral:
  - Short-term: small negative impact mainly via erosion of real spending power.
  - Long-term: likely beneficial given Canada’s substantial oil and natural gas exports (see Box 2).
- Household demand:
  - Forecasters relatively sanguine about household demand.
  - Despite staff concerns that the saving rate remains below equilibrium, official and private forecasters downplayed risk of abrupt adjustment.
  - Rationale: debt service burdens manageable, lower interest rate volatility reducing balance-sheet risk, and financial institutions having limited exposure to the housing sector.
- Investment outlook:
  - Investment provided an upside potential.
  - Officials upbeat about prospects in the energy and mining sectors.
  - High corporate profitability, limits to further increases in labor participation, and exchange rate appreciation conducive to capital accumulation.

### Box 2 — The Effect of Oil Price Fluctuations on the Canadian Economy
- General assessment: Oil price changes are generally viewed as broadly neutral for the Canadian economy; Canada is the ninth largest crude oil exporter and has the second largest potential oil reserves.
- GEM simulations (Fund’s multi-country model) suggest:
  - A sustained 25 percent increase in oil prices would lower output by up to ¼ percent after a year.
  - A sustained 25 percent increase in oil prices could raise real GDP by ½ percent after five years, with terms of trade benefits allowing domestic spending to increase by more.
- Regional effects:
  - Higher oil prices benefit the resource-rich west and hurt the central and some Atlantic provinces.
  - Oil production concentrated in the prairie provinces, particularly Alberta.
  - Central provinces (Ontario and Quebec) face higher energy costs and produce 70 percent of Canada’s GDP; exchange rate appreciation can exacerbate regional differences.
- Note: The author of this box is Rodolfo Luzio. (Simulations referenced: GEM: A New International Macroeconomic Model, IMF Occasional Paper 239, 2004.)

### Monetary policy and the exchange rate
- Inflation-targeting framework:
  - Framework aims to keep the 12-month change in the CPI in the middle of a 1–3 percent target band over an 18–24 month horizon.
  - Has brought down inflation and helped anchor expectations since 1991.
  - A review of the regime scheduled to be completed by end-2006; early focus likely on definition of core inflation, forecasting horizon, and the role of asset prices.
- Policy stance and timing:
  - Bank of Canada officials and staff agreed further withdrawals of stimulus would be needed at some point; real interest rates were well below neutral and indicators suggested the economy was approaching capacity.
  - Given long and variable monetary policy lags, officials were mindful of not unduly delaying a return to a more neutral stance.
- Room for patience:
  - Mission noted room for patience in withdrawing stimulus given absence of price pressure, firmly anchored expectations, and likely impact of exchange rate appreciation on external demand—suggesting a measured approach to tightening.
  - Authorities emphasized future interest rate moves would be determined by evolving prospects for capacity and inflation and would be played “quarter-by-quarter.” (The Bank subsequently left rates on hold on December 7.)
- Use of indicators:
  - Measures of economic slack provided important input into policy, but 2003 experience (where tightening had to be reversed as activity slowed) highlighted substantial uncertainty.
  - Officials favored a more gradual interest rate response and no longer focused on the mechanistic monetary conditions index as a policy guide.
- Communication:
  - Private sector and staff commended the Bank’s communication strategy for preparing markets for monetary tightening.
  - Staff welcomed inclusion of more projection information in Monetary Policy Reports and suggested richer background on policymakers’ views could be provided at fixed action dates; officials were not convinced to publish Governing Council minutes, citing concerns about candor and legal framework.
- Exchange rate and global imbalances:
  - Authorities reiterated commitment to flexible exchange rates but were concerned about spillovers from global current account imbalances.
  - Bank officials noted 2003 currency strengthening aligned with fundamentals (rising commodity prices), but recent further appreciation was harder to explain; multilateral exchange rate adjustments to correct global imbalances could be significant and impose burdens on industrial countries with freely-floating rates.

- Box 3 — Slack and inflation (key results)
  - Core inflation remains below 2 percent, but real output, unemployment, and capacity utilization comparisons with historical trends suggest tightening capacity constraints.
  - Staff estimated an expectations-augmented Phillips curve and found considerable uncertainty about the level of slack: the 95 percent confidence interval suggests the current NAIRU could range from below 6½ percent to over 7½ percent.
  - Selected estimates (Estimate in 2004:Q4; Root Mean Squared Error; 95 percent Confidence Interval):
    - Output gap (percent of GDP): 0.1; 0.9; -1.8 to 2.0
    - Capacity utilization gap 1/: 0.2; 1.9; -3.6 to 4.0
    - Unemployment gap 1/: 0.0; 0.2; -0.4 to 0.4
    - NAIRU: 7.0; 0.3; 6.3 to 7.6
    - Trend Capacity Utilization: 87.9; 1.0; 85.9 to 90.0
  - Note: The author of this box is Alejandro Justiniano.

### Fiscal framework and sustainability
- Federal fiscal framework achievements:
  - Two-year rolling commitment to budget balance or better led to seven consecutive years of fiscal surpluses.
  - Reduced federal net debt by almost 30 percent of GDP.
  - Framework preserved flexibility via:
    - A C$3 billion contingency reserve (¼ percent of GDP).
    - An economic prudence factor that rises by C$1 billion (about 0.1 percent of GDP) each year over the forecast horizon.
    - Conservative economic assumptions.
  - Public pension system actuarially sound for at least the next 75 years.
  - Most provinces have sharply reduced deficits and cut taxes; some supported by balanced budget rules.
- FY 2004–05 Budget:
  - Reaffirmed commitment to sound fiscal management and enshrined a debt-reduction target.
  - Restored the economic prudence factor reduced in the previous year.
  - New objective: lower the federal debt ratio from 41 percent of GDP to 25 percent within ten years, providing a medium-term anchor.
  - Core commitment remains budget balance or better on a year-to-year basis, which would deliver the debt target given current estimates of potential GDP growth.
- Constraints on fiscal maneuver:
  - Room for fiscal maneuver limited because of spending commitments, including increased transfers to provinces.
  - Recent federal-provincial agreements on health and equalization committed the federal government to increase transfers over an extended period to facilitate provincial fiscal planning.
  - Economic and Fiscal Update illustrated these measures largely eliminated the planning surplus (contingency reserve and prudence factor) over the coming two fiscal years.
- Federal Budget: Staff Projections (In percent of GDP)
  - Revenue: 2004/05 15.0; 2005/06 14.6; 2006/07 14.6; 2007/08 14.6; 2008/09 14.6
  - Outlays: 2004/05 14.4; 2005/06 14.3; 2006/07 14.2; 2007/08 14.1; 2008/09 13.8
    - Of which: New commitments: 0.3; 0.4; 0.4; 0.4; 0.4
  - Operating balance: 2004/05 0.6; 2005/06 0.3; 2006/07 0.4; 2007/08 0.5; 2008/09 0.8
  - Contingency Reserves: 0.2; 0.2; 0.2; 0.2; 0.2
  - Prudence factor: -; 0.1; 0.1; 0.2; 0.2
  - Planning balance: 0.4; 0.0; 0.1; 0.1; 0.4
  - Net debt (in percent of GDP): 2004/05 38.1; 2005/06 35.8; 2006/07 33.6; 2007/08 31.5; 2008/09 29.2

- Sources: Fund staff estimates based on The Economic and Fiscal Update, November 2004.

*Source: IMF staff report (text of content unit).*

### 31. Staff and officials discussed the relative merits of adopting a five-year fiscal

### 31. Staff and officials discussed the relative merits of adopting a five-year fiscal planning horizon.

### Fiscal planning horizon and medium-term risks
- Budget projections are presently presented for two years; officials noted recent medium-term spending commitments to provinces and the importance of transparency regarding the longer-term impact of measures, so a longer budget horizon might be appropriate.
- The mission agreed but cautioned against placing undue weight on planning surpluses expected to re-emerge from FY 2007/08.
- The team noted that uncertainties increase significantly with the forecast horizon and recent medium-term spending commitments exposed the budget to increased cyclical risk (Box 5).

### Expenditure Review, reallocation, and tax policy
- The ongoing Expenditure Review provides an opportunity to reassess broader policy priorities.
- Reallocating expenditure savings from the Review could allow weighing the merits of spending programs versus further reducing the relatively high tax burden.
- Officials indicated the government placed significant weight on expanding some social transfers, but agreed on the importance of raising efficiency by maximizing productive use of scarce resources.
- Tax policy could be important for efficiency-enhancing boosts to spending on federal infrastructure (for example, at border crossings).
- Consideration was being given to establishing a process to review spending on a regular basis.

### Federal-provincial agreements (Box 4)
- New Ten-Year Plan for Health Care:
  - In September 2004, federal government and provinces agreed to a 10-year plan.
  - Federal government committed to boosting health care transfers to provinces by C$41 billion (3 percent of 2004 GDP) over the next 10 years.
  - Includes a 25 percent increase to Canada Health Transfers in FY 2005–06 and a 6 percent subsequent escalator.
  - Agreement does not involve wide-ranging reforms of health care delivery; provinces agreed to improve service quality, accountability, and comparability by:
    - Reducing waiting times and improving access;
    - Increasing the supply of health care professionals;
    - Ensuring a minimum standard of home care;
    - Sharing best practices in primary care;
    - Developing a national pharmaceutical strategy.
- New Framework for Equalization and Territorial Financing Formula (TFF):
  - In October 2004, First Ministers reached agreement increasing support to provinces and territories by $33 billion over the next 10 years.
  - The new approach sets a minimum federal funding floor of C$10.9 billion for Equalization and C$2 billion for TFF for the next two years, followed by a 3½ percent growth in the base through FY 2009–10.
  - Agreement created a panel of experts to:
    - Examine and evaluate alternative methods of measuring fiscal disparities across provinces and territories;
    - Propose a new allocation mechanism that reduces uncertainty of transfers.
  - The panel is expected to report in late 2006, although the federal government retains full responsibility for decisions upon consultation with provinces.

### Uncertainty in budget forecasting (Box 5)
- The government’s framework includes contingency and prudential reserves and economic forecasts based on private sector input; this framework has been associated with larger-than-expected budget surpluses in recent years.
- Staff used a vector autoregression involving the budget deficit as a ratio to GDP, real GDP growth, inflation, changes in the real exchange rate, and short- and long-term interest rates to examine error bands around budget forecasts.
- Key quantitative findings:
  - The standard deviation around a fiscal forecast is estimated at ¾ of a percent of GDP in the first year of a projection, rising to 2¼ percent of GDP by the fifth year.
  - Impulse response functions indicate that a shortfall in real GDP growth of one percent per annum reduces the fiscal balance by about ¼ percent of GDP in the first year.
  - The fiscal framework’s contingency reserves and economic prudence factors rose from ¼ percent of GDP in the first year to ½ percent of GDP by the fifth; staff suggested these may not be large enough to guarantee budget balance or better.

### Long-term demographic and health spending challenges
- Canada’s projected increase in the old-age dependency ratio of around 20 percentage points over the next 25 years was in the upper range of G-7 countries.
- Public pension reforms have made the system actuarially sound, but demographic factors would weigh on health and other age-related public spending after 2010, raising concerns about long-term sustainability.
- Staff emphasized the importance of keeping the debt-to-GDP ratio on a downward path over the next decade and beyond and the need to curb cost increases in the health system.
- Health spending has been rising at an unsustainable pace due to increased utilization, population aging, and rapid technological innovation.
- Staff suggested measures over time to improve delivery of services and curb demand; recent health agreements involved larger transfers to provinces without fundamental reforms or a hardening of budget constraints.
- Officials viewed the federal role as ensuring access to core services and improving public accountability, while provinces are responsible for delivery and reform; user fees for core services were seen as detrimental to access by the poor.

### Equalization and fiscal entitlements
- Officials warned that recent Equalization agreements, by largely fixing the overall size of future federal Equalization payments over the next six years, risked eroding the principle that payments compensate for differing fiscal capacity.
- Two provinces’ insistence that their resource revenues be exempted from the system increased the risk that payments would be seen as an entitlement.
- Staff noted the upcoming review of the allocation mechanism must design a transparent and equitable basis for payments while avoiding the year-to-year volatility of the previous system.

### Fiscal surpluses, debt management, and transparency
- Recent overshoots of projected federal budget surpluses raised questions about the credibility of the fiscal framework and constrained debate over allocations between tax cuts, expenditure increases, and debt reduction.
- The government commissioned an independent assessment of Canada’s fiscal forecasting performance; staff agreed to provide an international perspective.
- Officials saw surpluses posing growing challenges for debt management:
  - With new debt issuances projected to fall, maintaining adequate liquidity in benchmark securities would be increasingly difficult.
  - Decision taken to maintain inflation-adjusted bonds and increase the proportion of short-term maturities to lower funding costs.
  - Since short-term interest rates tend to be correlated with revenues, overall fiscal risk would be lowered despite more volatile interest payments; staff observed this would also tend to reduce the size of automatic stabilizers.
- The mission welcomed efforts to enhance fiscal transparency:
  - Reestablishment of the Office of the Comptroller General to strengthen financial oversight across the federal government.
  - Latest Fiscal Update added more detail on how fiscal forecasts of private forecasters were converted to be consistent with the public accounts.

*Source: _cr05118 - 31. Staff and officials discussed the relative merits of adopting a five-year fiscal planning horizon_*

### 47. Officials noted that electricity reforms had slowed. Although provincial authorities

### _cr05118 - 47. Officials noted that electricity reforms had slowed. Although provincial authorities

### Electricity sector and environmental policy
- Electricity reforms had slowed; provincial authorities continued to seek private investments in the energy sector, but Ontario’s decision to reverse planned reforms to privatize part of its generating assets was described as a backward step.
- Reforms to enhance electricity system reliability were slowed by the failure to approve an energy bill in the U.S. Congress, which would set up an independent oversight board in Canada’s main trading partner.
- Environmental regulations and legislation in pursuit of the Kyoto Protocol were reported as well underway:
  - Guidelines for emissions-intensity targets and legislation to deal with large final emitters expected in place by spring 2005, including financial sanctions for transgressors.
  - An emissions trading mechanism was expected to be operational in 2008.

### Financial sector policies and regulatory issues
- Officials expressed confidence in the stability of the financial system and effectiveness of the prudential and supervisory system; banking and insurance sectors had posted strong performances, capital ratios were robust, and the system was well positioned to respond to monetary tightening. (See footnote: Chapters 6 and 7 of the Selected Issues paper analyze financial system soundness indicators and banking efficiency, respectively.)
- Regulatory developments:
  - A regular, five-year revision to financial services regulation was to begin shortly; consideration might be given to streamlining agency roles where responsibilities overlapped.
  - FINTRAC was continuing to implement earlier anti-money-laundering legislation.
  - Authorities responded favorably to staff’s suggestion that an Update of the 2000 pilot FSAP would be useful, while requesting details on the burden this would entail.
- Areas of limited progress:
  - Bank mergers:
    - Progress had been slow in finalizing financial sector consolidation policy, including clarifying the “public interest” criterion used for ministerial approval of bank mergers.
    - A consultation process concluded by end-2003 and revised merger guidelines were to have been issued in mid-2004; no new deadline had been set.
    - Officials noted that Canadian banks were profitable and able to invest in expanded operations abroad despite concerns that the present system impeded efficiency.
  - Securities market regulation:
    - The late-2003 report by a “Wise Persons Committee” called for establishment of a single securities market regulator to reduce compliance and administrative costs.
    - Progress on coordinating provincial regulations was underway, but unification at a more fundamental level faced continued opposition by most provinces.
- Corporate governance, accounting, and disclosure:
  - Tighter standards enacted in response to U.S. accounting scandals had enhanced market integrity and helped avoid regulatory gaps with the United States.
  - Some officials and regulators felt these measures followed U.S. legislation too closely and placed an excessive burden on small firms.
  - Mixed views on harmonizing Canada’s accounting practices with U.S. GAAP: advantages for cross-border companies, but U.S. rules were not always consistent with Canada’s corporate governance structure.
- Pensions:
  - Steps to harmonize regulation of defined benefit pension plans were welcomed; CAPSA issued for discussion a model law to harmonize regulations and simplify disclosure and compliance.
  - Given underfunding issues and recent court cases reducing management’s control after partial windups, consideration could be given to enhancing incentives for funding.

### Trade policy and international assistance
- Multilateral negotiations and Doha Round:
  - Officials welcomed revival of Doha Round negotiations in July 2004, while noting key issues remained to be negotiated.
  - On agriculture, Canada had agreed to eventual elimination of government schemes to guarantee export credits and underwrite losses of the Canadian Wheat Board (CWB); they planned to maintain the CWB’s monopoly status and sought flexibility for sectors governed by supply-management schemes.
  - Staff noted Canada, as a major agricultural exporter, had much to gain from the Doha round and that reducing trade barriers in supply-managed sectors could improve efficiency and support an ambitious Doha outcome.
  - Following the withdrawal of investment from the Doha Round agenda, Canada intends to pursue objectives through regional or bilateral initiatives.
- Regional and bilateral trade agreements:
  - Authorities viewed increasing pursuit of bilateral and regional free trade agreements (RTAs) as complementary to multilateral efforts.
  - Staff cautioned drawbacks of RTAs: scope for trade diversion; reduced incentives for multilateral liberalization; and webs of overlapping and cumbersome administrative provisions.
  - Authorities acknowledged proliferation of disparate RTAs as a concern but did not view it as an obstacle to an ambitious multilateral agreement.
- Trade preferences and market access:
  - In February 2004, Canada renewed trade preference schemes for less developed countries for a further ten years; authorities viewed such schemes as temporary instruments to help countries prepare export sectors for global competition.
  - Parallel efforts to enhance access beyond the United States, including initiatives to respond to security concerns while ensuring the smooth flow of goods and people across the common border, and efforts to tap export-growth potential in Brazil, China, and India.
- Further integration with the United States:
  - Officials presented analysis suggesting additional gains from further integration with the United States remain to be realized, including welfare gains from regulatory harmonization and liberalization of NAFTA’s rules-of-origin provisions.
- Official development assistance:
  - Authorities reiterated commitment to double the International Assistance Envelope by the end of the decade, which should raise Official Development Assistance (ODA) and improve Canada’s ODA/GNI ratio, which was 0.26 percent in 2003.
  - Nearly half of the additional funding would be targeted to Africa, strengthening Canada’s role in the G8 Action Plan for Africa and the U.K.-led Commission for Africa.

### Staff appraisal: macroeconomic outlook and policy priorities
- Recent performance and near-term outlook:
  - Canada’s recent macroeconomic performance described as enviable, reflecting sound institutions and a strong policy framework.
  - Inflation targeting provided a transparent basis for monetary policy; commitment to “budget balance or better” had yielded progress toward debt reduction.
  - Structural reforms contributed to the fastest growth in the G-7 since 1995.
  - Growth was expected at around 3 percent into 2005.
  - The Canadian dollar’s recent appreciation appeared broadly consistent with medium-term fundamentals.
  - Risks noted: a sharper drop in net exports, further significant exchange rate appreciation from global current account imbalances, and a more abrupt slowing of consumer spending.
- Medium- and long-term challenges:
  - Key challenges: exchange rate appreciation, commodity price volatility, prospective trade liberalization, spillovers from resolution of global current account imbalances.
  - Need for flexible labor and product markets.
  - Aging population will sharply increase share of elderly in coming decades; meeting this requires sustained fiscal prudence, fundamental reform to control health care costs, and structural policies to maximize productivity.
- Monetary policy assessment:
  - Bank of Canada had room to maintain a patient and measured approach to withdrawing stimulus; Bank had appropriately started to increase interest rates and further tightening would likely be needed.
  - Absence of wage pressures, risks to the outlook, and anchored inflation expectations implied a cautious and pragmatic approach to monetary tightening consistent with the inflation target.
  - Bank’s moves to strengthen policy transparency and communication were commended; additional macroeconomic projection information in the MPR was welcome.
  - Scope remained to provide richer background on policymakers’ views on distribution of risks and related policy implications at fixed action dates, especially when not accompanied by an MPR or an Update.
- Fiscal policy and public finances:
  - Recent agreements with provinces had removed much room for fiscal maneuver, increasing the premium on fiscal prudence.
  - Very limited room for new initiatives in the forthcoming budget; planning surpluses were projected to reemerge from FY 2007–08, but staff cautioned against placing undue weight on these forecasts.
  - Objective of lowering the federal debt-to-GDP ratio to 25 percent within ten years added a medium-term anchor to the fiscal framework; keeping debt-to-GDP on a downward path at all government levels over the next decade would be important preparing for population aging and could provide an anchor if a large shock required a temporary breach of the commitment to balanced budget or better.
- Health care and fiscal transparency:
  - More needed to ensure sustainability and efficiency of the health care system.
  - Latest federal-provincial agreement provided stable funding and mechanisms to improve accountability and comparability across provinces.
  - Major challenge: improve system efficiency through measures that improve incentives for providers and consumers; permitting diversity of provincial strategies could help identify best practices.
  - Helpful steps taken to enhance fiscal transparency; recent fiscal surpluses were greater than projected, partly reflecting a prudent framework and favorable economic developments; maintaining public confidence in the process is important to sustain social consensus for continued debt reduction.
- Structural reform priorities (selected):
  - The tax burden remains relatively high; with limited fiscal room, emphasis needed on measures yielding greatest efficiency gain.
  - The EI system combines unemployment insurance and social assistance; funding the latter through general revenues would be more efficient and transparent, and efforts should reinforce the insurance principle.
  - Reforms in other social programs could help increase labor utilization and efficiency: reduce incentives for early retirement in the public pension system and low “welfare walls” in the social transfer system.
  - Reduce regulatory barriers to trade and competition; strengthen regulatory frameworks and infrastructure investment, particularly in the electricity sector.
  - Maintain momentum for multilateral trade liberalization; Canada can play an important leadership role in completing the Doha Round, including by further relaxing trade barriers for “supply-managed” agricultural products.
- Financial sector reform recommendations (selected):
  - Clarify regulatory framework governing bank mergers to reduce uncertainty and enable efficiency gains.
  - Adopt a single national securities regulator to reduce compliance and administrative costs; upcoming review of financial sector regulation may provide scope for reducing regulatory overlap.
  - Continue harmonization of regulation of defined benefit pension plans; consider enhancing incentives for funding.
- International assistance:
  - Recent commitments to promoting foreign development and assistance commended; Canada’s support for African development, including cancellation of official debt owed to Canada by several African countries, highlighted.

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05118.pdf*

### 71. It is recommended that the next consultation occur on the usual 12-month cycle.

### _cr05118 - 71. It is recommended that the next consultation occur on the usual 12-month cycle.

### Recommendation
- It is recommended that the next consultation occur on the usual 12-month cycle.

### Macroeconomic projections and key indicators (selected)
- Per capita GDP (Annual percent change)
  - Canada: 1.1 3.2 4.7 4.3 0.7 2.3 1.1 1.8 1.7
  - United States: 1.9 3.0 3.3 2.5 -0.3 0.8 2.0 3.4 2.7
  - Japan: 2.7 -1.4 -0.2 2.2 0.0 -0.5 1.2 2.8 1.4
  - Germany: 2.7 2.0 2.0 2.7 0.7 -0.1 -0.1 1.7 1.2
  - G-7 countries: 2.1 2.1 2.4 2.8 0.3 0.6 1.4 2.7 2.1
- Real GDP (Annual percent change)
  - Canada: 2.4 4.1 5.5 5.2 1.8 3.4 2.0 2.7 2.9
  - United States: 3.0 4.2 4.4 3.7 0.8 1.9 3.0 4.4 3.7
  - Japan: 3.1 -1.1 0.0 2.4 0.2 -0.3 1.3 2.8 1.4
  - Germany: 3.4 2.0 2.0 2.9 0.8 0.1 -0.1 1.7 1.2
  - G-7 countries: 2.9 2.8 3.1 3.4 1.0 1.2 2.0 3.4 2.7
- Real domestic demand (Annual percent change)
  - Canada: 2.9 2.4 4.1 4.9 1.3 3.4 4.4 3.4 3.7
  - United States: 3.2 5.3 5.3 4.4 0.9 2.5 3.3 4.7 3.7
  - Japan: 3.7 -1.5 0.1 1.9 0.8 -0.9 0.8 2.1 1.3
  - Germany: 2.5 2.4 2.8 1.9 -0.8 -1.9 0.5 0.5 0.9
  - G-7 countries: 2.8 3.5 3.8 3.6 1.0 1.4 2.3 3.4 2.7
- GDP deflator (Annual percent change)
  - Canada: 2.6 -0.4 1.7 4.1 1.1 1.0 3.2 3.3 2.6
  - United States: 2.7 1.1 1.4 2.2 2.4 1.7 1.8 2.2 2.4
  - Japan: 0.9 -0.2 -1.3 -1.5 -1.3 -1.3 -1.4 -1.5 -0.4
  - Germany: 2.3 1.1 0.5 -0.3 1.3 1.5 1.1 0.7 0.8
  - G-7 countries: 2.7 1.0 0.9 1.2 1.6 1.4 1.5 1.5 1.8

### External sector and savings/investment (selected)
- Current account balance (in percent of GDP)
  - Canada: -2.6 -1.2 0.3 2.7 2.3 2.0 2.0 2.8 1.8
  - United States: -1.6 -2.4 -3.2 -4.2 -3.8 -4.5 -4.8 -5.5 -5.7
  - Japan: 2.4 3.0 2.6 2.5 2.1 2.8 3.2 3.6 3.1
  - Germany: 0.8 -0.5 -1.1 -1.4 0.1 2.2 2.2 3.7 3.7
  - G-7 countries: -0.2 -0.3 -0.9 -1.5 -1.4 -1.5 -1.6 -1.6 -1.8
- Gross savings (in percent of GDP)
  - Canada: 17.4 19.1 20.7 23.6 22.0 21.5 22.1 23.1 22.5
  - United States: 16.3 18.3 18.1 18.0 16.4 14.2 13.5 13.7 15.0
  - Japan: 32.5 29.8 28.6 28.8 27.8 26.8 27.1 27.4 27.5
  - Germany: 23.0 21.2 20.5 20.3 19.4 19.5 19.7 21.3 22.3
  - G-7 countries: 20.6 20.9 20.4 20.5 19.3 17.9 17.5 18.0 18.9
- Fixed investment (in percent of GDP)
  - Canada: 20.1 19.9 19.8 19.2 19.6 19.6 19.5 19.8 19.9
  - United States: 18.3 19.4 19.9 20.2 19.5 18.3 18.4 19.0 18.7
  - Japan: 29.9 26.8 26.4 26.4 25.7 24.2 23.9 24.1 24.5
  - Germany: 23.4 21.4 21.6 21.7 20.3 18.6 17.8 17.4 17.7
  - G-7 countries: 18.1 17.5 17.1 17.0 16.6 16.4 16.2 16.8 16.9

### Table 2 — Quarterly and annual selected indicators (2003–2005 projections)
- Real GDP (NIPA constant prices) annual/quarterly snapshots (selected)
  - 2003 annual: 2.0
  - 2004 annual: 2.7
  - 2005 annual: 2.9
  - Q4/Q4: 1.7 3.1 2.9
- Net exports (contribution to growth) series includes values such as: -2.4 -0.7 -0.6 -3.1 -3.3 0.3 -2.2 0.5 2.6 -5.1 -0.6 -0.2 0.1 0.0 0.2
- Total domestic demand (selected quarterly values): 4.4 3.4 3.7 6.0 2.5 0.9 5.3 2.2 1.7 8.8 3.2 3.2 2.9 3.0 2.9
- Unemployment rate (selected): 7.6 7.3 7.2 7.5 7.7 7.9 7.5 7.4 7.3 7.2 7.1 7.2 7.2 7.2 7.2
- CPI inflation (y/y) (selected): 2.7 1.8 2.3 4.4 2.8 2.1 1.7 0.8 2.2 0.2 2.3 2.5 2.1 2.4 2.2
- GDP deflator (selected): 3.2 3.3 2.6 6.8 -1.8 2.6 1.4 4.7 5.8 3.5 2.5 2.2 2.1 2.0 2.0
- Potential Output Growth: 3.0 2.9 2.9 3.0 3.0 2.9 2.9 2.9 2.9 2.9
- Current account balance (in percent of GDP) selected series: 2.0 2.8 1.8 1.7 1.8 2.2 2.2 2.6 3.5 2.9 2.4 2.0 1.9 1.6 1.7
- Exchange rate snapshots include values such as: 0.72 0.67 0.72 0.72 0.77 0.76 0.74 0.77 0.83
- Terms of trade (selected): 6.0 4.1 -0.5 15.4 0.9 5.3 3.5 5.4 1.8 9.1 -2.1 -3.9 -0.4 -1.7 0.3

### Balance of Payments (Table 3, selected, in billions of Canadian dollars unless indicated)
- Current account balance (2002–2009 forecast): 22.7 23.8 36.8 24.6 26.7 32.8 37.3 42.8
- In percent of GDP: 2.0 2.0 2.8 1.8 1.9 2.2 2.4 2.6
- Merchandise trade balance (2002–2009): 57.2 58.2 68.3 56.8 58.7 64.6 68.9 74.0
- Exports, goods (2002–2009): 413.8 400.0 431.8 444.9 462.1 490.2 518.9 552.6
- Imports, goods (2002–2009): 356.6 341.8 363.5 388.1 403.4 425.6 450.0 478.6
- Services balance (selected): -6.9 -10.9 -10.9 -9.8 -9.5 -9.4 -9.5 -9.9
- Investment income balance (selected): -28.7 -23.7 -21.1 -22.9 -23.0 -22.8 -22.6 -21.8
- Capital and financial accounts balance (selected): -12.8 -20.7 -54.3 -20.1 -22.2 -28.3 -32.8 -38.3
- Direct investment, net (selected): -8.4 -21.0 -54.0 -20.0 -24.0 -28.8 -34.5 -41.3
  - Direct investment in Canada (selected): 33.0 9.2 31.6 63.0 73.2 85.2 98.9 114.9
  - Direct investment abroad (selected): -41.5 -30.2 -85.5 -83.0 -97.2 -113.9 -133.4 -156.2
- Portfolio investment, net (selected): -4.2 6.0 9.3 -2.6 -0.6 -1.8 -0.5 1.0
- Other investment (selected): -5.5 -14.4 -14.0 -2.0 -2.1 -2.2 -2.3 -2.4
- Memorandum item: Net external investment position (selected): -202 -218 -159 -135 -108 -75 -38 5
  - In percent of GDP: -17.5 -17.9 -12.3 -9.9 -7.5 -5.0 -2.4 0.3

### Selected vulnerability indicators (Table 4, percent of GDP unless indicated)
- Official reserves (in billions of U.S. dollars): 23.4 28.6 32.4 34.2 37.2 36.3 34.5
- Broad money (M3) to foreign exchange reserves (ratio): 17.1 14.5 13.8 13.2 12.8 15.6 ...
- General government gross debt (percent of GDP): 114.8 111.6 101.5 99.1 95.4 90.9 ...
- Three-month treasury bill yield (percent): 4.7 4.7 5.5 3.9 2.6 2.9 2.2
- Ten-year government note (percent): 5.3 5.6 5.9 5.5 5.3 4.8 4.6
- Real three-month treasury bill yield (percent; deflated by CPI): 3.7 2.9 2.7 1.3 0.2 0.1 0.4
- Change in stock market index (TSE 300, annual percent change): 4.6 4.5 36.1 -19.5 -9.0 1.8 20.7
- Banking sector indicators (selected)
  - Total loans to assets (percent): 58.4 58.7 57.7 55.8 55.6 53.8 ...
  - Total loans to deposits (percent): 90.2 86.8 84.2 84.5 83.1 81.3 ...
  - Impaired assets/total assets: 0.66 0.60 0.59 0.60 0.84 0.90 0.64 ...
  - Total capital ratio: 10.6 11.3 11.9 12.3 12.4 13.4 ...
  - Tier 1 capital ratio: 7.4 8.2 8.6 9.0 9.2 10.3 ...
- Personal sector (selected)
  - Net worth in percent of disposable income: 514.5 514.2 509.0 509.4 516.3 519.2 ...
  - Total liabilities in percent of disposable income: 112.0 114.0 112.6 115.0 117.2 120.2 ...
  - Total liabilities in percent of net worth: 21.8 22.2 22.1 22.6 22.7 23.1 ...
- Corporate sector (selected)
  - Debt of private nonfinancial corporations (percent of GDP): 53.9 51.6 49.0 50.6 49.0 44.7 ...
  - Debt-to-equity ratio of nonfinancial private corporations: 82.7 78.5 71.8 70.0 65.8 57.5 ...

### Key fiscal indicators (Table 5, federal and general government; selected)
- Federal government (PA basis) in billions of dollars (1998/99–2008/09 projections)
  - Revenue (selected): 156.1 166.1 182.7 171.7 177.6 186.2 194.0 199.4 209.5 220.3 231.2
  - Program spending (selected): 110.0 109.6 118.7 125.0 133.5 141.4 150.9 159.8 167.5 174.4 180.8
  - Interest payments (selected): 43.3 43.4 43.9 39.7 37.3 35.8 34.8 35.4 35.8 38.3 38.2
  - Budgetary surplus (selected): 2.8 13.1 20.2 7.1 6.8 9.1 8.3 4.2 6.2 7.6 12.2
  - Net federal debt (selected): 557.2 543.4 524.5 517.5 510.5 501.5 493.2 489.0 482.8 475.2 463.0
- Federal government (in percent of GDP, selected)
  - Revenue: 17.1 16.9 17.0 15.5 15.3 15.3 15.0 14.6 14.6 14.6 14.6
  - Program spending: 12.0 11.2 11.0 11.3 11.5 11.6 11.7 11.7 11.7 11.5 11.4
  - Interest payments: 4.7 4.4 4.1 3.6 3.2 2.9 2.7 2.6 2.5 2.5 2.4
  - Budgetary surplus: 0.3 1.3 1.9 0.6 0.6 0.7 0.6 0.3 0.4 0.5 0.8
- General government (NIA/calendar year basis) in billions of dollars (selected)
  - Revenue: 404.7 428.9 470.2 471.9 473.8 499.3 526.7 547.6 575.1 604.4 634.0
  - Expenditure: 404.0 413.1 438.5 459.5 470.6 491.6 508.9 531.0 557.1 583.3 608.6
  - Balance: 0.8 15.9 31.7 12.3 3.3 7.6 17.8 16.6 18.0 21.1 25.4
  - Net public debt (selected): 767.2 741.0 703.4 659.1 654.1 632.6 614.8 598.2 580.2 559.1 533.7
- Memorandum items (selected)
  - Real GDP growth: 4.1 5.5 5.2 1.8 3.4 2.0 2.7 2.9 3.0 3.2 3.0
  - Nominal GDP growth rate: 3.7 7.4 9.6 2.9 4.5 5.3 6.1 5.6 5.1 5.2 5.0
  - Three-month treasury bill rate (selected): 4.7 4.7 5.5 3.9 2.6 2.9 2.2 2.9 3.9 4.7 4.7
  - Ten-year government bond rate (selected): 5.3 5.6 5.9 5.5 5.3 4.8 4.6 4.8 5.5 6.0 6.1

### Public sector debt sustainability framework (2000–2009, selected)
- Public sector debt (percent of GDP) actual/projections: 65.3 59.5 56.5 51.9 47.5 43.9 40.5 37.1 33.8 30.4
  - Foreign-currency denominated share (percent of GDP): 2.9 2.8 2.4 1.7 1.7 1.5 1.4 1.3 1.2 1.1
- Change in public sector debt (percent of GDP): -10.1 -5.9 -3.0 -4.6 -4.4 -3.7 -3.3 -3.4 -3.4 -3.4
- Identified debt-creating flows (percent of GDP): -11.7 -5.1 -5.2 -6.0 -6.4 -5.7 -5.4 -5.4 -5.3 -5.2
  - Primary deficit (percent of GDP): -10.1 -7.7 -6.1 -5.9 -6.3 -5.9 -5.8 -5.9 -5.9 -5.9
  - Revenue and grants (percent of GDP): 43.7 42.6 40.9 41.0 40.7 40.1 40.1 40.0 40.0 40.0
  - Primary (noninterest) expenditure (percent of GDP): 33.6 34.9 34.9 35.0 34.4 34.2 34.3 34.2 34.1 34.1
  - Automatic debt dynamics (percent of GDP): -1.6 2.6 0.9 0.0 -0.1 0.2 0.5 0.5 0.6 0.6
  - Contribution from interest rate/growth differential (percent of GDP): -1.8 2.4 0.9 0.3 -0.2 0.3 0.5 0.5 0.6 0.6
  - Contribution from real interest rate (percent): 1.8 3.5 2.8 1.4 1.2 1.5 1.7 1.7 1.7 1.6
  - Contribution from real GDP growth (percent): -3.6 -1.1 -2.0 -1.1 -1.3 -1.3 -1.3 -1.2 -1.0 -0.9
  - Contribution from exchange rate depreciation (percent): 0.1 0.2 0.0 -0.3 0.1 0.0 0.0 0.0 0.0 0.0
- Residual, including asset changes (percent of GDP): 1.6 -0.7 2.2 1.4 2.0 2.0 2.0 2.0 1.9 1.9
- Public sector debt in percent of revenues (selected): 149.6 139.7 138.0 126.7 116.7 109.4 101.1 92.8 84.5 76.1
- Gross financing (percent of GDP and USD amounts): -2.9 -1.1 -0.3 -0.6 -1.4 -1.2 -1.2 -1.4 -1.6 -1.8 (in billions of U.S. dollars: -21.3 -7.9 -2.0 -5.4 -13.2 -12.3 -13.4 -15.9 -19.6 -23.3)

### Key macro-fiscal assumptions (selected)
- Real GDP growth (in percent): 5.2 1.8 3.4 2.0 2.7 2.8 3.0 3.2 3.0 2.9
- Average nominal interest rate on public debt (in percent): 7.0 6.6 6.1 5.8 5.8 6.0 6.2 6.5 6.8 6.9
- Average real interest rate (percent): 2.9 5.5 5.0 2.7 2.5 3.4 4.2 4.5 4.8 4.9
- Nominal appreciation (increase in US dollar value of local currency, in percent): -3.8 -5.8 0.8 22.2 -2.9 1.2 0.9 1.0 1.1 0.4
- Inflation rate (GDP deflator, in percent): 4.1 1.1 1.0 3.2 3.3 2.6 2.0 2.0 2.0 2.0
- Growth of real primary spending (deflated by GDP deflator, in percent): 2.8 5.6 3.4 2.5 1.0 2.0 3.3 2.9 2.7 2.9

### IMF relations and assessments (selected)
- Membership Status: Joined 12/27/45; Article VIII.
- Quota: 6,369.20 (Million of Quota), Fund holdings of currency 4,219.63 (66.25), Reserve position in Fund 2,149.58 (33.75).
- SDR net cumulative allocation: 779.29 (100.00); Holdings 595.19 (76.38).
- Outstanding Purchases and Loans: None.
- Financial Arrangements: None.
- Projected Obligations to Fund: None.
- Implementation of HIPC Initiative: Not applicable.
- Safeguards Assessments: Not applicable.
- Exchange Rate Arrangements: Authorities do not maintain margins; may intervene to maintain orderly conditions; no taxes or subsidies on purchases or sales of foreign exchange.
- Last Article IV Consultation: Staff report for the 2004 consultation considered by the Executive Board on February 18, 2004 (EBM/04/14). Canada is on a 12-month consultation cycle.
- FSAP / ROSC findings: Financial system described as stable and highly advanced; fiscal transparency praised; data and statistical systems assessed as comprehensive, timely, and accurate, with specific recommendations listed and many addressed.

*Source: IMF staff report content as contained in the provided PDF content unit.*

### 1. Real GDP growth, real interest rate, and primary balance are at historical averages in 2005–200947.543.439.335.231.12

### _cr05118 - 1. Real GDP growth, real interest rate, and primary balance are at historical averages in 2005–2009

### Key scenario lines (as reported)
- 1. Real GDP growth, real interest rate, and primary balance are at historical averages in 2005–2009
  - 47.543.439.335.231.126.8
- 2. Real interest rate is at historical average plus two standard deviations in 2005 and 2006
  - 47.546.144.841.538.234.9
- 3. Real GDP growth is at historical average minus two standard deviations in 2005 and 2006
  - 47.544.942.539.235.932.5
- 4. Primary balance is at historical average minus two standard deviations in 2005 and 2006
  - 47.547.748.144.841.638.3

### Historical statistics for key variables (past 10 years)
- Average / Standard Deviation
  - Primary deficit -6.92.4
  - Real GDP growth (in percent)3.61.4
  - Nominal interest rate (in percent) 6/7.00.7
  - Real interest rate (in percent)5.31.5
  - Inflation rate (GDP deflator, in percent) 1.71.3
  - Revenue to GDP ratio 42.91.2
- Sources: Haver Analytics; and Fund staff estimates.

### External Sustainability framework — selected baseline and projections (2000–2009)
- Baseline medium-term projection excerpts (selected series shown as reported)
  - Net external liabilities/Exports of G&S42.742.342.447.432.025.920.314.58.72.8
  - Net external liabilities/GDP19.418.417.517.912.310.07.95.73.41.1
  - Change in net external liabilities/GDP-5.4-1.0-0.90.4-5.6-2.3-2.1-2.2-2.3-2.3
  - Net liability-creating external flows/GDP (5+9)-6.4-4.4-4.1-5.8-4.6-2.4-2.1-2.2-2.2-2.2
  - Current account deficit/surplus excluding interest/GDP-5.8-5.8-4.4-3.9-3.6-2.3-2.1-2.2-2.2-2.2
  - Balance on G&S/GDP5.75.74.33.94.84.34.14.04.03.9
  - Exports of G&S/GDP45.443.441.337.738.438.638.839.139.339.6
  - Imports of G&S/GDP39.737.836.933.933.634.234.735.135.435.7
  - (r-g-(ρ+gρ))/(1+g+ρ+gρ))debt/GDP (11/10) -0.71.40.3-1.9-1.0-0.10.00.00.00.0
  - Adjustment factor: 1+g+ρ+gρ 1.11.01.01.21.11.11.11.11.11.1
  - (r-g-(ρ+gρ))debt/GDP (12+13+14) -0.71.40.4-2.3-1.1-0.10.00.00.00.0
  - r (interest rate) times debt/GDP1.71.10.90.91.00.70.60.50.40.2
  - minus g (real GDP growth rate) times debt/GDP-1.3-0.3-0.6-0.4-0.5-0.3-0.3-0.2-0.2-0.1
  - minus (ρ + gρ) (ρ = US dollar value of GDP deflator, growth rate) times debt/GDP -1.10.60.1-2.8-1.6-0.5-0.3-0.2-0.2-0.1
  - Residual, incl. change in gross foreign assets/GDP (3-4)1.03.43.26.6-1.00.10.00.0-0.1-0.1

- Memorandum items (selected)
  - Nominal GDP (in Can$ bln.)1077110811581219129213611429149915711646
  - Nominal GDP (US dollars) 72571673887097010351096116112301295
  - Real GDP growth (in percent per year)5.21.83.42.02.72.83.03.23.02.9
  - Exchange rate (LC per US dollar) 1.51.51.61.41.31.31.31.31.3
  - Nominal GDP deflator (in US dollars, change in percent per year)4.2-3.0-0.315.68.73.82.93.13.12.4
  - External interest rate (percent per year)6.75.85.15.05.76.06.36.36.36.3
  - Growth of exports of G&S (US dollar terms, in percent per year)15.8-5.6-2.17.913.66.96.66.76.76.0
  - Growth of imports of G&S (US dollar terms, in percent per year)10.5-6.20.88.210.78.67.57.06.96.3

### Sensitivity analysis for external debt-to-GDP ratio (selected scenarios)
- 1. Interest rate, real GDP growth rate, US$ GDP deflator growth, non-interest current account, and non-debt flows (in percent of GDP) are at historical averages in 2005-2009
  - 12.39.05.62.1-1.5-5.3
- 2. Interest rate is at historical average plus two standard deviations in 2005 and 2006
  - 12.310.28.36.13.81.5
- 3. Real GDP growth is at historical average minus two standard deviations in 2005 and 2006
  - 12.310.28.46.23.91.6
- 4. US$ GDP deflator is at historical average minus two standard deviations in 2005 and 2006
  - 12.312.111.99.77.45.2
- 5. Non-interest current account (in percent of GDP) is at historical average minus two standard deviations in 2005 and 2006
  - 12.311.911.59.37.04.8
- 6. Combination of 2-5 using one standard deviation shocks
  - 12.311.710.98.76.54.2
- 7. One-time 30 percent depreciation in 2005 (-30% GDP deflator shock), others at baseline.
  - 12.315.012.910.78.46.1

- Historical statistics for these external sensitivity variables (past 10 years)
  - Current account balance excluding interest (percent of GDP)-3.61.6
  - Net non-debt creating capital inflows (percent of GDP)-1.41.4
  - Interest rate6.30.8
  - Real GDP growth rate3.51.4
  - Growth in GDP deflator, US dollar terms1.06.1
- Sources: Haver Analytics; and Fund staff estimates.

### Statement excerpts (staff observations and projections)
- Recent developments: economic indicators moderated in Q4 2004; annualized 3¼ percent increase in real GDP in Q3 2004, slowed to a 1½ percent rate in October and November.
- Staff project 2005 growth at slightly below 3 percent; Bank of Canada left overnight rate at 2½ percent on January 25.
- Financial markets pricing: currently pricing in only one 25 basis point rate increase in the year; long-term interest rates declined by about 80 basis points since mid-2004.
- Fiscal outlook: FY 2005/06 Budget to be released on February 23; limited room for major spending or tax initiatives given tight budget constraint.

*Italic: Source — _cr05118 (IMF staff report excerpts provided in the supplied content).*

### conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the

### _cr05118 - conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the

### Context and purpose
- The action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF's assessment of these policies.
- (ii) following policy discussions in the Executive Board at the decision of the Board.
- The Staff Report for the 2004 Article IV Consultation with Canada is also available.

### Canada: Selected Economic Indicators (Annual change in percent, unless otherwise noted) — est. 1998–2004
- Real GDP: 1998: 4.1; 1999: 5.5; 2000: 5.2; 2001: 1.8; 2002: 3.4; 2003: 2.0; 2004: 2.7
- Net exports 2/ (contribution to growth): 1998: 1.7; 1999: 1.4; 2000: 0.6; 2001: 0.7; 2002: -0.1; 2003: -2.4; 2004: -0.7
- Total domestic demand: 1998: 2.4; 1999: 4.1; 2000: 4.9; 2001: 1.3; 2002: 3.4; 2003: 4.4; 2004: 3.4
- Final domestic demand: 1998: 2.8; 1999: 4.2; 2000: 4.0; 2001: 3.2; 2002: 3.1; 2003: 3.6; 2004: 3.6
- Private consumption: 1998: 2.8; 1999: 3.8; 2000: 4.0; 2001: 2.7; 2002: 3.4; 2003: 3.1; 2004: 3.2
- Public consumption: 1998: 3.2; 1999: 2.1; 2000: 3.1; 2001: 3.7; 2002: 2.8; 2003: 3.8; 2004: 2.8
- Private fixed domestic investment: 1998: 2.8; 1999: 6.2; 2000: 4.8; 2001: 3.3; 2002: 1.4; 2003: 4.6; 2004: 6.0
- Private investment rate (as a percent of GDP): 1998: 17.7; 1999: 17.4; 2000: 16.9; 2001: 17.2; 2002: 17.1; 2003: 16.9; 2004: 17.2
- Public investment: 1998: -0.7; 1999: 15.6; 2000: 3.8; 2001: 10.1; 2002: 9.1; 2003: 6.8; 2004: 1.8
- Change in business inventories 2/ (contribution to growth): 1998: -0.3; 1999: 0.1; 2000: 0.8; 2001: -1.9; 2002: 0.6; 2003: 0.9; 2004: -0.1
- GDP (current prices): 1998: 3.7; 1999: 7.4; 2000: 9.6; 2001: 2.9; 2002: 4.5; 2003: 5.3; 2004: 6.1

### Employment and inflation
- Unemployment rate: 1998: 8.3; 1999: 7.6; 2000: 6.8; 2001: 7.2; 2002: 7.7; 2003: 7.6; 2004: 7.3
- Consumer price index: 1998: 1.0; 1999: 1.7; 2000: 2.7; 2001: 2.5; 2002: 2.3; 2003: 2.7; 2004: 1.8
- GDP deflator: 1998: -0.5; 1999: 1.7; 2000: 4.2; 2001: 1.1; 2002: 1.0; 2003: 3.2; 2004: 3.3

### Exchange rate (period average)
- U.S. cents/Canadian dollar: 1998: 0.67; 1999: 0.68; 2000: 0.67; 2001: 0.64; 2002: 0.64; 2003: 0.72; 2004: 0.77
- Percent change (U.S. cents/Canadian dollar): 1998: -6.8; 1999: 0.6; 2000: -0.3; 2001: -4.2; 2002: -1.1; 2003: 12.9; 2004: 7.2
- Nominal effective exchange rate: 1998: -5.8; 1999: -0.4; 2000: 1.9; 2001: -2.8; 2002: -2.1; 2003: 8.9; 2004: 5.5
- Real effective exchange rate: 1998: -6.0; 1999: -0.9; 2000: 0.9; 2001: -3.7; 2002: -0.8; 2003: 11.2; 2004: 6.9

### Indicators of financial policies (national accounts basis, as a percent of GDP)
- Federal fiscal balance: 1998: 0.8; 1999: 0.9; 2000: 1.9; 2001: 1.3; 2002: 0.8; 2003: 0.4; 2004: 0.8
- General government: 1998: 0.1; 1999: 1.6; 2000: 2.9; 2001: 1.1; 2002: 0.3; 2003: 0.6; 2004: 1.4
- Three-month treasury bill: 1998: 4.7; 1999: 4.7; 2000: 5.5; 2001: 3.9; 2002: 2.6; 2003: 2.9; 2004: 2.2
- Ten-year government bond yield: 1998: 5.3; 1999: 5.6; 2000: 5.9; 2001: 5.5; 2002: 5.3; 2003: 4.8; 2004: 4.6

### Balance of payments
- Current account balance (as a percent of GDP): 1998: -1.2; 1999: 0.3; 2000: 2.7; 2001: 2.3; 2002: 2.0; 2003: 2.0; 2004: 2.8
- Merchandise trade balance (as a percent of GDP): 1998: 2.6; 1999: 4.3; 2000: 6.2; 2001: 6.3; 2002: 4.9; 2003: 4.8; 2004: 5.3
- Export volume: 1998: 8.5; 1999: 11.7; 2000: 9.2; 2001: -3.5; 2002: 0.7; 2003: -2.2; 2004: 5.8
- Import volume: 1998: 6.1; 1999: 8.5; 2000: 8.6; 2001: -5.6; 2002: 1.5; 2003: 3.4; 2004: 8.5
- Invisibles balance (as a percent of GDP): 1998: -3.8; 1999: -4.0; 2000: -3.5; 2001: -4.1; 2002: -3.0; 2003: -2.8; 2004: -2.4

### Saving and investment (as a percent of GDP)
- Gross national saving: 1998: 19.1; 1999: 20.7; 2000: 23.6; 2001: 22.0; 2002: 21.5; 2003: 22.1; 2004: 23.1
- General government: 1998: 2.1; 1999: 3.6; 2000: 5.1; 2001: 3.4; 2002: 2.7; 2003: 3.1; 2004: 3.8
- Private: 1998: 17.0; 1999: 17.1; 2000: 18.5; 2001: 18.6; 2002: 18.8; 2003: 19.0; 2004: 19.2
- Personal: 1998: (not listed); 1999: 6.1; 2000: 5.3; 2001: 5.6; 2002: 5.7; 2003: 4.8; 2004: 3.8; 2004 (alternate value listed): 5.9
- Business: 1998: 10.9; 1999: 11.7; 2000: 12.9; 2001: 12.9; 2002: 14.0; 2003: 15.2; 2004: 13.4
- Gross domestic investment: 1998: 20.5; 1999: 20.5; 2000: 20.4; 2001: 19.2; 2002: 19.6; 2003: 20.1; 2004: 20.2

*Sources: Statistics Canada; and IMF Staff estimates. 1/ Data as available at the time of the Executive Board Discussion on February 18, 2005. 2/ Contribution to growth.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05118.pdf_