## _cr06230 — Executive Summary and Selected Chapters (Canada, 2006 Article IV Consultation)

## Source details

**Canonical URL:** [_cr06230 — Executive Summary and Selected Chapters (Canada, 2006 Article IV Consultation)](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06230.pdf)

## Other formats

- [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06230.pdf.md)
- [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06230.pdf.json)

---

### Macroeconomic outlook and key projections
- Growth is projected to remain at around its 3 percent potential.
- Inflation is projected to stay near its 2 percent target.
- The Bank of Canada will likely need to undertake further modest increases in the overnight rate, balancing evidence that slack is eroding against the drag from an appreciated exchange rate and the potential for a disorderly unwinding of global imbalances.
- The success of the inflation targeting framework suggests no need for significant amendments when it is renewed later this year; there is some room to enhance policy communication.
- The new government has pledged debt reduction by C$3 billion (about ¼ percent of GDP) per year while aiming at enhancing incentives to save and invest.

### Recent developments (activity, demand, and trade)
- Real GDP growth was close to 3 percent during 2005 (Q4/Q4 basis).
- Final domestic demand rose 4½ percent.
- Private consumption expanded by 3¾ percent; household wealth as a ratio to income remains close to historical highs despite a record-low saving rate.
- Private fixed investment rose by 7½ percent.
- Real exports expanded almost 5 percent over 2005; real imports increased 6½ percent.
- Soaring energy prices buoyed the nominal trade balance and the current account.
- The Canadian dollar has gained some 30 percent in real effective terms since early 2003.
- Multilateral IMF Research Department analysis suggests the exchange rate is up to 15 percent undervalued when compared with equilibrium saving-investment balances (gap smaller using PPP-adjusted methods).

### Canada as an energy exporter (factual findings and projections)
- Oil sands contain one of the world’s largest known hydrocarbon deposits; recoverable oil is estimated at about one sixth of global reserves.
- Production projections imply a tripling of oil sands production volume to 2½–3 million barrels per day (mb/d) over 10 years.
- With conventional oil output already past its peak, Canada’s total oil production would increase from 2.5 mb/d in 2003 to about 4 mb/d by 2015.
- At current energy prices, Canada’s current account balance could improve by about ½ percent of GDP by 2015.
- Constraints and risks to oil sands expansion:
  - Limited infrastructure and difficulties in attracting skilled labor have boosted costs.
  - Canada’s natural gas output is expected to peak in about 10 years; natural gas is a key input for oil sands production.
  - Greenhouse gas emissions from oil sands production are likely to conflict with Canada’s Kyoto Accord commitments.
- Staff model suggests the impact of rising oil production on Canada’s real effective exchange rate would be small.

### Monetary policy assessment
- Bank of Canada maintained a stimulative stance through September 2005, then resumed rate hikes as capacity utilization rose and employment strengthened.
- The Bank raised its target for the overnight interest rate to 3¾ percent in five consecutive ¼ percentage point steps starting in September (later raised to 4 percent on April 25).
- In March 2006 the Bank indicated that “modest” further tightening may be needed; markets expected a further 25-50 basis points through end-2006.
- Recent increases in monetary policy transparency are noted positively.
- Staff and Bank officials agreed some further increases in short-term interest rates would likely be needed.

### Fiscal policy assessment and recommendations
- Fiscal outlook remains very favorable: surplus in FY2005/06 (ending in March) expected due to buoyant personal income tax collections and large corporate income tax payments.
- New government pledged to pay down federal debt by C$3 billion (about ¼ percent of GDP) a year.
- Planned and warranted measures:
  - Cuts in corporate rates; early elimination of the federal capital tax.
  - Staff view cutting the consumption tax rate as less effective than personal income tax cuts to stimulate labor supply, saving, and investment.
- Recommendations to ensure a prudent fiscal framework:
  - Raise the size of budgetary reserves (O’Neill Report cushion: C$9 billion, ¾ percent of GDP).
  - Anchor policies on a debt objective over a 5–10 year horizon.
  - Provide an annual analysis of long-term budget prospects by an independent body.
- Provincial-level pressures should be addressed to support longer-term fiscal sustainability.
- Any new allocation formula for the Equalization system should take resource-based revenues into account.

### Structural policies to raise long-term growth and flexibility
- Canada's productivity performance has lagged despite robust growth; opportunity to boost long-term potential.
- Suggested reforms:
  - Labor market: reduce welfare walls, make immigration systems more flexible, restore reforms of the Employment Insurance system.
  - Product markets: reduce barriers to foreign direct investment; reform the electricity sector.
  - Trade and agriculture: widen market access for agricultural goods.
  - Health system reform remains key to long-term fiscal sustainability.

### Financial sector policies and resilience
- Financial system shows high profitability, robust balance sheets, benign provisioning, and strong distance-to-default indices.
- Priorities:
  - Greater clarity on regulatory framework governing bank mergers.
  - Establishment of a national securities regulator.
  - Better alignment of incentives in defined benefit pension plans.
- Underfunding of many DB plans noted; measures under discussion include extending solvency funding periods and tax preferences for overfunding.

### Risks and policy priorities
- Major risks: a disorderly unwinding of global imbalances and macroeconomic implications of a sharply appreciated exchange rate.
- Staff policy priorities:
  - Maintain credible and prudent fiscal policy while implementing tax relief.
  - Continue measured monetary policy tightening as warranted.
  - Advance structural reforms to raise productivity and flexibility.
  - Address provincial fiscal challenges and health care cost pressures.

### Detailed labor market and inflation indicators
- Unemployment rate has fallen to 6¼ percent—a 31-year low.
- Headline inflation at 2.2 percent; core measure has stayed below 2 percent since January 2004.
- Wage increases accelerated during 2005; unit labor costs rose by 3½ percent (driven largely by the service sector).
- Staff and Bank estimate a negligible output gap.

### Exchange rate, oil sands scenario, and composition effects
- Dynamic projection (2002Q1–2005Q2): about 5 percentage points of the 30 percent appreciation of the Canadian dollar against the U.S. dollar remain unexplained.
- Projected contribution of Alberta’s tar sands:
  - Adds some 1 percent of GDP to net oil exports over 15 years.
  - Increases net oil exports as a ratio of noncommodity imports by some 4 percentage points.
  - Model implication: a real appreciation of only around 4 percent would be expected from this increase.
- Policy implications:
  - Oil sands expansion likely to have a small direct impact on the exchange rate and limited crowding-out of non-energy exporters.
  - Structural policy support: review immigration restrictions, adapt regulatory environment for infrastructure and environment.

### Perfect Storm alternative scenario (assumptions and outcomes)
- Scenario assumptions:
  - Loss of economic confidence reduces U.S. fixed investment and consumption by 3 percent relative to baseline in 2006, expanding to 5 percent by end-2010.
  - Oil price drops by 30 percent relative to baseline within two years.
  - U.S. currency depreciates and the Canadian dollar appreciates by 25 percent over the same period.
- Key model results (difference between simulated model and baseline; in percent unless noted):
  - GDP: 2006 -1.1; 2007 -2.7; 2008 -3.2; 2009 -4.1; 2010 -5.5
  - GDP growth (percentage points): 2006 -1.1; 2007 -1.7; 2008 -0.5; 2009 -1.0; 2010 -1.5
  - Real net exports (contribution to growth): 2006 -1.3; 2007 -2.9; 2008 -1.9; 2009 -1.0; 2010 -0.5
  - Current account balance (percent of GDP): 2006 0.0; 2007 -2.0; 2008 -4.1; 2009 -5.6; 2010 -6.8
  - CPI inflation (percentage points): 2006 -0.8; 2007 -2.8; 2008 -3.9; 2009 -4.4; 2010 -5.0
  - Short-term interest rate (percentage points): 2006 -2.3; 2007 -4.6; 2008 -5.1; 2009 -4.8; 2010 -4.8
  - Long-term interest rate (percentage points): 2006 -1.2; 2007 -3.3; 2008 -3.7; 2009 -3.1; 2010 -2.8
  - Fiscal balance (percent of GDP): 2006 -0.1; 2007 -0.4; 2008 -0.6; 2009 -0.8; 2010 -1.1
- Narrative: Canadian GDP could fall by over 5 percent relative to baseline by 2010; short-term interest rates hit the zero bound in 2007; current account deteriorates by more than 6½ percent of GDP by 2010.
- Source for simulation: Oxford Economics; staff calculations.

### Selected empirical and statistical highlights (as reported)
- O’Neill Report cushion: C$9 billion (¾ percent of GDP; 2–3 times past contingency reserves).
- Debt repayment target: C$3 billion per year.
- Federal Health Accord funding announced: C$41 billion over 10 years.
- Private share of total health spending increased to around 30 percent.
- Alberta Heritage Savings Trust Fund: recent C$1 billion deposit; fair value about C$14 billion at end-2005; FY 2006/07 budget pledged a further C$1 billion investment.
- Canada achieved eight consecutive years of federal surpluses and falling government debt.
- Objective to reduce federal debt/GDP ratio to below 25 percent by FY 2014–15; extended in November 2005 to 20 percent by 2020.
- Bank of Canada overnight rate target: 4 percent (after six consecutive ¼ percentage point steps).
- FY 2005/06 surplus: 0.6 percent of GDP.
- Employment growth averaged 2¼ percent (annualized) during first four months of 2006; unemployment rate rose slightly to 6.4 percent in April 2006.
- Business sector labor productivity growth (2005, revised): 2.2 percent.
- Wage and unit labor cost growth (Q4 2005, y/y): 3¼ percent.
- Real effective exchange rate appreciation since early 2003: some 30 percent.

### Key macro projections and indicators (selected series as listed)
- Per capita real GDP (annual percent change) — Canada series excerpt: 2.3, 4.3, 0.7, 1.9, 1.0, 1.9, 2.0, 2.0, 2.1 (2000–2008 series).
- Real GDP (annual percent change) — Canada: 3.3, 5.2, 1.8, 3.1, 2.0, 2.9, 2.9, 3.1, 3.0.
- General government financial balance (percent of GDP) — Canada: 0.8, 2.9, 0.7, -0.1, 0.0, 0.7, 1.7, 1.3, 1.1.
- Gross national saving (percent of GDP) — Canada: 21.3, 23.6, 22.2, 21.3, 21.7, 22.9, 23.4, 24.5, 24.7.
- Fixed investment (percent of GDP) — Canada: 19.6, 19.2, 19.6, 19.5, 19.6, 20.1, 20.5, 20.8, 21.2.
- Current account balance (percent of GDP) — Canada: 1.1, 2.7, 2.3, 1.8, 1.5, 2.2, 2.2, 3.1, 2.9.

### Financial sector and vulnerability indicators (selected)
- Official reserves (in billions of U.S. dollars, 1999–2005): 28.6, 32.4, 34.2, 37.2, 36.3, 34.5, 33.0.
- Broad money (M3) to foreign exchange reserves (ratio): 14.5, 13.8, 13.2, 12.8, 15.6, 19.2, 23.6.
- General government gross debt (percent of GDP): 111.6, 101.5, 100.3, 97.4, 91.9, 87.9, 85.0.
- Net international investment position (percent of GDP): -24.8, -19.4, -18.4, -17.9, -17.0, -14.0, -12.8.
- Banking sector (six largest chartered banks) — Total capital ratio: 11.3, 11.9, 12.3, 12.4, 13.4, 13.3, 12.9; Tier 1 capital ratio: 8.2, 8.6, 8.9, 9.2, 10.3, 10.6, 10.2.
- Personal sector — Net worth (percent of disposable income): 514.2, 509.0, 508.9, 520.4, 518.6, 518.3, 520.4; Total liabilities (percent of disposable income): 114.0, 112.6, 114.6, 117.5, 120.7, 124.0, 127.6.

### Staff appraisal and recommended follow-up
- Macroeconomic outlook: growth expected to remain around underlying potential of 3 percent through 2007 with inflation returning to the 2 percent target.
- Monetary policy: further modest increases in the overnight rate likely required; no major change to inflation-targeting framework warranted though communication could improve.
- Fiscal policy: planned reductions in corporate rates and early elimination of the federal capital tax are warranted; preference for cutting marginal personal income tax rates and increasing tax-deferred saving limits rather than cutting the GST rate.
- Fiscal framework: merit in raising budgetary reserves and anchoring policies on a 5–10 year debt objective; recommend annual independent analysis of long-term budget prospects.
- Structural priorities: reduce welfare walls, reform EI and immigration, product market reforms (including electricity and FDI thresholds), complete review of Equalization to account for resource revenues.
- Financial system: clarify bank merger policy, harmonize securities regulation, act to improve DB pension funding.

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

*IMF staff report excerpt: Canada — Staff Report for the 2006 Article IV Consultation (PDF chapter _cr06230).*

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

### _cr06230 - Executive Summary ......................................................................................................

### Macroeconomic outlook and key projections
- Growth is projected to remain at around its 3 percent potential.
- Inflation is projected to stay near its 2 percent target.
- The Bank of Canada will likely need to undertake further modest increases in the overnight rate, balancing evidence that slack is eroding against the drag from an appreciated exchange rate and the potential for a disorderly unwinding of global imbalances.
- The success of the inflation targeting framework suggests no need for significant amendments when it is renewed later this year, though there is some room to enhance policy communication.
- The new government has pledged debt reduction by C$3 billion (about ¼ percent of GDP) per year while aiming at enhancing incentives to save and invest.

### Recent developments (activity, demand, and trade)
- Real GDP growth was close to 3 percent during 2005 (Q4/Q4 basis), reflecting a strong expansion in construction, services, and resource industries.
- Final domestic demand rose 4½ percent, which more than offset a drop in inventory investment and net exports.
- Private consumption expanded by 3¾ percent; household wealth as a ratio to income remains close to historical highs despite a record-low saving rate.
- Private fixed investment rose by 7½ percent; residential construction moderated while purchases of machinery and equipment accelerated.
- Real exports expanded almost 5 percent over the course of 2005, while real imports increased 6½ percent, spurred by a strong currency.
- Soaring energy prices buoyed the nominal trade balance and the current account.
- The Canadian dollar has gained some 30 percent in real effective terms since early 2003.
- Multilateral IMF Research Department analysis suggests the exchange rate is up to 15 percent undervalued when compared with equilibrium saving-investment balances, though the gap is smaller using purchasing power parity–adjusted methods that account for improved terms of trade.

### Canada as an energy exporter (Box 1: factual findings and projections)
- Canada’s oil sands contain one of the world’s largest known hydrocarbon deposits; recoverable oil is estimated at about one sixth of global reserves.
- Production projections tend to imply a tripling of oil sands production volume to 2½–3 million barrels per day (mb/d) over 10 years.
- With conventional oil output already past its peak, Canada’s total oil production would increase from 2.5 mb/d in 2003 to about 4 mb/d by 2015.
- At current energy prices, Canada’s current account balance could improve by about ½ percent of GDP by 2015.
- Constraints and risks to oil sands expansion identified:
  - Limited infrastructure and difficulties in attracting skilled labor have boosted costs.
  - Canada’s natural gas output is expected to peak in about 10 years’ time; natural gas is a key input for oil sands production and this could pose a serious long-term cost problem.
  - Greenhouse gas emissions created by oil sands production are likely to conflict with Canada’s Kyoto Accord commitments.
- Staff analysis indicates most of the recent appreciation of the Canadian dollar against the U.S. dollar has been driven by fundamentals; the staff’s model suggests the impact of rising oil production on Canada’s real effective exchange rate would be small.

### Monetary policy assessment
- The Bank of Canada maintained a stimulative stance through September 2005, then resumed rate hikes as capacity utilization rose and employment strengthened.
- Further modest increases in the overnight rate will likely be required.
- The Bank’s credibility allows a flexible response to macroeconomic developments.
- Recent increases in monetary policy transparency are noted positively.

### Fiscal policy assessment and recommendations
- The new government has pledged to maintain the strong social consensus in favor of fiscal surpluses and to reduce the role of government while delivering promised tax relief.
- Planned measures that staff view as warranted:
  - Cuts in corporate rates.
  - Early elimination of the federal capital tax.
- Cutting the consumption tax rate would provide economic benefits, although personal income tax cuts could be a more effective use of resources.
- Recommendations to ensure a prudent fiscal framework:
  - Raise the size of budgetary reserves.
  - Anchor policies on a debt objective over a 5-10 year horizon.
  - Provide an annual analysis of long-term budget prospects by an independent body to emphasize the need for debt reduction.
- Addressing fiscal pressures at the provincial level is necessary to support longer-term fiscal sustainability.
- Any new allocation formula for the Equalization system should take resource-based revenues into account.
- There remains a case for allowing provinces greater flexibility in using price and other market-based mechanisms to help align the demand and supply for health care.

### Structural policies to raise long-term growth and flexibility
- Despite robust growth, Canada’s productivity performance has been less impressive; the new government has an opportunity to boost long-term growth potential.
- Suggested reforms include:
  - Labor market: reducing welfare walls, making immigration systems more flexible, and restoring reforms of the Employment Insurance system.
  - Product markets: reducing barriers to foreign direct investment and reforming the electricity sector.
  - Trade and agriculture: widening market access for agricultural goods.
- Health system: reform remains key to long-term fiscal sustainability (see Box 3 referenced in the original content).

### Financial sector policies and resilience
- The financial system appears well placed to support growth, but there is scope to further its efficiency and resilience.
- Priorities include:
  - Providing greater clarity on the regulatory framework governing bank mergers.
  - Establishing a national securities regulator.
  - Better aligning incentives of defined benefit pension plan sponsors and members.

### Risks and policy priorities
- Major risks include a possible disorderly unwinding of global imbalances and the macroeconomic implications of a sharply appreciated exchange rate.
- Policy priorities emphasized by staff:
  - Maintain credible and prudent fiscal policy while implementing tax relief.
  - Continue measured monetary policy tightening as warranted by domestic slack and inflation developments.
  - Advance structural reforms to raise productivity and flexibility in labor, product, and financial markets.
  - Address provincial fiscal challenges and health care cost pressures to safeguard long-term fiscal sustainability.

*IMF staff: Executive Summary, Article IV Consultation — Canada*

### 8. Most indicators suggest that the

### _cr06230 - 8. Most indicators suggest that the

### Economic activity and labor market
- Most indicators suggest the economy is operating at around potential.
- Unemployment rate has fallen to 6¼ percent—a 31-year low—reflecting employment growth in the commodity-producing western provinces and in central provinces where losses in export industries were offset by gains in construction and services.
- Both the staff and the Bank of Canada estimate a negligible output gap.

### Inflation, wages, and unit labor costs
- Headline inflation has fallen back to 2.2 percent, close to the center of the Bank of Canada’s 1-3 percent target range.
- The core measure has stayed below 2 percent since January 2004.
- Since 2002, the Bank of Canada’s composite commodity price index has increased by 90 percent, compared to a 30 percent appreciation of Canada’s real effective exchange rate.
- Wage increases accelerated during 2005 and, despite a pickup in productivity, unit labor costs rose by 3½ percent driven largely by the service sector.
- Core inflation has been stable in the bottom half of the Bank of Canada’s target range.

### Monetary policy stance and interest rates
- After pausing for almost a year, the Bank of Canada resumed withdrawing monetary stimulus in the fall of 2005.
- The Bank raised its target for the overnight interest rate to 3¾ percent in five consecutive ¼ percentage point steps starting in September.
- In March 2006 the Bank indicated that “modest” further tightening may be needed; markets interpreted this as suggesting rates would rise by only a further 25-50 basis points through end-2006.
- Yields on long-term government bonds remain close to historic lows in real and nominal terms, despite modest recent rises.
- The Bank was careful to be more cautious in raising interest rates than otherwise, accepting the possibility that domestic output could rise somewhat above potential in the near term.
- Staff and Bank officials agreed some further increases in short-term interest rates would likely be needed, given that monetary policy remained mildly accommodative.

### Financial and corporate sector soundness
- Financial sector: high profitability, robust balance sheets, a benign provisioning environment, and strong distance-to-default indices do not suggest systemic risks.
- Staff analysis finds the gradual trend to greater direct financing has strengthened the monetary transmission mechanism.
- Corporate sector: strong balance sheets and profitability.
- Funding situation of many defined benefit (DB) pension plans has deteriorated as declines in long-term interest rates and increases in life expectancy have boosted the present value of liabilities.

### Fiscal outlook and policy intentions
- Fiscal outlook remains very favorable: buoyant personal income tax collections and large corporate income tax payments are expected to lead to a surplus in FY2005/06 (ending in March).
- The new government pledged a range of tax cuts and spending restraint that—if fully implemented—would be consistent with a commitment to pay down federal debt by at least C$3 billion (about ¼ percent of GDP a year).
- Canada has achieved eight consecutive years of federal surpluses and falling government debt.
- Authorities maintained an informal fiscal rule including commitments to “balanced budgets or better,” a ¼ percent of GDP contingency reserve, and a macroeconomic prudence factor that rose by 0.1 percent of GDP a year over the forecast horizon.
- Objective established to reduce federal debt/GDP ratio to below 25 percent by FY 2014–15, extended in November 2005 to 20 percent by 2020.
- The new government’s campaign pledges included a 2 percentage point reduction in the GST (the first percentage point to be implemented immediately), cuts in a range of business taxes over five years, and limiting direct “program spending” (other than on defense or Indian affairs) to inflation plus population growth.
- Staff noted a reduction in corporate tax rates and elimination of the capital tax seem appropriate; staff analysis suggested a cut in personal income tax rates and lowering taxes on saving would be more likely to stimulate labor supply, saving, and investment than a lowering of the GST rate.
- Staff observed that difficult decisions would be needed to achieve planned expenditure containment; targeting the proposed child care allowance could lower fiscal cost (the proposed child care allowance: a blanket C$1,200 per child under six; officials highlighted means testing concerns).

### Outlook and risks
- Staff and most other forecasters expected growth at around 3 percent in 2006 and 2007.
- Real net exports expected to decline in 2006 as a result of recent currency appreciation, but improved terms of trade would lend support to domestic demand.
- Short-term risks evenly balanced:
  - Upside: higher energy and other commodity prices could further support incomes and domestic demand; further appreciation of the currency could not be ruled out given strength of commodity prices and global current account imbalances.
  - Downside: sharper-than-expected slowdown in U.S. activity would weigh heavily on Canada (exports to the United States account for about 35 percent of GDP); a sharp drop in commodity prices would reverse gains in the terms of trade and dampen income growth and domestic demand.
- Staff presented an alternative “perfect storm” scenario combining a major decline in U.S. activity, a large drop in commodity prices, and a sharp appreciation of the Canadian dollar against the U.S. currency that would pose intense challenges to the economy and financial sector.
- Domestic saving-investment balances pose risks: rise in household wealth has coincided with strong consumption growth leaving the personal saving rate close to zero; strong profits, particularly in commodity-producing industries, have turned the corporate sector into a net lender to the rest of the economy.
- Staff noted Canada’s fiscal and current account surpluses and declining government and net foreign debt ratios imply no sustainability issues, but interest rate or other shocks could lead the household saving rate to adjust abruptly.
- Officials and private sector participants were more sanguine about the household saving rate, seeing little risk of a sharp contraction in private consumption; vulnerabilities in the housing market were limited given limited refinancing and home equity withdrawals and a less developed sub-prime market than in the United States.

### Productivity and investment
- Labor productivity growth slowed since 2000 because of a sharp decrease in capital deepening and frictions associated with reallocation into the booming energy sector.
- The Bank of Canada shaded down its estimate of potential output growth in 2005 and 2006.
- Emerging signs that the drop in the price of imported capital goods associated with the strong exchange rate was boosting business investment, providing a potential upside risk to productivity growth.

### Exchange rate, communication, and inflation-targeting framework
- Officials viewed the recent appreciation of the Canadian dollar as consistent with rebalancing external and domestic demand in light of improving terms of trade.
- Mission background analysis and Bank of Canada staff found energy prices have a greater impact on the exchange rate than earlier believed.
- The team commended the Bank’s commitment to transparency but suggested scope for providing greater detail on assumptions and risks, particularly for fixed action dates not followed by a Monetary Policy Report (MPR).
- Officials preferred not to publish detailed forecasts of interest rates and exchange rates to avoid market misinterpretation and to preserve the timing of MPR releases.
- Canada’s inflation targeting framework was due for renewal later in 2006; issues under review included modifying the definition of core inflation, reducing the inflation target, shifting to a form of price-level targeting, and lengthening the horizon for achieving the inflation target in the presence of asset price disturbances.
- Officials did not expect significant changes in the present round, noting the success of the current framework and the high burden of proof for adopting different arrangements.

*Source: IMF staff report (excerpt).*

### 27. It was still not clear how much of the previous fiscal framework would be retained,

### _cr06230 - 27. It was still not clear how much of the previous fiscal framework would be retained,

### Fiscal framework, debt policy, and budget forecasting
- Officials emphasized the new government’s commitment to paying down debt and pointed to the plan to pay down C$3 billion in debt each year.
- The previous fiscal framework had led to biased fiscal forecasts—e.g., persistently higher-than-expected surpluses—undermining both transparency and parliamentary oversight.
- The new government pledged to establish a new Parliamentary Budgetary Authority and require more accurate and timely budget forecasts.
- The mission recommended elevating public debt reduction as a fiscal policy objective, arguing a debt objective over a 5–10 year horizon would help anchor policies amid unexpected events.

### Reserve cushion and the O’Neill Report
- Given uncertainties in budget forecasts, the Fund team argued achieving the new debt reduction objective would require a significant increase in budgetary reserves.
- The O’Neill Report (commissioned by the previous government, written with input from Fund staff) argued a cushion of about C$9 billion (¾ percent of GDP; 2–3 times the amount of past contingency reserves) would be needed to be reasonably certain of avoiding a budget deficit.
- A similarly high cushion would be needed to assure a C$3 billion minimum debt repayment.

### Long-term fiscal sustainability and aging population
- With the retirement of the baby boom generation imminent, staff suggested further solidifying the social consensus for prudent fiscal policies by regular publication of an annual analysis of long-term budget prospects to highlight fiscal challenges of an aging population.
- Staff analysis emphasizing the role of debt reduction for long-term fiscal sustainability was presented in last year’s Staff Report (IMF Country Report 05/118).

### Health care spending, Canada Health Act (CHA), and federal-provincial arrangements
- Staff and officials agreed controlling the growth of health care spending was essential.
- Federal officials noted recent spending increases partly made up for large cuts in the early 1990s; Canada had been the only large industrial country to keep health spending growth close to nominal GDP growth for more than a decade.
- The new government would adhere to the federal-provincial Health Accord of September 2004, which fixed a 10-year path for federal funding of provincial health plans.
- Officials intended to work with provinces to establish wait time guarantees for necessary medical services; provincial measures to contain medical spending and establish and publish medical service benchmarks were expected to yield efficiency benefits.
- The CHA establishes principles: Public administration; Comprehensiveness; Universality; Portability; Accessibility. These principles have been interpreted as precluding charges for medically necessary services covered by the Act; provisions under the CHA require a cut in federal transfers to provinces that permit such changes.
- Federal transfers announced in September 2004 totaled C$41 billion of new federal transfers over the next 10 years.
- Even with increased funding, pressures remain:
  - With CHA services provided free, demand containment has occurred through rising wait times.
  - Provincial support for rapidly growing spending on prescription drugs (not covered under the CHA) has added to budget strains.
  - The proportion of total health spending covered by individuals has increased steadily to around 30 percent.
- Recent judicial rulings and tribunal decisions highlighted strains on the public system (examples described in source).
- The new government pledged to allow a mix of private and public health care delivery so long as health care remains publicly funded and universally accessible; officials noted the only strict mandate under the CHA was to prohibit charges for medically necessary services.
- Officials suggested greater flexibility in service delivery could increase efficiency and pointed to rising private spending on dental care and pharmaceuticals as indicative of room for service innovation under the CHA.

### Federal-provincial fiscal imbalances and equalization
- The new government committed to addressing vertical and horizontal financial imbalances between the federal and provincial governments.
- Officials suggested concerns over unequal distribution of fiscal resources had dissipated as most provinces were running budget surpluses.
- An expert panel was to provide recommendations for amending equalization payments to reduce complexity and volatility of payments.
- The mission questioned whether the current system adequately accounted for disparities in natural resource endowments, noting last year’s decision to largely exempt royalties from offshore oil and gas production for some provinces; officials committed to maintaining earlier agreements and expected reforms to focus on complexity and volatility reduction.

### Alberta, resource windfalls, and the Heritage Savings Trust Fund
- In 2005 Alberta became essentially debt-free and had tax rates considerably lower than other provinces.
- Officials noted C$1 billion had recently been invested in Alberta’s Heritage Savings Trust Fund—the first such deposit since 1987.
- Before the additional deposit, the fair value of the Fund stood at about C$14 billion at end-2005.
- Subsequent to these discussions, the FY 2006/07 budget pledged a further C$1 billion investment in the Heritage Fund.
- Officials did not rule out similar future deposits but indicated a current focus on improving infrastructure and education to boost production potential, consistent with the nonrenewable nature of resources.
- The mission mentioned Norway as an example for using investment funds to share windfall fiscal gains with future generations.

### Productivity, labor market, and policies to increase economic efficiency and flexibility
- Canada’s recent productivity performance was disappointing: fast growth mainly from increased labor participation; investment and total factor productivity growth lagged U.S. rates.
- A likely explanation was a lack of capital deepening during the 1990s due to labor costs being low relative to mostly imported capital goods.
- Given demographic trends reducing the working-age share, the mission focused on policies to sustain growth and incomes and to ensure flexible responses of labor and capital to improved terms of trade.

Key policy areas discussed:
- Taxes and business incentives
  - The new government prioritized “rewarding effort” via lower taxes and reduced regulatory impediments.
  - The corporate income tax surtax and the federal capital tax would be eliminated as of 2006, followed by cuts in marginal corporate tax rates.
  - Tax treatment of small businesses would be more favorable; tax credits for apprenticeships and options for expanding tax credits for R&D would be explored.
  - On personal income tax, the government was sympathetic to raising the pension income amount eligible for tax relief and providing additional tax relief for capital gains when resources allowed.
  - Staff noted Canada’s marginal effective corporate tax rates would still be relatively high; officials prioritized avoiding loss of tax competitiveness vis-à-vis the United States and expected marginal effective rates to fall significantly by 2010 when further tax reductions were in place.
- Employment Insurance (EI) and social benefits
  - The mission voiced concern about rollbacks in earlier EI reforms: elimination of the intensity rule and new pilot projects enhancing benefits in high-unemployment areas could hinder labor market flexibility.
  - Staff analysis suggested scope for reducing social benefits provided through the EI program.
  - Officials argued benefit increases were important to ensure fairness for vulnerable regions and noted premiums had been lowered significantly and were being set transparently.
- Labor market attachment and participation
  - Staff analysis (Box 4 and Annex I) suggested tax and benefit policies helped boost female participation; rapid clawbacks of provincial benefits created high “welfare walls.”
  - There was scope to amend Canada Pension Plan (CPP) benefit formulas to make retirement decisions actuarially neutral; officials agreed adjustments could improve labor market attachment among the elderly but provincial agreement would be needed.
  - A more flexible immigration policy was seen as helpful to ease regional labor shortages by improving skill matching; increased settlement and integration services were pledged.
- Internal trade and labor mobility
  - Officials agreed on the need to remove remaining internal trade restrictions and facilitate internal labor mobility; provinces had progressed on dispute settlement, energy negotiations were advanced, and a pan-Canadian energy strategy was planned.
  - A federal initiative launched in April 2005 aimed to advance recognition of foreign credentials.
- Product market reform and foreign investment
  - The mission suggested room for more ambitious product market reform to improve Canada’s attractiveness for investment.
  - OECD indicators imply Canada’s product market regulation reverted to the G-7 average since the late 1990s, while Australia moved further ahead.
  - The Investment Canada Act’s restrictions on foreign ownership in network industries and thresholds for review appeared restrictive and might discourage resource and technology transfer; officials were split, with some defending screening as a necessary safeguard.

### Empirical and statistical findings highlighted in the chapter
- O’Neill Report cushion: C$9 billion (¾ percent of GDP; 2–3 times past contingency reserves).
- Debt repayment target: C$3 billion per year.
- Federal Health Accord funding announced: C$41 billion over 10 years.
- Private share of total health spending increased to around 30 percent.
- Alberta Heritage Savings Trust Fund: recent C$1 billion deposit; fair value about C$14 billion at end-2005; FY 2006/07 budget pledged a further C$1 billion investment.
- Suggested debt objective horizon: 5–10 year.
- Policy timing: elimination of corporate income tax surtax and federal capital tax as of 2006; marginal effective corporate tax rates expected to fall significantly by 2010.

*Source: IMF staff report excerpt in PDF chapter _cr06230.*

### Box 5. Structural Reforms and Economic Growth: Canada and Australia

### Box 5. Structural Reforms and Economic Growth: Canada and Australia

### Growth Performance and Drivers
- Both Canada and Australia have grown rapidly over the last decade, supported by sound macroeconomic frameworks and structural reform programs.
- As major commodity producers, both countries are relatively exposed to external shocks.
- Inflation targeting has yielded near price stability in both countries, and prudent fiscal frameworks have delivered significant reduction in public debt:
  - Australia’s net government debt is negligible.
  - Debt has fallen to under 40 percent of GDP in Canada.
- Concomitantly, average economic growth since 1995 has increased in both countries relative to the 1981–1994 period and to the GDP-weighted average growth of the “G-6” (i.e., G-7 nations excluding Canada).
- Average annual growth rates (Labor Utilization; Labor Productivity; Real GDP Per Capita):
  - 1995-2004: Canada 2.15; Australia 2.32; G-6 2.02; Canada 1.28; Australia 1.76; G-6 0.93; Canada 0.23
  - 1981-1994: Canada 1.04; Australia 1.49; G-6 1.78; Canada 1.15; Australia 1.20; G-6 -0.23; Canada 0.16
- Key contrast:
  - Australia’s rise in per capita GDP growth reflects an increase in labor productivity growth.
  - Canada’s faster growth largely reflects higher labor utilization.

### Structural Reform Indicators: Product and Labor Markets
- OECD structural reform indicators suggest:
  - Australia has moved ahead of Canada and the GDP-weighted G–6 in product markets.
  - Canada continues to have a more flexible labor market.
- Product market reform:
  - Australia’s “National Competition Policy” (commencing mid-1980s) gradually reformed product markets toward OECD ‘best practice’ in electricity, airlines, post, and road sectors—surpassing Canada’s overall benchmark index by the mid-1990s.
  - Canada has reverted to the G–6 average; the OECD has noted that Canada could undertake further reforms in its electricity and rail sectors.
  - Corporate effective tax rates remain high in Canada.
- Labor markets:
  - Canada retains an advantage in labor market flexibility despite some rollbacks in Employment Insurance reforms.
  - Australia passed important labor reforms in the mid-1990s, decentralizing wage-setting and linking wages more closely to productivity.
  - Late 2005 legislation in Australia aimed to reduce dismissal costs for small companies, narrow the range of minimum working conditions, and establish a new commission to determine minimum wage increases.
- Policy implication:
  - With gains from higher labor market participation likely to diminish in Canada, further product market reforms could help improve Canada’s labor productivity.
  - Recommended focus areas include removal of restrictions on inter-provincial trade and FDI, and increasing competition in sectors dominated by government-owned firms (e.g., electricity), possibly through privatization as occurred in Australia and in the Canadian gas industry.

### Relative Structural Reform Indices and Tax Rates (as reported)
- Structural reform indices (relative to a PPP-weighted average of G-6):
  - Product markets (1998 and 2003): Canada 1.18; Australia 1.00; Canada 1.28; Australia 1.34
  - Labor markets: Canada 1.10; Australia 1.09; Canada 0.73; Australia 0.74
- Average Effective Tax Rates:
  - Labor: 27% (Canada 1995), 25% (Australia 2004), 24% (Canada 1995), 24% (Australia 2004)
  - Corporate: 39% (Canada 1995), 31% (Australia 2004), 28% (Canada 1995), 18% (Australia 2004)

### Financial Sector Policies and Risks
- Overall conditions in Canada’s financial sector were viewed positively:
  - Aggregate bank capital and credit quality were extremely high.
  - Banks had a comfortable financial buffer.
- Identified limited credit risks:
  - Combination of high energy prices, exchange rate appreciation, and competition from Asia placed significant financial stress on sectors such as auto that were collectively owing about 12 percent of corporate debt.
- Regulatory initiatives and issues:
  - A forthcoming Legislation Review aimed to eliminate some regulatory overlap and simplify rules on foreign bank entry.
  - Authorities agreed in principle to conduct an FSAP update in conjunction with a 2007 FATF review of Canada.
  - Staff concern over lack of progress on regulatory issues related to:
    - Bank mergers: ongoing debate on size of efficiency gains versus competition and other considerations.
    - Securities market regulation: most provinces continued to oppose a national securities regulator; provinces agreed on key objectives but disagreed on final regulatory setup.
- Pensions and corporate governance:
  - Underfunding of many defined benefit (DB) plans noted; decline in solvency ratios largely due to low interest rates and upward revision of life expectancy.
  - Measures under discussion: extending tax preferences for plan overfunding, addressing asymmetries in distribution of plan surpluses, and extending the period to restore solvency.
  - Significant harmonization of corporate governance rules with the United States had taken place; Canadian Securities Administrators decided against requiring auditor certification of internal controls over financial reporting.
- Government bond market liquidity:
  - String of fiscal surpluses affected the government’s ability to maintain depth and liquidity in benchmark bond issues; annual bond issuance had fallen.
  - Staff agreed converting Crown Corporation debt to government bonds could boost liquidity and save up to 10–15 basis points in liquidity premium.
  - Footnote: Crown Corporation debt amounts to about one tenth of outstanding government debt and, at C$11 billion, new issuance would significantly deepen the government’s current C$30–35 billion issuance of new securities.

### Trade, International Assistance, and Dispute Issues
- Trade negotiations:
  - Officials observed progress at the Hong Kong Ministerial Conference but acknowledged more had to be done; outcome of the Doha Round seen as dependent on compromise among larger players.
  - Officials reiterated commitment to protecting Canada’s supply management systems in response to calls for liberalizing agricultural market access.
- Softwood lumber dispute:
  - Progress noted; recent reduction in the U.S. anti-dumping duty helpful.
  - Officials cautiously welcomed U.S. decision to rescind the Byrd amendment going forward.
  - Frustration expressed that dispute settlement procedures appeared relatively ineffective in this case.
- International assistance:
  - Officials reiterated commitment to double the International Assistance Envelope by the end of the decade, with half targeted to Africa.
  - Canada announced cancellation of all debt held by Senegal, Madagascar, Ghana, and Ethiopia.

### Staff Appraisal: Macroeconomic Outlook, Policy Priorities, and Recommendations
- Macroeconomic and outlook assessment:
  - Canada’s macroeconomic and policy performance has continued to exceed most other industrial countries; outlook remains favorable.
  - Employment continues to expand at a solid pace; boom in energy prices supported domestic incomes and drove a record-high external current account surplus.
  - Growth expected to remain at around its underlying potential of 3 percent through 2007, with inflation returning to the 2 percent target.
- Monetary policy:
  - The Bank of Canada has appropriately continued to withdraw stimulus in recent months.
  - Further modest increases in the overnight rate will likely be required to bring inflation back to target.
  - The inflation targeting framework is due for renewal this year but success to date does not suggest need for significant amendments; further progress could be made in communicating key assumptions underlying policy decisions.
- Fiscal policy and tax recommendations:
  - New government committed to lowering the tax burden, maintaining fiscal surpluses, and continuing debt reduction.
  - Emphasis on limiting government spending is appropriate; challenge to identify areas for cuts to accommodate new priorities.
  - Planned reductions in corporate rates and early elimination of the federal capital tax are warranted given relatively high marginal effective corporate tax rates.
  - Recommendation: rather than cutting the GST rate, reduce marginal personal income tax rates and increase tax-deferred saving limits to better use scarce fiscal resources.
  - Shifting the tax burden from income toward consumption would improve incentives to save and invest, while supporting revenues as the population ages.
- Fiscal framework and reserves:
  - Given uncertainties in budget forecasts and federal debt ratio still around 40 percent of GDP, merit in raising budgetary reserves and anchoring policies on a debt objective over a 5–10 year horizon.
  - Recommend annual analysis of long-term budget prospects by an independent body to support social consensus for prudent fiscal policies.
- Provincial fiscal stresses:
  - Provincial/territorial health outlays rising rapidly; agreement to lock in federal health transfers over next 10 years provides incentives to improve efficiency and quality of health care.
  - Case for allowing provinces greater flexibility in using price and market-based mechanisms to align demand and supply for health care.
  - Forthcoming review of the Equalization system should ensure regional disparities in fiscal capacity are not exacerbated by the boom in oil and gas revenues; any new allocation formula should take resource-based revenues into account.
- Productivity and structural reform priorities:
  - Despite rapid growth and low unemployment, productivity performance has been less encouraging.
  - Priority areas to boost economic potential:
    - Labor markets: reduce welfare walls to improve labor participation among low income groups; amend immigration systems to address skills shortages; simplify recognition of occupational qualifications across provinces; consider funding Employment Insurance parental and other social benefits through general revenues rather than payroll tax; curb extended regional benefits.
    - Product markets: update sector-specific constraints and thresholds for review under the Investment Canada Act; regulatory reform needed in the electricity sector where productivity growth has been lower and markups higher.
    - Trade and agriculture: Canada can play a leadership role in completing the Doha Round, particularly by widening market access for agricultural goods, including those subject to “supply management” schemes.
- Financial system recommendations:
  - Bank mergers: greater clarity regarding the public interest criterion would allow more transparent examination of potential benefits and costs of merger proposals.
  - Securities regulation: harmonizing securities regulation would reduce compliance and administrative costs; support establishment of a national securities regulator as proposed by the Wise Persons’ Committee.
  - Defined benefit pension plans: early action warranted to better align incentives of plan sponsors and members to improve funding of the system; recent decision to enter public consultation on regulatory reform is welcome.

*Written by S. Ouliaris. Sources: OECD; C.D. Howe Institute; and Fund staff estimates.*

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

### _cr06230 - 58. 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.

### Key macroeconomic projections and indicators (Canada)
- Per capita real GDP (annual percent change):  
  - Canada: 2.3, 4.3, 0.7, 1.9, 1.0, 1.9, 2.0, 2.0, 2.1 (2000–2008 series as listed).
  - United States: 2.2, 2.5, -0.3, 0.6, 1.7, 3.2, 2.6, 2.4, 2.3.
  - Euro Area: 1.6, 3.3, 1.5, 0.4, 0.2, 1.5, 0.8, 1.7, 1.6.
  - Japan: 1.0, 2.7, 0.1, -0.1, 1.6, 2.2, 2.7, 2.7, 2.1.
  - United Kingdom: 2.4, 3.7, 1.8, 1.6, 2.1, 2.7, 1.3, 2.0, 2.2.
  - Australia: 2.4, 2.1, 0.9, 2.9, 1.9, 2.3, 1.2, 1.6, 1.9.
  - Sweden: 2.5, 4.1, 0.8, 1.6, 1.3, 3.3, 2.3, 3.1, 2.0.

- Real GDP (annual percent change):  
  - Canada: 3.3, 5.2, 1.8, 3.1, 2.0, 2.9, 2.9, 3.1, 3.0.
  - United States: 3.3, 3.7, 0.8, 1.6, 2.7, 4.2, 3.5, 3.4, 3.3.
  - Euro Area: 2.0, 3.8, 1.9, 0.9, 0.7, 2.1, 1.3, 2.0, 1.9.
  - Japan: 1.2, 2.9, 0.4, 0.1, 1.8, 2.3, 2.7, 2.8, 2.1.
  - United Kingdom: 2.8, 4.0, 2.2, 2.0, 2.5, 3.2, 1.8, 2.5, 2.7.
  - Australia: 3.7, 3.3, 2.2, 4.1, 3.1, 3.6, 2.5, 2.9, 3.2.
  - Sweden: 2.7, 4.3, 1.1, 2.0, 1.7, 3.7, 2.7, 3.5, 2.4.

- Real domestic demand (annual percent change):  
  - Canada: 3.7, 4.7, 1.2, 3.5, 4.7, 4.0, 4.6, 3.5, 3.0.
  - United States: 3.8, 4.4, 0.9, 2.2, 3.0, 4.7, 3.6, 3.4, 3.1.

- GDP deflator (annual percent change):  
  - Canada: 2.0, 4.1, 1.1, 1.0, 3.3, 3.1, 3.1, 3.0, 1.7.
  - United States: 2.0, 2.2, 2.4, 1.7, 2.0, 2.6, 2.8, 2.4, 2.0.
  - Japan: -1.0, -1.7, -1.2, -1.6, -1.6, -1.2, -1.3, 0.0, 0.4.

- General government financial balance (in percent of GDP):  
  - Canada: 0.8, 2.9, 0.7, -0.1, 0.0, 0.7, 1.7, 1.3, 1.1.
  - United States: -2.0, 1.3, -0.7, -4.0, -5.0, -4.7, -4.1, -4.3, -4.0.
  - Japan: -6.5, -7.7, -6.4, -8.2, -8.1, -6.6, -5.8, -5.7, -5.4.

- Gross national saving (in percent of GDP):  
  - Canada: 21.3, 23.6, 22.2, 21.3, 21.7, 22.9, 23.4, 24.5, 24.7.
  - United States: 15.9, 18.0, 16.4, 14.2, 13.4, 13.4, 13.6, 14.1, 14.4.
  - Japan: 27.7, 27.8, 26.9, 25.9, 26.2, 26.4, 26.8, 26.9, 26.9.

- Fixed investment (in percent of GDP):  
  - Canada: 19.6, 19.2, 19.6, 19.5, 19.6, 20.1, 20.5, 20.8, 21.2.
  - United States: 19.2, 20.2, 19.5, 18.3, 18.3, 19.1, 19.9, 20.2, 20.6.
  - Japan: 25.0, 25.2, 24.7, 23.3, 22.9, 22.9, 23.3, 24.0, 24.3.

- Current account balance (in percent of GDP):  
  - Canada: 1.1, 2.7, 2.3, 1.8, 1.5, 2.2, 2.2, 3.1, 2.9.
  - United States: -3.8, -4.2, -3.8, -4.5, -4.7, -5.7, -6.4, -6.5, -6.5.
  - Japan: 2.8, 2.6, 2.1, 2.9, 3.2, 3.8, 3.6, 3.2, 2.9.
  - Sweden: 5.0, 4.1, 4.4, 5.1, 7.3, 6.8, 6.1, 5.1, 4.5.

### Quarterly and short-run dynamics (selected)
- NIPA in constant prices (quarterly real GDP, seasonally adjusted, annual rates):  
  - Real GDP (quarterly): 2.1, 3.6, 3.5, 2.5, 3.2, 3.1, 3.0, 3.0, 3.0, 3.0, 3.0.
  - Net exports contribution 1/: -1.3, 0.9, -0.7, -0.2, -0.6, -0.3, 0.2, 0.2, 0.2, 0.2, 0.1.
  - Total domestic demand: 3.4, 2.6, 4.5, 3.0, 4.0, 3.6, 3.0, 2.9, 2.9, 2.9, 3.0.

- Employment and inflation:  
  - Unemployment rate (percent): 7.0, 6.8, 6.8, 6.5, 6.6, 6.6, 6.6, 6.6, 6.6, 6.6, 6.6.
  - CPI inflation (y/y): 2.1, 1.9, 2.7, 2.3, 2.2, 2.0, 1.5, 1.7, 2.0, 2.0, 2.0.
  - Core CPI inflation (y/y): 1.5, 1.9, 1.1, 2.0 (series then dotted).

- Interest rates:  
  - Three-month treasury bill (percent): 2.5, 2.5, 2.7, 3.2, 3.6, 3.8, 4.0, 4.1, 4.2, 4.3, 4.3.
  - Ten-year government bond yield (percent): 4.3, 4.0, 3.9, 4.1, 4.1, 4.4, 4.6, 4.9, 5.1, 5.2, 5.3, 5.4 (series includes multiple entries).

### External sector and balance of payments (selected)
- Current account balance (quarterly percent of GDP): 1.3, 1.5, 2.2, 3.8, 3.3, 3.1, 3.0, 3.1, 2.8, 2.8, 3.0.
- Merchandise trade balance (percent of GDP): 3.9, 4.1, 5.2, 6.2, 6.0, 5.8, 5.6, 5.6, 5.6, 5.4, 5.3, 5.5.
- Exports and imports (long-run series in Table 3, billions of Canadian dollars):  
  - Exports, goods (selected series): 414.1, 400.2, 429.1, 453.4, 492.3, 514.6, 538.9, 567.0, 594.5, 623.4 (2002–2011 series as listed).
  - Imports, goods (selected series): 356.8, 342.6, 363.1, 386.8, 408.6, 431.7, 454.6, 479.5, 505.8, 522.7.

- Balance on invisibles and investment income:  
  - Services balance (selected): -7.7, -11.4, -12.7, -13.4, -13.8, -14.6, -15.7, -16.7, -17.8, -20.2.
  - Investment income balance (selected): -29.4, -28.0, -24.9, -22.8, -24.5, -23.7, -23.6, -23.4, -23.2, -23.2.

- Capital and financial accounts balance (in billions): -13.0, -16.1, -22.5, -22.2, -45.4, -44.5, -44.9, -47.4, -47.6, -47.5 (series listed).

### Vulnerability and financial sector indicators
- Official reserves (in billions of U.S. dollars): 28.6, 32.4, 34.2, 37.2, 36.3, 34.5, 33.0 (1999–2005).
- Broad money (M3) to foreign exchange reserves (ratio): 14.5, 13.8, 13.2, 12.8, 15.6, 19.2, 23.6.
- Official reserves in months of imports: 1.3, 1.4, 1.5, 1.6, 1.5, 1.2, 1.0.
- General government gross debt (percent of GDP): 111.6, 101.5, 100.3, 97.4, 91.9, 87.9, 85.0.
- Net international investment position (current prices, percent of GDP): -24.8, -19.4, -18.4, -17.9, -17.0, -14.0, -12.8.
- External debt to exports ratio (in percent): 57.7, 42.7, 42.3, 43.4, 44.8, 36.9, 34.0.

- Banking sector (six largest chartered banks, unless otherwise indicated):  
  - Total loans to assets (percent): 59.0, 58.0, 56.2, 55.9, 54.1, 54.3, 53.9.
  - Total loans to deposits (percent): 87.0, 84.4, 84.7, 83.3, 81.4, 81.7, 80.8.
  - Impaired assets/total assets: 0.59, 0.60, 0.84, 0.90, 0.65, 0.39, 0.27.
  - Loan loss provision (percent of total assets): 0.23, 0.27, 0.39, 0.56, 0.22, 0.06, 0.09.
  - Total capital ratio: 11.3, 11.9, 12.3, 12.4, 13.4, 13.3, 12.9.
  - Tier 1 capital ratio: 8.2, 8.6, 8.9, 9.2, 10.3, 10.6, 10.2.

- Personal sector indicators:  
  - Net worth (in percent of disposable income): 514.2, 509.0, 508.9, 520.4, 518.6, 518.3, 520.4.
  - Total liabilities (in percent of disposable income): 114.0, 112.6, 114.6, 117.5, 120.7, 124.0, 127.6.
  - Household credit (growth rate, percent): 5.1, 7.1, 4.9, 7.1, 8.4, 9.8, 10.5.

### Fiscal indicators and projections
- Federal government (PA basis, in billions of dollars, staff projections):  
  - Revenue: 182.7, 171.7, 177.6, 186.2, 198.4, 202.3, 209.9, 217.7, 224.8, 232.3, 239.0.
  - Program spending: 118.7, 125.0, 133.5, 141.4, 162.7, 161.7, 172.5, 179.9, 187.2, 194.7, 201.5.
  - Interest payments: 43.9, 39.7, 37.3, 35.8, 34.1, 34.0, 34.4, 34.8, 34.6, 34.5, 34.4.
  - Budgetary balance (accruals basis): 20.2, 7.1, 6.8, 9.1, 1.6, 6.7, 3.0, 3.0, 3.0, 3.0, 3.0.

- Federal government (in percent of GDP):  
  - Revenue: 17.0, 15.5, 15.4, 15.3, 15.4, 14.8, 14.4, 14.3, 14.1, 13.9, 13.7.
  - Program spending: 11.0, 11.3, 11.6, 11.6, 12.6, 11.8, 11.9, 11.8, 11.7, 11.7, 11.5.
  - Interest payments: 4.1, 3.6, 3.2, 2.9, 2.6, 2.5, 2.4, 2.3, 2.2, 2.1, 2.0.
  - Budgetary balance (accruals basis): 1.9, 0.6, 0.6, 0.7, 0.1, 0.5, 0.2, 0.2, 0.2, 0.2, 0.2.

- General government (NIA basis, in billions):  
  - Revenue: 470.2, 469.3, 472.5, 494.5, 520.6, 558.6, 574.3, 598.0, 622.4, 647.0, 672.8.
  - Expenditure: 438.5, 462.1, 473.6, 494.5, 511.8, 534.9, 558.5, 582.9, 611.3, 636.0, 661.8.
  - Balance: 31.7, 7.3, -1.1, 0.1, 8.7, 23.7, 15.8, 15.0, 11.1, 11.1, 11.0.

- Net federal debt (fiscal year basis, in billions): 524.5, 517.5, 510.5, 501.5, 499.9, 493.3, 490.3, 487.3, 484.3, 481.3, 478.3.
- Net public debt (in percent of GDP): 65.3, 60.2, 57.9, 51.4, 46.8, 41.9, 38.4, 35.7, 33.4, 31.2, 29.1.

### Annex I — Energy, exchange rate, and oil sands (summary and policy implications)
- Main findings:  
  - Canada’s future as an energy-exporting nation increasingly depends on unconventional oil and gas production; conventional production in the Western Canada Sedimentary Basin appears to have peaked despite record drilling.  
  - Large reserves of coal bed methane and coal exist; commercial feasibility could boost gas production.  
  - Oil sands (mostly in Alberta) offer the greatest near-term potential to expand energy exports; oil sands contain one of the largest known hydrocarbon deposits in the world.15

- Economics of oil sands:  
  - Extracting oil from tar sands is capital- and energy-intensive; historical costliness has been reduced by technological progress and tighter global energy markets.  
  - The long-term break-even point for oil sands projects is estimated at US$30–35/bbl, which is stated to be well below most investors’ long-term oil price expectations.

- Resource and input constraints:  
  - A sustained increase in oil sands production requires adequate skilled labor and additional electricity, water, diluents, and other inputs.  
  - Demand for natural gas by oil sands operations is expected to roughly double by 2015, potentially tightening the North American gas market and increasing oil sands production costs.  
  - Increased production complicates Canada’s efforts to meet emissions reduction objectives under the Kyoto Protocol despite energy-efficiency improvements.

- Exchange rate, manufacturing, and crowding-out concerns:  
  - Recent Canadian dollar appreciation raised concerns about manufacturing crowding out due to trade balance improvements.  
  - Historical review finds few signs that natural resource exports persistently hurt manufacturing: energy exports rose relative to GDP since 1980 while the real effective exchange rate declined; manufacturing output and exports remained stable as a ratio to GDP; the decline in manufacturing employment share was smaller than in other resource-exporting industrial countries.  
  - Short-term manufacturing fluctuations were not correlated with real effective exchange rate movements until the real effective exchange rate began appreciating in 2002.  
  - The evidence suggests Canadian manufacturing conditions remain closely tied to U.S. economic developments, reflected in a strong correlation between U.S. investment and Canadian goods exports.

*Source: IMF staff report content (tables and Annex I summary) contained in the provided PDF content.*

### 5. Although a close link between nonenergy commodity prices and the value of the

### _cr06230 - 5. Although a close link between nonenergy commodity prices and the value of the

### Commodity prices, exchange rate, and composition of trade
- An exchange rate equation relates the Canadian dollar’s value to energy and nonenergy commodity trade, with focus on changes in the composition of trade over time.
- Dynamic projection over 2002Q1 through 2005Q2: about 5 percentage points of the 30 percent appreciation of the Canadian dollar against the U.S. dollar remain unexplained.
- The estimate of the unexplained gap is relatively insensitive to varying the starting date of the projection.

### Oil sands production scenario and implied exchange rate effect
- Projected contribution of Alberta’s tar sands production:
  - Adds some 1 percent of GDP to net oil exports over 15 years.
  - Increases net oil exports as a ratio of noncommodity imports by some 4 percentage points.
- Model implication: a real appreciation of only around 4 percent would be expected from this increase—much less than the implied appreciation since early 2002 but similar to the unexplained gap over that period.

### Policy implications for energy expansion
- The expansion of oil sands production is likely to have a small impact on the Canadian economy:
  - Potential gains in export revenues could cause upward pressure on the exchange rate, but not large enough to significantly affect non-energy exporters.
  - Considerable demand for labor and capital inputs from oil sands exploration and production would spread gains to other provinces and boost domestic activity.
  - Even with a growing energy sector, it will remain one of several pillars in a well diversified Canadian economy.
- Structural policy recommendations to assist oil sands development:
  - Review immigration restrictions with the objective of providing relief to tight labor supply in some key professions.
  - Adapt the regulatory environment for infrastructure development and the environment to ensure a sustainable production increase amid increased investor interest.

### Disintermediation and Monetary Transmission in Canada — key findings
- The Canadian financial system has become more market-based since the late 1980s; the ratio of direct to indirect finance for the Canadian corporate sector increased steadily since the late 1980s following Bank Act amendments in 1987, 1992 and 1997.
- Two notable structural changes over the last two decades:
  - Increased use of direct (market) financing relative to intermediated (bank) financing (financial disintermediation).
  - Increased household access to credit, reflected in rises in consumer and mortgage credit.
- Methodologies used:
  - Vector autoregression (VAR) models extended with financial variables and tested for structural breaks/parameter instability.
  - Structural econometric IS-type models assessing the impact of the ratio of direct to indirect finance on the interest rate sensitivity of aggregate demand.
- Empirical results:
  - Estimated VAR models show a break in monetary transmission in 1988 after regulatory changes initiated disintermediation.
  - Inclusion of financial variables improves characterization of transmission before the structural break; monetary impulses do not have a statistically significant impact on real activity in the 1990s in VAR impulse responses.
  - Evidence suggests the systematic component of monetary policy became more important in the 1990s, possibly explaining reduced impulse-response effects.
  - Estimates of the interest rate elasticity of aggregate demand in IS equations increase in the 1990s.
  - Changes in the ratio of direct to indirect finance help explain changes in interest rate elasticity, suggesting increased effectiveness of monetary policy with greater use of market-based finance.
  - Increased household credit access may lower the impact of interest rates on aggregate demand per the model, but could also increase the role of bank balance sheets in transmission.
- Broader benefits:
  - More market-based financial systems provide more diversification opportunities and greater information on financial risk pricing, supporting financial stability and economic activity.

### Policy implications for monetary transmission
- Changes in financial structure appear to have made monetary policy more effective in the 1990s, easing stabilization of economic activity.
  - As the impact of interest rate changes on aggregate demand increased with disintermediation, smaller rate changes would be needed to respond to shocks.
  - This process seems to have come to a halt since 2002 as financial companies focused more on household lending.
- More effective monetary policy reduces the required rate response to external shocks, but:
  - Lower nominal interest rates and proximity to the zero bound caution against a shorter policy horizon when the likelihood of large shocks increases.

### Female labor-force participation — findings (Canada focus)
- Study uses annual panel data of 10 large industrial countries over 1980–2001 (sample comprises Australia, Canada, Denmark, Finland, France, Germany, Spain, Sweden, the United Kingdom, and the United States).
- Canada experienced an impressive increase in female participation in the last decade following mid-1990s reforms in the tax and benefit system (decrease in the secondary earner’s tax wedge and more generous public childcare provision).
- Econometric estimates:
  - The mid-1990s decrease in the secondary earner’s tax wedge coupled with increases in childcare benefits could help explain 30–80 percent of the increase in Canadian women’s participation rate between 1995 and 2001.
  - A 1 percentage point tax cut would raise female participation rate by 0.17-0.19 percentage points.
  - An equivalent increase in childcare benefits would raise female participation by 0.14–0.99 percentage points.
- Non-policy determinants affecting female participation:
  - Unemployment rate dampens female participation (possible “discouraged worker” effect).
  - Labor market regulation (e.g., union density, employment protection) has a positive impact on female participation.
  - High wage compression discourages female participation by raising the relative price of childcare.
  - Preferences and institutional factors (years of education enrollment, fertility decisions) act as disincentives to enter the labor market.
  - Cultural characteristics and country fixed effects (role of women in politics) are important explanatory factors.

### Policy implications for female participation
- Mid-1990s Canadian tax and benefit reforms were successful in boosting female participation.
- Policies that reconcile work and family (e.g., lower secondary earner tax wedges, affordable and available childcare) could be used by other countries to increase female labor force participation.
- Given population aging challenges, further raising participation is desirable even in Canada; potential policy options include lower tax wedges and pension system reforms to boost participation among older and low-income workers.

### Canadian labor markets and mobility — findings
- Labor market flexibility is a key determinant of differences in economic performance across countries.
- Canada shows relatively flexible labor markets by international standards; migration plays a significant role in adjusting to labor demand shocks, similar to the United States and unlike Spain, France, and Germany.
- Regional differences within Canada:
  - Labor markets become more flexible moving west; migration is a more important adjustment mechanism in the western provinces than in the Atlantic provinces.
  - Ontario exhibits a significantly more flexible labor market than Quebec.
  - Migration is the main process of labor market adjustment over time; real wage differentials are a minor factor.
  - Adjustment processes are relatively similar across macroeconomic disturbances.
- These east–west differences in labor adjustment are pronounced (labor adjustment appears very different east and west of the Ottawa River).

### Policy implications for labor market flexibility
- Canada’s relatively flexible labor markets are well placed to respond to the recent rise in oil prices:
  - Oil prices support activity in the raw-material rich west.
  - Exchange rate appreciation is likely to affect Ontario, whose manufacturing base is closely integrated with the United States.
  - The relative flexibility of these provinces’ labor markets facilitates reasonably smooth adjustment to shocks.

*https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06230.pdf*

### 32. The flexibility of Canadian labor markets could be further increased by market-

### 32. The flexibility of Canadian labor markets could be further increased by market-oriented reforms of the Employment Insurance system.

### Labor market flexibility and migration
- Key finding: Inter- and intra-national results suggest that the key difference in labor market flexibility are incentives for migration.
- Empirical determinants of inter-provincial migration in Canada identified: economic opportunities, cost of migration, age, and language.
- Role of EI (Employment Insurance): EI appears to play a more minor role, but eliminating differences in eligibility and benefits across localities would tend to reduce the differences in labor market flexibility across regions identified in the analysis.

### Canada — Fund relations (As of February 28, 2006)
- I. Membership Status: Joined 12/27/45; Article VIII
- II. General Resources Account:
  - Quota: 6,369.20 Million of Quota (100.00 percent)
  - Fund holdings of currency: 5,648.46 (88.68 percent)
  - Reserve position in Fund: 720.75 (11.32 percent)
- III. SDR Department:
  - Net cumulative allocation: 779.29 Million (100.00 percent)
  - Holdings: 632.81 (81.20 percent)
- IV. Outstanding Purchases and Loans: None
- V. Financial Arrangements: None
- VI. Projected Obligations to Fund (SDR Million; based on existing use of resources and present holdings of SDRs):
  - 2006: Charges/Interest 3.77; Total 3.77
  - 2007: Charges/Interest 5.03; Total 5.03
  - 2008: Charges/Interest 5.05; Total 5.05
  - 2009: Charges/Interest 5.03; Total 5.03
  - 2010: Charges/Interest 5.03; Total 5.03
- VII. Implementation of HIPC Initiative: Not applicable.
- VIII. Safeguards Assessments: Not applicable.
- IX. Exchange Rate Arrangements:
  - The Canadian authorities do not maintain margins with respect to exchange transactions, and exchange rates are determined on the basis of demand and supply conditions in the exchange market.
  - Authorities may intervene to maintain orderly conditions in the exchange market.
  - There are no taxes or subsidies on purchases or sales of foreign exchange.
  - Canada has lifted restrictions imposed in 1992 with respect to the Federal Republic of Yugoslavia (Serbia and Montenegro) and has replaced restrictions imposed with respect to Iraq with a new regulation, which the authorities have notified to the Executive Board under Decision 144 (52/51).
- X. Last Article IV Consultation: The Staff Report for the 2005 consultation with Canada was considered by the Executive Board on February 16, 2005 (EBM/05/15). Canada is on a 12-month consultation cycle.
- XI. FSAP Participation and ROSC Assessments:
  - Canada—Financial System Stability Assessment–Volume II: Report on Observance of Standards in the Financial System FO/Dis/00/2, Sup. 1, 04/01/00
    - Summary: The FSSA report concluded that Canada has a stable and highly advanced financial system, which is among the soundest in the world, supported by a well-developed regulatory system that shows a high degree of compliance with major international standards.
    - Recommendations (most already addressed), including:
      - Introducing capital requirements for the guarantees in life insurance segregated fund (completed by end-2001);
      - Tabling legislation granting the Office of the Superintendent of Financial Institutions (OSFI) powers to remove a financial institution’s director or senior officer if the person is deemed not suitable to hold that office based on a number of criteria. The latter legislation brought Canada into broad compliance with the Basel Core Principles;
      - Making significant progress in harmonizing securities regulation and improving coordination among provincial securities regulators, including through a newly created association of securities regulators, the Canadian Securities Administrators. Although there remain multiple regulators at the provincial level, a Senate commission was created to develop specific recommendations on further harmonization and streamlining of securities regulation.
  - Canada: Report on the Observance of Standards and Codes—Fiscal Transparency Module IMF Country Report No. 02/51, 03/12/02
    - Summary: Fiscal management in Canada meets the requirements of the fiscal transparency code, and in a number of instances represents best practice.
    - Commended practices: use of private sector economic forecasts, prudence factors, contingency reserve for fiscal forecasting, statistical integrity, impartial tax administration, open procurement, transparent regulatory process.
    - Areas for improvement (report recommendations), including:
      - (i) the preparation of timely, current year estimates of federal and provincial budgets on a comparable basis,
      - (ii) a comprehensive account of the procedures for the budget cycle and expenditure management system,
      - (iii) systematic reporting of the use of reserves for non-economic contingencies,
      - (iv) resumption of publication of reconciled national and public accounts forecasts of major aggregates over the forecast horizon,
      - (v) publication by all governments of quasi-fiscal activities.
    - Follow-up actions reported as addressed, including:
      - (i) the release by Statistics Canada of consolidated data for federal and provincial budgets for 2001–02 (on a Financial Management System basis),
      - (ii) the publication of comprehensive descriptions of budget and expenditure management procedures, including: a joint document entitled “Budgeting in Canada” by the Government and the OECD; detailed accounts of policies and procedures on expenditure management at the website of the Treasury Board Secretariat; and the explanation of the budget cycle and process in Budget and Update documents.
  - Canada: Report on the Observance of Standards and Codes—Data Module IMF Country Report No. 03/328, 10/23/03
    - Summary: Canada’s macroeconomic statistics are comprehensive, timely, and accurate and thus adequate to conduct effective surveillance of economic and financial policies.
    - Priorities for strengthening the statistical system (most already being addressed), including:
      - Articulate the roles of Statistics Canada and the Bank of Canada in producing financial sector statistics and explore possibilities for more data sharing of monetary and financial statistics;
      - Estimate consumption of fixed capital at replacement cost rather than historic costs now used for the corporate sector in the Canadian System of National Accounts (CSNA);
      - Disseminate information on the sources and methods used in compiling quarterly public sector statistics for the quarterly CSNA;
      - Reclassify certain transactions that are not recorded in line with the 5th edition of the Balance of Payments Manual (BPM5).
- XII. Technical Assistance: Not applicable.
- XIII. Resident Representative: Not applicable.

### Statistical issues and data quality
- Overall assessment: The quality, coverage, periodicity, and timeliness of Canada’s economic data are considered to be excellent for Article IV consultation and ongoing surveillance.
- SDDS participation: Canada has subscribed to the Fund’s Special Data Dissemination Standard (SDDS), and its metadata are posted on the Fund’s Dissemination Standards Bulletin Board (DSBB).
- Real Sector:
  - Statistics Canada provides timely and adequate data in monthly, quarterly, and annual frequency.
  - In May 2001, Statistics Canada effected a smooth transition from Laspeyres methodology for estimating real expenditure-based GDP to Fisher index formulae.
- Fiscal Sector:
  - The Department of Finance Canada provides monthly and annual data on the federal government’s budget, tax policies, rules and regulations for Canada’s banks and other financial institutions.
- Monetary Sector:
  - The Bank of Canada provides timely and adequate coverage of daily, weekly, monthly and quarterly data related to the monetary sector.
- External Sector:
  - Statistics Canada provides timely information on a quarterly frequency on the balance of payments, external debt, and the international investment position (IIP).
  - Finance Canada provides monthly data on Official International Reserves in a format comparable to the IMF’s reserve data template, thus enabling adequate surveillance. Data are published at http://www.fin.gc.ca/finsearch/finresults_e.asp?Who=News.

*Source: _cr06230 - 32. The flexibility of Canadian labor markets could be further increased by market-*

### APPENDIX II  - 50 -

### APPENDIX II - 50 -  CANADA: TABLE OF COMMON INDICATORS REQUIRED FOR SURVEILLANCE (As of March 30, 2006)

### Memo items and data coverage / frequency
- Exchange Rates: Date of latest observation 2/16/06; Date received 2/16/06; Frequency of data D; Frequency of reporting D; Frequency of publication D.
- International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Date of latest observation 02/08/06; Date received 02/10/06; Frequency W; Frequency of reporting W; Frequency of publication W.
- Reserve/Base Money: Date of latest observation 02/08/06; Date received 02/10/06; Frequency W; Frequency of reporting W; Frequency of publication W.
- Broad Money: Date of latest observation Jan. 2005; Date received Mar. 2005; Frequency M; Frequency of reporting M; Frequency of publication M.
- Central Bank Balance Sheet: Date of latest observation 02/08/06; Date received 02/10/06; Frequency W; Frequency of reporting W; Frequency of publication W.
- Consolidated Balance Sheet of the Banking System: Date of latest observation Jan. 2005; Date received Mar. 2006; Frequency M; Frequency of reporting M; Frequency of publication M.
- Interest Rates: Date of latest observation 2/16/06; Date received 2/16/06; Frequency D; Frequency of reporting D; Frequency of publication D.
- Consumer Price Index: Date of latest observation Dec. 2005; Date received Jan. 2005; Frequency M; Frequency of reporting M; Frequency of publication M.
- Revenue, Expenditure, Balance and Composition of Financing – General Government: Date of latest observation Q3 2005; Date received Nov. 2005; Frequency Q; Frequency of reporting Q; Frequency of publication Q.
- Revenue, Expenditure, Balance and Composition of Financing – Central Government: Date of latest observation Nov. 2005; Date received Jan. 2005; Frequency M; Frequency of reporting M; Frequency of publication M.
- Stocks of Central Government and Central Government-Guaranteed Debt: Date of latest observation FY 2004; Date received Nov. 2005; Frequency A; Frequency of reporting A; Frequency of publication A.
- External Current Account Balance: Date of latest observation Q3 2005; Date received Nov. 2005; Frequency Q; Frequency of reporting Q; Frequency of publication Q.
- Exports and Imports of Goods and Services: Date of latest observation Dec. 2005; Date received Feb. 2005; Frequency M; Frequency of reporting M; Frequency of publication M.
- GDP/GNP: Date of latest observation Q3 2005; Date received Nov. 2005; Frequency Q; Frequency of reporting Q; Frequency of publication Q.
- Gross External Debt: Date of latest observation Q3 2005; Date received Dec. 2005; Frequency Q; Frequency of reporting Q; Frequency of publication Q.

### Data quality assessments (methodological soundness and accuracy)
- Footnote summary: Methodological soundness (assessment from data ROSC published October 23, 2003, mission January 22–February 5, 2003) uses O (fully observed), LO (largely observed), LNO (largely not observed), NO (not observed), NA (not available).
- Accuracy and reliability refer to international standards on source data, statistical techniques, assessment/validation of source and intermediate data, statistical outputs, and revision studies.

### Alternative Scenario: The Perfect Storm — assumptions and outcomes
- Scenario assumptions:
  - Loss of economic confidence reduces U.S. fixed investment and consumption by 3 percent relative to baseline in 2006, expanding to 5 percent by end-2010.
  - Oil price drops by 30 percent relative to baseline within two years.
  - U.S. currency depreciates and the Canadian dollar appreciates by 25 percent over the same period.
- Key model results (Difference between simulated model and baseline scenario; in percent unless otherwise noted):
  - GDP: 2006 -1.1; 2007 -2.7; 2008 -3.2; 2009 -4.1; 2010 -5.5
  - GDP growth (percentage points): 2006 -1.1; 2007 -1.7; 2008 -0.5; 2009 -1.0; 2010 -1.5
  - Consumption: 2006 0.1; 2007 0.3; 2008 0.5; 2009 0.8; 2010 0.8
  - Private fixed investment: 2006 0.8; 2007 3.6; 2008 5.3; 2009 3.1; 2010 -1.0
  - Real net exports (contribution to growth): 2006 -1.3; 2007 -2.9; 2008 -1.9; 2009 -1.0; 2010 -0.5
  - Current account balance (percent of GDP): 2006 0.0; 2007 -2.0; 2008 -4.1; 2009 -5.6; 2010 -6.8
  - CPI inflation (percentage points): 2006 -0.8; 2007 -2.8; 2008 -3.9; 2009 -4.4; 2010 -5.0
  - Short-term interest rate (percentage points): 2006 -2.3; 2007 -4.6; 2008 -5.1; 2009 -4.8; 2010 -4.8
  - Long-term interest rate (percentage points): 2006 -1.2; 2007 -3.3; 2008 -3.7; 2009 -3.1; 2010 -2.8
  - Fiscal balance (percent of GDP): 2006 -0.1; 2007 -0.4; 2008 -0.6; 2009 -0.8; 2010 -1.1
- Narrative summary of impact:
  - Canadian GDP could fall by over 5 percent relative to baseline over the forecast horizon.
  - Export sector most adversely affected due to 25 percent exchange rate appreciation.
  - Current account balance deteriorates by more than 6½ percent of GDP by 2010.
  - Short-term interest rates hit the zero bound in 2007.
  - Fiscal balance deteriorates and falls into deficit by 2008.
- Source for simulation: Oxford Economics; staff calculations.

### Net Foreign Liabilities Position (Table 1 highlights, 2001–2011; in percent of GDP unless otherwise indicated)
- Baseline: Net Foreign Asset Position: 2001 18.4; 2002 17.9; 2003 17.0; 2004 14.0; 2005 12.8; 2006 9.4; 2007 6.3; 2008 3.5; 2009 0.7; 2010 -1.9; 2011 -4.4
- Change in net foreign asset position: 2001 -1.0; 2002 -0.4; 2003 -1.0; 2004 -2.9; 2005 -1.2; 2006 -3.5; 2007 -3.0; 2008 -2.8; 2009 -2.8; 2010 -2.6; 2011 -2.5
- Identified external liability-creating flows (4+8+9): 2001 -4.3; 2002 -3.9; 2003 -5.9; 2004 -5.4; 2005 -4.8; 2006 -5.5; 2007 -4.2; 2008 -4.1; 2009 -4.1; 2010 -4.0; 2011 -3.9
- Current account deficit excluding income flows: 2001 -5.8; 2002 -4.4; 2003 -3.8; 2004 -4.2; 2005 -3.9; 2006 -4.8; 2007 -4.5; 2008 -4.3; 2009 -4.2; 2010 -4.0; 2011 -3.9
- Exports (percent of GDP): 2001 43.4; 2002 41.3; 2003 37.8; 2004 38.1; 2005 37.7; 2006 38.4; 2007 38.3; 2008 38.3; 2009 38.4; 2010 38.4; 2011 37.7
- Imports (percent of GDP): 2001 37.7; 2002 37.0; 2003 34.0; 2004 33.9; 2005 33.8; 2006 33.6; 2007 33.8; 2008 34.0; 2009 34.1; 2010 34.3; 2011 34.5
- Automatic debt dynamics: 2001 1.5; 2002 0.5; 2003 -2.0; 2004 -1.3; 2005 -1.0; 2006 -0.7; 2007 0.3; 2008 0.2; 2009 0.1; 2010 0.0; 2011 -0.1
- Residual, incl. change in gross foreign assets (2-3): 2001 3.3; 2002 3.5; 2003 4.9; 2004 2.5; 2005 3.7; 2006 2.0; 2007 1.2; 2008 1.3; 2009 1.3; 2010 1.4; 2011 1.4
- Net foreign liabilities-to-exports ratio (in percent): 2001 42.3; 2002 43.4; 2003 44.8; 2004 36.9; 2005 34.0; 2006 24.4; 2007 16.6; 2008 9.2; 2009 1.9; 2010 -5.1; 2011 -11.8
- Key macro assumptions underlying baseline:
  - Real GDP growth (in percent): 2001 1.8; 2002 3.1; 2003 2.0; 2004 2.9; 2005 2.9; 2006 3.1; 2007 3.0; 2008 2.9; 2009 2.9; 2010 2.9; 2011 2.9
  - GDP deflator in US dollars (change in percent): 2001 -3.0; 2002 -0.3; 2003 16.0; 2004 10.9; 2005 10.5; 2006 8.4; 2007 1.7; 2008 2.6; 2009 2.3; 2010 2.8; 2011 2.9
  - Nominal external interest rate (in percent): 2001 6.3; 2002 5.4; 2003 4.9; 2004 5.6; 2005 5.9; 2006 5.9; 2007 6.0; 2008 6.1; 2009 6.2; 2010 6.3; 2011 6.3
  - Growth of exports (US dollar terms, in percent): 2001 -5.7; 2002 -2.2; 2003 8.4; 2004 14.9; 2005 12.8; 2006 13.7; 2007 4.6; 2008 5.5; 2009 5.6; 2010 5.8; 2011 4.0
  - Growth of imports (US dollar terms, in percent): 2001 -6.3; 2002 0.8; 2003 8.8; 2004 13.8; 2005 13.5; 2006 10.9; 2007 5.6; 2008 6.0; 2009 5.8; 2010 6.4; 2011 6.5
  - Current account balance, excluding interest payments: 2001 5.8; 2002 4.4; 2003 3.8; 2004 4.2; 2005 3.9; 2006 4.8; 2007 4.5; 2008 4.3; 2009 4.2; 2010 4.0; 2011 3.9

### Public Sector Debt Sustainability (Table 2 highlights, 2001–2011; in percent of GDP unless otherwise indicated)
- Baseline: Public sector net debt: 2001 60.2; 2002 57.9; 2003 51.4; 2004 46.8; 2005 41.9; 2006 38.2; 2007 35.4; 2008 33.1; 2009 31.0; 2010 28.9; 2011 27.0
- Public sector net debt-to-revenue ratio: 2001 142.0; 2002 141.4; 2003 126.4; 2004 115.9; 2005 102.7; 2006 96.5; 2007 91.1; 2008 85.7; 2009 80.7; 2010 76.0; 2011 70.8
- Change in public sector debt: 2001 -5.2; 2002 -2.3; 2003 -6.5; 2004 -4.6; 2005 -4.8; 2006 -3.7; 2007 -2.8; 2008 -2.3; 2009 -2.2; 2010 -2.0; 2011 -2.0
- Identified debt-creating flows (4+7+12): 2001 -4.7; 2002 -4.7; 2003 -5.6; 2004 -5.9; 2005 -6.6; 2006 -5.9; 2007 -4.9; 2008 -4.4; 2009 -4.2; 2010 -4.0; 2011 -3.8
- Primary deficit: 2001 -7.3; 2002 -5.7; 2003 -5.3; 2004 -5.5; 2005 -6.3; 2006 -5.6; 2007 -5.2; 2008 -4.7; 2009 -4.4; 2010 -4.2; 2011 -4.1
- Revenue and grants: 2001 42.4; 2002 40.9; 2003 40.7; 2004 40.3; 2005 40.8; 2006 39.6; 2007 38.9; 2008 38.7; 2009 38.3; 2010 38.1; 2011 38.1
- Primary (noninterest) expenditure: 2001 35.1; 2002 35.2; 2003 35.3; 2004 34.8; 2005 34.5; 2006 34.0; 2007 33.7; 2008 34.0; 2009 33.9; 2010 33.8; 2011 34.0
- Automatic debt dynamics: 2001 2.6; 2002 1.0; 2003 -0.2; 2004 -0.4; 2005 -0.3; 2006 -0.3; 2007 0.3; 2008 0.3; 2009 0.3; 2010 0.3; 2011 0.3
- Residual, including asset changes (2-3): 2001 -0.5; 2002 2.4; 2003 -0.9; 2004 1.2; 2005 1.8; 2006 2.2; 2007 2.1; 2008 2.1; 2009 2.0; 2010 1.9; 2011 1.8
- Gross financing need (percent of GDP): 2001 13.6; 2002 12.7; 2003 13.5; 2004 13.1; 2005 12.1; 2006 11.7; 2007 11.0; 2008 10.4; 2009 9.8; 2010 9.1; 2011 8.5
- Gross financing need (in billions of U.S. dollars): 2001 97.5; 2002 93.1; 2003 117.7; 2004 130.1; 2005 136.3; 2006 148.2; 2007 145.1; 2008 146.0; 2009 143.5; 2010 141.7; 2011 139.5
- Key macro and fiscal assumptions underlying baseline:
  - Real GDP growth (in percent): 2001 1.8; 2002 3.1; 2003 2.0; 2004 2.9; 2005 2.9; 2006 3.1; 2007 3.0; 2008 2.9; 2009 2.9; 2010 2.9; 2011 2.9
  - Average nominal interest rate on public debt (in percent): 2001 6.7; 2002 6.0; 2003 5.8; 2004 5.6; 2005 5.5; 2006 5.4; 2007 5.5; 2008 5.6; 2009 5.6; 2010 5.7; 2011 5.8
  - Average real interest rate (percent): 2001 5.6; 2002 5.0; 2003 2.5; 2004 2.6; 2005 2.4; 2006 2.4; 2007 3.9; 2008 3.8; 2009 3.8; 2010 3.9; 2011 3.9
  - Nominal appreciation (increase in US dollar value of local currency, in percent): 2001 -5.8; 2002 0.8; 2003 22.2; 2004 7.4; 2005 3.4; 2006 1.2; 2007 0.1; 2008 0.8; 2009 0.5; 2010 1.0; 2011 1.1
  - Inflation rate (GDP deflator, in percent): 2001 1.1; 2002 1.0; 2003 3.3; 2004 3.1; 2005 3.1; 2006 3.0; 2007 1.7; 2008 1.8; 2009 1.8; 2010 1.8; 2011 1.8
  - Growth of real primary spending (deflated by GDP deflator, in percent): 2001 6.2; 2002 3.5; 2003 2.3; 2004 1.4; 2005 2.2; 2006 1.4; 2007 2.1; 2008 3.9; 2009 2.6; 2010 2.7; 2011 3.4
  - Primary deficit: 2001 -7.3; 2002 -5.7; 2003 -5.3; 2004 -5.5; 2005 -6.3; 2006 -5.6; 2007 -5.2; 2008 -4.7; 2009 -4.4; 2010 -4.2; 2011 -4.1

### Bound tests and shock scenarios (figures summary)
- Figures present net foreign assets and public debt bound tests under baseline, historical, and shock scenarios including:
  - Permanent one-half standard deviation shocks (individual shocks) and combined shocks.
  - Specific scenarios noted: CA shock; Combined shock; Real depreciation shock (one-time real depreciation of 30 percent in 2007); Non-interest current account shock; Growth shock; Interest rate shock; Primary balance shock; Contingent liabilities shock (10 percent of GDP in 2007 combined with 30 percent depreciation).
- Notes:
  - Shaded areas in figures represent actual data.
  - Figures in boxes represent average projections for baseline and scenario; ten-year historical average also shown.

### Recent economic developments (Supplementary Information — as of May 19, 2006)
- Summary findings:
  - Real GDP grew 0.2 percent in both January and February 2006, bringing year-on-year growth to 3.3 percent.
  - Staff projects growth around 3 percent in both 2006 and 2007.
  - Canada’s exports: United States absorbs 90 percent of Canada’s exports (noted earlier in Appendix III context).
  - Trade balance recorded another strong surplus in March 2006.
  - Canadian dollar reached a 28-year high against the U.S. dollar; rose above $0.90 in mid-May, 3½ percent above its level in mid-April.
  - Labor market: Employment growth averaged 2¼ percent (annualized) during first four months of 2006; unemployment rate rose slightly to 6.4 percent in April.
  - Productivity: Labor productivity growth in the business sector estimated at 2.2 percent in 2005 after revisions; narrowed productivity growth gap with the United States to ½ percentage point.
  - Inflation: 12-month change in CPI remained at 2.2 percent in March 2006; core inflation at 1.7 percent.

*Source: INTERNATIONAL MONETARY FUND, CANADA — Staff Report for the 2006 Article IV Consultation; Supplementary Information (Prepared by Western Hemisphere Department; Approved by Christopher Towe; May 19, 2006).*

### 5.      The Bank of Canada raised the target for the overnight rate by ¼ percentage point

### _cr06230 - 5.      The Bank of Canada raised the target for the overnight rate by ¼ percentage point

### Monetary policy and Bank of Canada decision
- The Bank of Canada raised the target for the overnight rate by ¼ percentage point to 4 percent on April 25.
- The Bank’s Governing Council judged the economy was at or just above capacity and noted that some modest further increase in the policy interest rate might be required.
- The decision followed a sequence of six consecutive ¼ percentage point steps that raised the target for the overnight interest rate to 4 percent.
- The Bank observed diminished concern of a possible disorderly unwinding of global imbalances and that the economy had been evolving broadly in line with its expectations.
- The Bank’s decision was anticipated by the market and was in line with staff recommendations.

### Fiscal policy: outcomes, budget priorities, and fiscal framework
- FY 2005/06 preliminary estimate suggests a surplus of 0.6 percent of GDP, double the amount projected in the November 2005 Update.
- The FY 2005/06 improvement reflected higher-than-expected tax revenues across all major categories and unexpected savings on program spending related to the early dissolution of Parliament in November 2005.
- End-year decisions reduced the surplus by:
  - boosting transfers to the provinces and territories by some ¼ percent of GDP; and
  - committing an additional C$330 million for ODA.
- The government plans to reduce federal debt by C$3 billion annually.
- The government took advantage of the C$8 billion surplus in FY 2005/06 to advance the objective of lowering the debt-to-GDP ratio to 25 percent by one year to FY 2013/14.
- Budget commitments and tax measures in FY 2006/07:
  - retain half of a marginal income tax cut introduced by the last government;
  - cut the GST rate from 7 percent to 6 percent;
  - increase the basic personal income tax exemption and provide a new C$1,000 employment credit;
  - reduce the general corporate tax rate from 21 percent to 19 percent by 2010;
  - eliminate the federal capital tax in 2006 and the corporate surtax in 2008;
  - introduce a new child care allowance and pledge support to farmers and infrastructure projects.
- Spending control and savings:
  - Overall expenditure growth to be kept to a “sustainable” pace;
  - a budget review aimed at generating C$1 billion in annual saving.
- Fiscal transparency and institutions:
  - proposed establishment of a Parliamentary Budget Office;
  - provide quarterly updates of the fiscal outlook;
  - improve financial reporting as recommended by the Auditor General.
- Policy judgment and risks:
  - On balance, the budget reflects a continuation of fiscal prudence, including C$3 billion for debt repayment and small unallocated surpluses.
  - Staff note the small size of budgetary reserves relative to uncertainty around Canada’s fiscal projections and stress the importance of anchoring fiscal policies on the medium-term debt objective.

### Structural issues and policy measures
- Securities regulation:
  - Budget reaffirmed commitment to work with provinces and territories toward a common securities regulator;
  - provinces and territories have narrowed regulatory differences and streamlined administration of securities laws.
- Pension plan funding relief (defined benefit plans):
  - Proposals include consolidating solvency payment schedules and extending solvency funding payments from 5 to 10 years, subject to a buy-in by plan members and retirees, or when the difference is secured by a letter of credit.
  - Only plan sponsors whose payments were up-to-date would be eligible.
- Trade: softwood lumber dispute with the United States:
  - Canada agreed a framework with the United States to settle exports of softwood lumber “for now.”
  - The framework will remain effective for at least 7 years, returns to Canadian producers all but $1 billion of the approximately $5 billion in U.S.-collected duties, and allows duty-free access to the U.S. market as long as prices remain above a benchmark price.

### Executive Board assessment and macroeconomic context
- Recent performance and outlook:
  - GDP growth remained close to 3 percent in 2005.
  - Final domestic demand expanded 4¼ percent in 2005.
  - Net exports subtracted 1½ percentage points from real GDP in 2005.
  - Current account balance remained at 2¼ percent of GDP.
  - Real effective exchange rate appreciated a further 6 percent over the previous year.
- Labor market and productivity:
  - Employment growth averaged a solid 2¼ percent (annualized) during the first four months of 2006.
  - Unemployment rate rose slightly to 6.4 percent in April.
  - Labor productivity growth in the business sector was revised to 2.2 percent in 2005.
  - Wage and unit labor cost growth reached 3¼ percent (year-on-year) in the fourth quarter of 2005.
- Inflation and monetary stance:
  - Headline CPI inflation remained within the Bank of Canada’s 1 to 3 percent target band except for a temporary overshoot in September 2005.
  - Core inflation has stayed below 2 percent since early 2004.
  - Directors commended the Bank of Canada for carefully withdrawing monetary stimulus and observed that further modest increases in the overnight interest rate will likely be required to bring headline inflation back to target.
- Directors’ policy recommendations and observations:
  - Maintain prudent fiscal and monetary policies and further improve the economy’s flexibility given risks from a potential rapid adjustment of global imbalances and the low household saving rate.
  - No significant amendments needed to Canada’s inflation targeting framework; commendable record of transparency.
  - Support for the government’s commitment to lowering the tax burden, maintaining fiscal surpluses, and continuing debt reduction.
  - Preference by most Directors for reducing marginal personal income tax rates and promoting tax-deferred saving over cutting the GST rate; some concern that many new tax deductions and credits could increase tax code complexity.
  - Support establishment of a Parliamentary Budget Officer and a medium-term debt anchor.
  - Attention drawn to fiscal pressures from rising provincial and territorial health care outlays and the need to avoid exacerbating regional fiscal disparities from the oil and gas boom.
  - Calls for further improvements in financial system efficiency and resilience, review of federal financial sector legislation, clarity on bank merger policy, harmonization of securities regulation, and measures to improve funding of defined benefit pension plans.
  - Recommendations for labor and product market reforms to boost productivity, including reducing welfare walls, amending immigration processes to address skills shortages, simplifying recognition of occupational qualifications across provinces, and considering funding Employment Insurance social benefits through general revenues rather than the payroll tax.
  - Suggestion that sector-specific constraints under the Investment Canada Act may discourage foreign direct investment; advocacy for regulatory reform in the electricity sector and broadened market access for agricultural goods, including those under supply management.

### Key statistics and selected indicators (as reported)
- Overnight rate target: 4 percent (after six consecutive ¼ percentage point steps).
- FY 2005/06 surplus: 0.6 percent of GDP.
- End-year transfers boost to provinces/territories: some ¼ percent of GDP.
- Additional ODA commitment: C$330 million.
- Planned annual federal debt reduction: C$3 billion.
- FY 2005/06 surplus amount used to advance debt-to-GDP target: C$8 billion.
- Debt-to-GDP ratio objective: 25 percent by FY 2013/14.
- GST rate: from 7 percent to 6 percent (policy change).
- Corporate tax rate: from 21 percent to 19 percent by 2010.
- Solvency funding extension: from 5 to 10 years (subject to conditions).
- Softwood lumber duties returned: all but $1 billion of approximately $5 billion; framework effective for at least 7 years.
- 2005 real GDP growth: close to 3 percent.
- Final domestic demand growth in 2005: 4¼ percent.
- Net exports contribution in 2005: -1½ percentage points to real GDP.
- Current account balance: 2¼ percent of GDP.
- Real effective exchange rate appreciation (year): 6 percent.
- Employment growth (first four months of 2006, annualized): 2¼ percent.
- Unemployment rate (April 2006): 6.4 percent.
- Business sector labor productivity growth (2005): 2.2 percent.
- Wage and unit labor cost growth (Q4 2005, y/y): 3¼ percent.
- Core inflation: below 2 percent since early 2004.

*Public Information Notice (PIN) No. 06/68, June 16, 2006.*

---


_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06230.pdf_