## _cr0869

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---

### Scope and focus
- Mission focus: near-term outlook risks and policy responses against the backdrop of slowing U.S. growth, currency appreciation, and global financial strains.
- Discussions also covered: enhancing productivity and financial sector efficiency.

### Outlook, risks, and stress-test scenario
- Baseline: growth moderation through mid-2008 due to weaker external demand and tighter credit conditions.
- Balance of risks: tilted to the downside given concerns about U.S. growth and unsettled global financial markets; domestic demand could slow by less than expected.
- Stress-test “perfect storm” scenario (deviations from baseline, year-on-year percent change):
  - U.S. real GDP: -4.7 (2008), -4.8 (2009), 0.2 (2010)
  - U.S. core CPI: -1.4 (2008), -3.8 (2009), -1.9 (2010)
  - Real exchange rate, US$ per C$: 4.3 (2008), 2.0 (2009), -0.6 (2010)
  - Canada real GDP: -3.3 (2008), -3.8 (2009), 0.4 (2010)
  - Canada core CPI: -0.9 (2008), -2.3 (2009), -1.1 (2010)
- Staff note: while highly unlikely, this scenario could put the Canadian financial sector and economy under greater strain than the sharp recession of the early 1990s (real GDP fell by 2 percent in 1991).

### Exchange rate, external sector, and competitiveness
- Canadian dollar developments and valuation:
  - Appreciated about 20 percent against the U.S. dollar in 2007; appreciated by almost half in real effective terms between early 2002 and end-2007.
  - At near parity against the U.S. dollar at end-2007 and with oil prices of $90–100 a barrel, the currency seems broadly in line with fundamentals, although some measures suggest modest overvaluation.
  - Staff estimate roughly one-half of last year’s appreciation against the U.S. dollar reflects higher oil prices.
  - Momentum trading and a falling Canada–U.S. risk premium also played a role.
  - Most analysts pegged the equilibrium value against the greenback at between 90 cents and parity; Governor Dodge said a value in the “low to mid 90s” was justified by historical relationships.
- Trade and current account implications:
  - The U.S. receives 3/4 of Canada’s exports.
  - Real net exports are likely to be a major drag on activity through at least the first half of 2008.
  - At a constant real exchange rate, the current account surplus is expected to continue to narrow despite high projected commodity prices.
  - Strong commodity prices led to a turnaround in the current account balance; real trade balance has deteriorated with rapidly rising import volumes.

### Monetary policy and inflation outlook
- Bank of Canada actions and stance:
  - Appropriately shifted from tightening to easing in response to evolving balance of risks.
  - Policy rate cut in early December 2007; policy rate reduced further with a 25 basis points cut to 4 percent at the January 22 meeting.
  - Future policy moves will depend on incoming information; no presumption about the direction of the next move in rates.
- Inflation dynamics:
  - Core CPI was in the upper half of the Bank of Canada’s 1–3 percent target range since fall 2006 but recently dropped below the midpoint due to exchange rate passthrough.
  - Core inflation likely to remain below the 2 percent mid-point for some time; downside risks from financial strains and weaker-than-expected external demand and upsides from stronger domestic demand and weaker productivity growth.
  - Staff noted some private analysts indicated core inflation could fall to the bottom of the 1–3 percent target range after adjustments.

### Financial sector resilience, strains, and ABCP episode
- Banking system characteristics:
  - Conservatively regulated, relatively well capitalized, and appears better placed to weather balance sheet problems than banks in other major markets.
  - Major banks control 85 percent of bank assets; stress tests suggest major banks have sufficient capital to withstand large shocks.
  - Basel II capital adequacy framework started to come into effect in November and will be fully operational in February 2008.
- Financial strains and transmission:
  - Interbank spreads for major Canadian banks have risen and remained elevated, though generally at lower levels than in the United States and Europe.
  - Interbank rates highly correlated with U.S. rates since August.
  - Average cost of borrowing for households and businesses estimated to have risen by some 25 basis points (October Monetary Policy Report); staff suggested in early December the increase might well be double that estimate.
  - Recent strong credit growth likely to decelerate in the face of balance sheet strains.
- Asset-backed commercial paper (ABCP) episode:
  - Shutdown of one-third of the ABCP market posed contagion risks prior to a late-December agreement.
  - Agreement in principle reached on December 23, 2007, to restructure almost all of the 2½ percent of GDP of frozen ABCP into longer-term notes matching underlying asset maturities, substantially reducing contagion risks.
  - Lessons highlighted: interaction between reputation of banks and support for nonbank entities; appropriate charges for unconditional and conditional support; transparency of unregulated entities; insufficient investor due diligence and rating practices.

### Fiscal policy, performance, and projections
- Fiscal framework and recent outcomes:
  - Prudent framework aiming at budget surpluses and further reduction of public debt ratios; ten consecutive years of federal budget surpluses.
  - FY 2006/7 surplus estimated at 1 percent of GDP, half a percentage point above the budget forecast.
  - Federal objective to eliminate general government net debt by 2021 reaffirmed.
- Federal budget projections (percent of GDP):
  - Revenue: 2003/04 16.4; 2004/05 16.4; 2005/06 16.2; 2006/07 16.3; 2007/08 15.9; 2008/09 15.3; 2009/10 15.2; 2010/11 15.2
  - Outlays: 2003/04 15.6; 2004/05 16.3; 2005/06 15.2; 2006/07 15.4; 2007/08 15.2; 2008/09 15.1; 2009/10 15.0; 2010/11 14.8
  - Budget balance: 2003/04 0.8; 2004/05 0.1; 2005/06 1.0; 2006/07 1.0; 2007/08 0.7; 2008/09 0.1; 2009/10 0.2; 2010/11 0.4
  - Planned debt reduction: 2005/06 1.0; 2006/07 1.0; 2007/08 0.7; 2008/09 0.2; 2009/10 0.2; 2010/11 0.2
  - Net debt: 2003/04 40.9; 2004/05 38.3; 2005/06 35.0; 2006/07 32.3; 2007/08 30.0; 2008/09 28.6; 2009/10 27.2; 2010/11 25.7
- Use of budget overperformance:
  - Overperformance to be used for tax relief and debt reduction: Economic Statement proposes tax relief (¼ percentage point of GDP) and a one-off additional debt reduction (½ percentage points of GDP).
  - Staff caution: some revenue gains (particularly from commodity industries) may be temporary; expenditure restraint important.
  - Staff calculation: nominal GDP would need to slow by 1 percentage points more than in the baseline to push the federal government into deficit in fiscal year 2008–09.

### Tax and structural reform recommendations
- Tax policy recommendations:
  - Support for the 1 percentage point cut in the general corporate income tax rate in 2008 and further reduction to a 15 percent tax rate by 2012.
  - Harmonizing remaining provincial sales taxes with the GST base to exempt business inputs and lower METRs on capital; staff suggested more explicit federal assistance to provinces might be effective.
  - Protecting all types of saving from taxes up to a cap to reduce high marginal effective taxes on saving; welcome reduction in the lowest personal income tax rate to 15 percent and the Working Income Tax Benefit.
  - Staff viewed the GST cut to 5 percent as having limited efficiency benefits relative to other tax relief options.
- Product market and competition reforms:
  - Lower restrictions on inward FDI, especially in network industries (airlines, telecommunication, utilities, media).
  - Reduce barriers to interprovincial trade in goods and services and to mobility in regulated professions; use TILMA as a model.
  - Increase contestability in banking: removing barriers to acquisition of large banks (including by foreign entities) to foster competition, innovation, and better access to finance for high-growth firms.
- Labor supply and immigration:
  - Increase participation of older workers, improve integration of foreign immigrants, and reduce disincentives for older workers created by pension structures.
  - Suggestion to make economic migration more flexible to match changing labor demand.

### Sectoral assessments and key quantitative indicators (selected)
- Consumption and housing:
  - Consumption buoyant since 2002; projected to decelerate moderately as income growth cools and financial conditions tighten.
  - Housing demand expected to moderate; house prices recently started to decelerate; residential investment remains buoyant with signs of slowing in Alberta.
  - Risk of a U.S.-style rapid housing downturn judged small.
- Business investment: tempered by dependence on U.S. cyclical developments despite high profitability and healthy corporate balance sheets.
- U.S. spillovers:
  - A one-percentage point shock to U.S. GDP changes Canada’s growth by between 1/2 to 3/4 of a percentage point via trade, financial, and commodity-price channels.
  - Autos and parts represent one-third of Canadian goods exports.
- Selected macro indicators (annualized percent change unless otherwise indicated):
  - Real GDP: 2005 3.1; 2006 2.8; 2007 2.6; 2008 Q1–Q4 (Est./Proj.): 2.0, 3.5, 3.8, 2.9; 2009 Q1–Q4 (Proj.): 1.8, 1.3, 1.6, 2.1; 2010 (Proj.): 2.5
  - Net exports (contribution): -1.7 (2005), -1.4 (2006), -1.1 (2007); quarterly: -1.7, 0.3, -1.4, -5.0, -2.2, -1.3, -1.1, -0.4, -0.2
  - Total domestic demand: 5.1 (2005), 4.4 (2006), 3.8 (2007)
  - Private consumption: 3.8 (2005), 4.2 (2006), 4.1 (2007)
  - Private fixed investment: 8.1 (2005), 7.1 (2006), 4.2 (2007)
  - Unemployment rate (percent): 6.8 (2005), 6.3 (2006), 6.0 (2007)
  - Consumer price index (y-o-y): 2.2 (2005), 2.0 (2006), 2.1 (2007)
  - Federal fiscal balance/GDP: 0.1 (2005), 0.6 (2006), 0.4 (2007); 2008 Q1: -0.1
  - Current account balance/GDP: 2.0 (2005), 1.6 (2006), 1.0 (2007)
  - Oil prices ($/Barrel), simple average of UK Brent, Dubai, and WTI: 2005 53.4; 2006 64.3; 2007 71.1; selected quarterly/proj. values include 86.3, 57.2, 66.1, 73.6, 87.6, 87.3, 86.5, 86.0, 85.3

### Fund advice, governance, and data transparency
- Article IV timing: next consultation expected on the regular 12-month cycle.
- Governance, transparency, and communication:
  - Bank of Canada has gradually increased transparency; options monitored include publishing minutes, providing projected path of interest rates, and using probabilities/alternative scenarios to illustrate risks.
  - Securities regulation: “passport plus” is progress; staff agree a single securities regulator would promote timely policy responses, lower costs, and consistent enforcement.
- Statistical quality and reporting:
  - Canada subscribes to the SDDS; key indicator reporting frequencies and latest observation dates provided (e.g., international reserve assets: Jan. 1, 2008; date received Jan. 4, 2008).

### Executive Board assessment and recommendations
- Directors commended Canada’s macroeconomic track record: strong GDP growth, declining unemployment, low and stable inflation, consecutive fiscal surpluses, and reductions in federal debt-to-GDP ratio.
- Near-term risks identified: potential sharp slowing of the U.S. economy; effects of past currency appreciation; tighter credit conditions.
- Policy recommendations summarized:
  - Monetary: welcome measured easing; room for further reductions in overnight rate noted by some Directors; no change to inflation-targeting regime without compelling evidence.
  - Fiscal: allow automatic stabilizers to operate; maintain expenditure restraint; support objective to eliminate general government debt by 2021.
  - Structural: reduce high marginal effective tax rates on capital, saving, and labor; enhance business productivity; create a dynamic and globally competitive financial system; enhance interprovincial labor mobility.
  - Financial sector: continue vigilance; welcome ABCP restructuring; consider further opening to takeovers to boost flexibility and innovation while weighing resilience benefits of current system.

*Source: IMF staff, “EXECUTIVE SUMMARY”, _cr0869 - EXECUTIVE SUMMARY_*

### EXECUTIVE SUMMARY

### _cr0869 - EXECUTIVE SUMMARY

### Scope and focus
- Mission focus: near-term outlook risks and policy responses against the backdrop of slowing U.S. growth, currency appreciation, and global financial strains.
- Discussions also covered: enhancing productivity and financial sector efficiency.

### Background: recent macro performance
- Canada: real GDP grew faster than other G-7 countries over the past decade; inflation low and stable; fiscal balances in surplus.
- Commodity boom over the past five years strengthened the external position and boosted domestic demand, offset in part by real net exports due to real exchange rate appreciation.
- Labor market: unemployment near a recent 33-year low; economy assessed as operating above potential.
- Core CPI: was in the upper half of the Bank of Canada’s 1–3 percent target range since fall 2006 but recently dropped below the midpoint due to exchange rate passthrough.

### Outlook (baseline and risks)
- Baseline: growth moderation through mid-2008 due to weaker external demand and tighter credit conditions.
- Balance of risks: on the downside given concerns about U.S. growth and unsettled global financial markets; domestic demand could slow by less than expected.
- Stress-test “perfect storm” scenario (deviations from baseline, year-on-year percent change):
  - U.S. real GDP: -4.7 (2008), -4.8 (2009), 0.2 (2010)
  - U.S. core CPI: -1.4 (2008), -3.8 (2009), -1.9 (2010)
  - Real exchange rate, US$ per C$: 4.3 (2008), 2.0 (2009), -0.6 (2010)
  - Canada real GDP: -3.3 (2008), -3.8 (2009), 0.4 (2010)
  - Canada core CPI: -0.9 (2008), -2.3 (2009), -1.1 (2010)
- Staff note: while highly unlikely, this scenario could put the Canadian financial sector and economy under greater strain than the sharp recession of the early 1990s (real GDP fell by 2 percent in 1991).

### External currency value and competitiveness
- Canadian dollar: near parity against the U.S. dollar at end-2007; appreciated by almost half in real effective terms between early 2002 and end-2007.
- With oil prices of $90–100 a barrel, the Canadian dollar seems broadly in line with fundamentals, although some measures suggest modest overvaluation.
- Commodity fundamentals explain most appreciation; speculative futures positions and a falling Canada–U.S. risk premium also played a role.
- Trade linkages: the U.S. receives 3/4 of Canada’s exports.

### Monetary policy
- Bank of Canada appropriately shifted from tightening to easing in response to the evolving balance of risks.
- Future policy moves will depend on incoming information.

### Financial sector: resilience and contestability
- Canadian banking system: conservatively regulated and appears better placed to weather balance sheet problems than banks in other major markets.
- Spillovers: not immune to global liquidity squeeze—parts of the asset-backed commercial paper market experienced a shutdown that was recently resolved in principle.
- Caveat: resilience partly reflects barriers to market contestability that likely hamper access to finance.

### Fiscal policy
- Policy framework: prudent, aiming at budget surpluses and further reduction of public debt ratios.
- 2007 Economic Statement: emphasizes tax relief; lowering the federal GST tax rate judged to have limited efficiency benefits.

### Macro-structural policies
- Policy focus timely: enhancing productivity growth in view of pressures from real dollar appreciation and an aging population.
- Recommended emphasis: tax reforms, improving financial intermediation, and product market reform.

### Analytical and sectoral findings
- Consumption and housing:
  - Consumption buoyant since 2002 due to commodity-induced real income and net worth gains; projected to decelerate moderately as income growth cools and financial conditions tighten.
  - Strong housing demand expected to moderate; house prices recently started to decelerate; residential investment remains buoyant with signs of slowing in Alberta.
  - Risk of a U.S.-style rapid housing downturn judged small: house price appreciation has lagged many industrial countries; inventories below average; housing starts and building permits remain favorable.
- Business investment: prospects tempered by dependence on U.S. cyclical developments despite high profitability and healthy corporate balance sheets.
- U.S. spillovers:
  - On average, a one-percentage point shock to U.S. GDP changes Canada’s growth by between 1/2 to 3/4 of a percentage point via trade, financial, and commodity-price channels.
  - Direct impact to date largely confined to building material-related industries; broader U.S. slowdown likely to generate more general trade effects, particularly for autos (autos and parts represent one-third of Canadian goods exports).
- Analytical work and studies undertaken: background studies on financial and other spillovers, labor churning, Canada’s inflation targeting framework, and access of small borrowers to finance.

### Key quantitative economic indicators (selected from Economic Outlook table; annualized percent change unless otherwise indicated)
- Real GDP (selected quarters, Est./Proj.):
  - 2005: 3.1
  - 2006: 2.8
  - 2007: 2.6
  - 2008 Q1–Q4 (Est./Proj.): 2.0, 3.5, 3.8, 2.9
  - 2009 Q1–Q4 (Proj.): 1.8, 1.3, 1.6, 2.1
  - 2010 (Proj.): 2.5
- Net exports (contribution): -1.7 (2005), -1.4 (2006), -1.1 (2007); quarterly: -1.7, 0.3, -1.4, -5.0, -2.2, -1.3, -1.1, -0.4, -0.2
- Total domestic demand: 5.1 (2005), 4.4 (2006), 3.8 (2007); selected quarters: 3.7, 3.3, 5.5, 8.1, 4.0, 2.7, 2.7, 2.5, 2.7
- Private consumption: 3.8 (2005), 4.2 (2006), 4.1 (2007); selected quarters: 3.0, 3.4, 5.9, 3.0, 3.1, 3.1, 2.7, 2.2, 2.3
- Private fixed investment: 8.1 (2005), 7.1 (2006), 4.2 (2007); selected quarters include 5.0, 2.3, 4.4, 7.6, 6.5, 3.9, 4.3, 4.3, 4.3
- Unemployment rate (percent): 6.8 (2005), 6.3 (2006), 6.0 (2007); selected quarters: 6.2, 6.1, 6.1, 6.0, 5.9, 6.1, 6.2, 6.3, 6.3
- Consumer price index (y-o-y): 2.2 (2005), 2.0 (2006), 2.1 (2007); selected quarters show variability including 1.4, 1.9, 2.0, 2.1, 2.5, 1.5, 1.1, 1.6, 1.6
- Federal fiscal balance/GDP: 0.1 (2005), 0.6 (2006), 0.4 (2007); 2008 Q1: -0.1
- Current account balance/GDP: 2.0 (2005), 1.6 (2006), 1.0 (2007); selected quarters: 0.1, 1.7, 1.7, 0.3, 0.3, 0.3, 0.3, 0.0, -0.1
- Partner country growth (export-weighted): 3.1 (2005), 3.0 (2006), 2.5 (2007); projections: 1.8, 2.3, 2.4, 1.9, 1.4, 1.2, 1.4, 1.9, 2.4
- Oil prices ($/Barrel), simple average of UK Brent, Dubai, and WTI:
  - 2005: 53.4
  - 2006: 64.3
  - 2007: 71.1
  - Selected quarterly values and projections: 86.3, 57.2, 66.1, 73.6, 87.6, 87.3, 86.5, 86.0, 85.3

*Source: IMF staff, “EXECUTIVE SUMMARY”, _cr0869 - EXECUTIVE SUMMARY_*

### 13.      Strong appreciation during 2007, however, has intensified earlier concerns about

### _cr0869 - 13.      Strong appreciation during 2007, however, has intensified earlier concerns about

### Exchange rate appreciation: magnitude, drivers, and valuation
- The Canadian dollar appreciated about 20 percent against the U.S. dollar in 2007, after plunging some 10 percent from November’s record high of US$1.10.
- Staff estimate that roughly one-half of last year’s appreciation against the U.S. dollar reflects higher oil prices; non-energy commodity price changes have been modest.
- Recent ups and downs in the exchange rate have also reflected momentum trading.
- Exchange rate model work suggests much of the appreciation since 2002 has reflected the global commodity boom.
- At near parity against the U.S. dollar and with oil prices of $90-100 a barrel, the currency currently appears broadly in line with fundamentals, although:
  - Several exchange rate models suggest there could be a small overvaluation by the end of 2007.
  - The Consultative Group on Exchange Rate Issues (CGER) equilibrium exchange rate approach also suggests a possible small overvaluation.
  - CGER analysis based on external balances suggests the currency is fully consistent with fundamentals.
  - Most analysts pegged the equilibrium value against the greenback at between 90 cents and parity.
  - Governor Dodge said that a value in the “low to mid 90s” was justified by historical relationships.

### External sector, trade, and current account implications
- Given the dominance of the United States in Canada’s trade, appreciation reinforced concerns that Canada has borne a disproportionate share of U.S. dollar adjustment with associated pressures on exposed sectors.
- Staff and officials agreed that real net exports are likely to be a major drag on activity through at least the first half of 2008.
  - Past currency appreciation and weakening U.S. activity are projected to lead to a significant deterioration in exports of manufactures and services, which remain the bulk of Canadian exports.
  - Weakness has been exacerbated by a recent spike in cross-border shopping as the currency surged to parity against the U.S. dollar.
- At a constant real exchange rate, the current account surplus is expected to continue to narrow despite high projected commodity prices.
  - Officials agreed that favorable effects of elevated commodity prices, further modest increases in fuel export volumes, and declining net income payments would only partly offset weaker exports of manufactures and services.
- Strong commodity prices have led to a turnaround in the current account balance, and increasing net energy export volumes have contributed to the nominal trade balance; however, the real trade balance has deteriorated with rapidly rising import volumes.

### Labor market and domestic adjustment
- Reflecting flexible labor markets, the domestic adjustment to currency appreciation and rising commodity prices has been remarkably smooth.
  - Unemployment rates have steadily declined, including in more manufacturing-oriented central provinces.
  - Employment gains in services, construction, and mining as well as interprovincial migration have more than offset manufacturing job losses.
- Rising labor demand in resource-rich provinces has been partly met through net migration from elsewhere in Canada, as local wages have been bid up.
- At current exchange rates, staff suggested that this relatively smooth adjustment is likely to continue.
- Senior officials broadly agreed, while noting that activity in parts of manufacturing and forestry may well lead to local difficulties.

### Financial sector strains and transmission to the real economy
- Bank balance sheets have deteriorated in response to global financial problems, although strains appear smaller than in other major markets.
  - Estimated exposures to asset-backed securities and related products appear more limited than in the United States or Europe.
  - Synthetic credit default insurance spreads have risen significantly since the late summer but remain lower than in the United States.
  - Stress tests for the accompanying FSSA Update suggest major banks have sufficient capital to withstand large shocks.
- Interbank money markets remain under strain.
  - Interbank spreads for major Canadian banks have risen and remained elevated, albeit generally at lower levels than in the United States and Europe.
  - Canadian interbank rates have been particularly highly correlated with U.S. rates since financial strains emerged in August.
- Overall financial conditions had tightened noticeably since the summer.
  - The October Monetary Policy Report estimated that the average cost of borrowing for households and businesses had risen by some 25 basis points, while availability and terms of credit had also tightened modestly.
  - Staff suggested that in early December the increase in the cost of borrowing might well be double that estimated in October.
- Staff observed that recent strong growth in credit is likely to decelerate in the face of balance sheet strains, slowing future activity.
  - Officials responded that the increase in domestic credit risk will likely remain limited, given relatively low household debt ratios and high commodity prices that support incomes.
  - Officials suggested that writedowns to date have fairly accurately reflected the likely scale of losses and that comfortable risk-adjusted capital ratios allow banks to absorb these developments.
  - Officials agreed uncertainties related to banks’ foreign exposures were greater and less predictable, with particular concern about further deterioration in U.S. market conditions given significant U.S. operations and exposures of some Canadian banks.

### Asset-backed commercial paper (ABCP) episode and resolution
- Prior to a late-December agreement, staff and officials saw the shutdown of one-third of the ABCP market as posing contagion risks.
  - The shutdown of paper sponsored by non-banks reflected regulations that gave incentives to provide only limited support.
  - With foreign banks refusing backstop liquidity, there was a risk of a fire sale of assets.
  - The remaining two-thirds of ABCP (backed by main domestic commercial banks) remained liquid, reflecting better quality underlying assets and reputation-induced liquidity support, though higher rates and shorter maturities indicated some strains.
- An agreement in principle was reached on December 23, 2007, to restructure almost all of the 2½ percent of GDP of frozen ABCP.
  - The agreement between all main parties, including major Canadian banks, substantially reduced the risks of contagion.
  - It converts the commercial paper into longer-term notes, whose maturity corresponds to the underlying assets.
  - Difficulties in obtaining an agreement partly reflected the reduction in value of U.S. and other foreign assets underlying the ABCP.

### Inflation outlook and passthrough
- The recent downward pressure on inflation from exchange rate passthrough was described as a surprise.
  - The limited passthrough of currency appreciation since 2002 was abruptly reversed since October as parity with the U.S. dollar simplified price comparison and cross-border shopping spiked (including through the internet).
  - As a result, core inflation has fallen abruptly to below the 2 percent mid-point of the target range despite strong domestic demand and tight labor markets.
- Staff and Bank of Canada officials concurred that core inflation is likely to remain below the 2 percent target for some time.
  - Bank officials emphasized that the size and length of the downward adjustment in Canadian prices relative to U.S. prices remains highly uncertain, as does the associated downward pressure on inflation.
  - Staff noted that, at one extreme, some private analysts had indicated that core inflation (which will be adjusted to exclude the impact of January 1 indirect tax cuts) could fall to the bottom of the 1–3 percent target range.
  - Like the Bank, staff see core inflation as moderating more modestly, with downside risks from financial strains and weaker-than-expected external demand and upsides from stronger domestic demand and weaker productivity growth.

### Policy discussions and monetary policy stance
- The policy agenda is being shaped against the possibility of an early election following the January 2006 election that produced a minority government.
- Discussions focused on policies to mitigate increased near-term risks to macroeconomic stability and to enhance productivity growth.
- The main near-term issue is the appropriate monetary policy stance given large competing risks: possible downsides from unsettled financial conditions and U.S. growth, and upsides from strong domestic demand.
- Bank of Canada officials explained that monetary policy shifted in response to increasing downside risks to output and inflation.
  - The Bank had tightened through July 2007 on concerns about upward creep in core inflation; policy paused in the fall; the policy rate was cut in early December as concerns intensified and room was afforded by the fall in core inflation from strengthened exchange rate passthrough.
  - Staff supported the December decision, which took into account the evolving balance of risks.
- Staff and officials agreed that large upsides and downsides around the current forecast make the future path of monetary policy particularly difficult to chart.
  - Officials emphasized there was no presumption about the direction of the next move in rates.
  - Staff observed that strong recent exchange rate passthrough could temporarily lower inflation even though underlying inflationary pressures may not have dissipated.
- Bank officials agreed that worsening financial conditions had been a factor in the December easing and remain a concern.
  - The 25bp estimate published in the October Monetary Policy Report was based on average market rates over a range of instruments and maturities; some observers who focused on selected markets suggested the estimate was too low.
- On liquidity provision and term money market strains:
  - Staff asked if the Bank’s statutory limitations were hampering its response to term money market strains.
  - Officials responded current facilities have been adequate; initial focus on overnight operations reflected concerns about effectiveness of term operations rather than statutory limits.
  - Recently the Bank participated in term interventions with the Federal Reserve, ECB, Bank of England, and Swiss National Bank.
  - Officials viewed coordinated action and the recently-announced expansion of the list of eligible securities for some forms of liquidity provision as appropriate responses to current financial strains.

*Source: IMF staff report (content unit provided).*

### 33.      While the floating currency is generally a shock absorber, it was agreed that

### _cr0869 - 33.      While the floating currency is generally a shock absorber, it was agreed that

### Exchange rate policy and monetary response
- Monetary policy should respond to disequilibrating exchange rate movements; this response is consistent with the Bank of Canada’s exchange rate assessment framework.
- Staff and officials agreed that, in hindsight, the Bank has relatively successfully distinguished currency movements that rebalance external and internal demand from those that do not, thereby keeping output fairly close to potential.
- Foreign exchange interventions are generally ineffective; the Bank started with the presumption that exchange rate movements reflect fundamentals.
- The Bank did not intervene when the currency briefly hit US$1.10 in November and limited its communication then to clarifying its assessment of economic and financial conditions and risks to markets.
- Subsequently, Governor Dodge became much more specific about the Bank’s views on the appropriate value of the currency.

### Transparency, governance, and communication
- The Bank adopted a gradual approach to increased transparency because such changes are difficult to reverse.
- Greater discussion of risks around the forecast has appeared in Monetary Policy Reports and an increasing range of issues has been covered in speeches.
- Decisions were made by the governor and staff who reported directly to him; the Bank continued to present a uniform public view, focusing on the consensus assessment while avoiding publishing minutes.
- Possible transparency innovations monitored by officials include:
  - publishing minutes,
  - providing the projected path of interest rates in the forecast,
  - increasing use of probabilities of outcomes or alternative scenarios to illustrate risks around the forecast.

### Domestic asset prices and policy treatment
- The team inquired whether the Bank’s exchange rate assessment framework could be adapted to include domestic asset prices.
- Officials responded that assessing appropriate asset price levels is extremely difficult.
- Officials' view: it is best to include the expected consequences of domestic asset price movements directly in economic forecasts rather than to provide public assessments of their relationship to fundamentals.

### Inflation targeting and price level targeting considerations
- Officials noted arguments in favor of price level targeting and a lower inflation target but emphasized that the bar is high for changing the current regime.
- Initial results of the Bank’s research program suggest potential benefits from reducing nominal distortions from inflation and reducing uncertainty about the future price level, but evidence would need to be compelling before altering the successful current policy regime.
- The team concurred and outlined analysis in Chapter 3 of the Selected Issues paper suggesting that Canada—and some other inflation targeters who have kept average inflation close to target—may already be reaping some benefits of price level targeting in terms of anchoring expectations about the future price level.

### Financial stability: FSSA Update findings
- The accompanying FSSA Update finds that Canada’s financial system is stable, conservatively regulated, and relatively well capitalized.
- The regulatory and supervisory framework meets best practice in many dimensions, including with regard to the revised Basel Core Principles for effective banking supervision.
- The Basel II capital adequacy framework started to come into effect in November and will be fully operational in February 2008.

### Lessons from the ABCP shutdown and conduit issues
- The ABCP shutdown reflected interaction between Canada-specific regulation and insufficient investor due diligence:
  - Conditional liquidity in Canada (triggered only by general market disruption)—which was absent in other markets—reflected regulation aimed at bank stability that provided incentives for such arrangements. Domestic banks faced a capital charge for unconditional liquidity support but not for conditional support.
  - Lax ratings and insufficient investor due diligence were central to eventual financial problems. The local rating agency gave a top rating to Canadian ABCP with conditional liquidity support even though Moody’s and S&P refused; large investors used such paper despite the lack of a second rating.
  - Canadian capital charges had reflected international best practice and had only covered domestic banks, which provided backstop liquidity; foreign banks that had not provided such liquidity were subject to home-country regulation.
  - Recent changes in market behavior have ensured no near-term repetition: all continuing bank-sponsored conduits now have unconditional liquidity support, and the local rating agency is no longer rating paper with conditional support.
- Agreed lessons include:
  - interaction between the reputation of banks and their support for nonbank entities,
  - appropriate charges for unconditional and conditional support,
  - transparency of unregulated entities,
  - whether Basel II should allow regulated institutions to limit and scale credit risk exposure based on only one rating.
- Officials supported an orderly private-sector resolution of third-party ABCP to avoid a fire sale of structured assets; without a standstill, third-party conduits would have been forced to sell assets rapidly into illiquid markets, causing further market disruption and significant losses for Canadian investors. Staff agreed that the risk of a fire sale made government-supported orderly workout appropriate.

### Securities regulation and market structure
- The “passport plus” system of provincial securities market regulation under implementation is a significant step forward:
  - Regulators in every province except Ontario are bound to accept the rulings of other provinces, while Ontario can opt out of any decision.
- Staff agreed with federal and Ontario officials that a single securities regulator would promote timely policy responses, lower costs, and consistent enforcement.
- Maintaining multiple jurisdictions raises costs for issuers operating across provinces, complicates elements of investor protection, and delays policy development by requiring cumbersome negotiations.

### Bank competition, entry barriers, and financial intermediation
- Staff suggested that increased competitive pressures across banks would support more dynamic firms and individuals, boosting economic flexibility and productivity.
- Key observations:
  - Major banks control 85 percent of bank assets and must be widely-held to guard against takeovers; mergers require approval of the finance minister and are effectively prohibited.
  - With limited competitive pressures, banks maintain low-risk balance sheets and achieve high returns on equity.
  - Stress tests performed for the FSSA Update suggest that systemic banking sector problems are unlikely even when faced with a large adverse shock.
  - Banks may shy away from pricing risk, underserving high-growth enterprises (see Chapter 4 of the Selected Issues paper). Increasing contestability would raise competitive pressures, support financial innovation, and foster efficient capital allocation.
  - Other sources of financing for small firms are underdeveloped: there is no high yield bond market and the venture capital market is inefficient, likely reflecting the large role of tax-advantaged labor-sponsored venture capital corporations.
- Finance officials noted:
  - Foreign banks were only prohibited from buying large Canadian institutions; foreign subsidiaries and smaller domestic companies provide a competitive fringe.
  - Studies find Canadian banks’ response to changes in costs is consistent with a high level of competition.
  - Allowing takeovers may not increase the number of banks competing in the market.
  - An expert panel examining competition in Canada has shown interest in studying the financial sector.
- Staff argued foreign ownership of core financial institutions is more likely to promote innovation than ownership of marginal ones; representatives of small businesses report banks do not serve this sector well and that private sector analysts view the banking system as uncompetitive and lacking innovation.

### Government guarantees and housing sector distortions
- Staff expressed concern that government guarantees associated with the housing sector could be distorting behavior.
- Government support to induce private sector entry to compete with the government-owned mortgage insurer, and government guarantees of mortgage-backed securities arranged by the Canada Mortgage and Housing Corporation, could provide artificial incentives for risk taking.
- Officials responded that this issue is being examined.

### Fiscal framework, recent performance, and projections
- A prudent fiscal policy framework has underpinned ten consecutive years of federal budget surpluses.
- In 1997, Canada adopted a framework based on the principle “budget balance or better,” modified in 2006 to target an annual reduction of C$3 billion in federal government debt (around ¼ percent of 2007 GDP), with a medium-term target to reduce federal debt to 25 percent of GDP.
- Budgeting has been conservative, with actual surpluses typically exceeding projections.
- At 1 percent of GDP, the FY 2006/7 surplus was a half percentage point above the budget forecast, owing largely to buoyant corporate income tax revenue.

### Federal budget projections (in percent of GDP)
- Revenue: 2003/04 16.4; 2004/05 16.4; 2005/06 16.2; 2006/07 16.3; 2007/08 15.9; 2008/09 15.3; 2009/10 15.2; 2010/11 15.2
- Outlays: 2003/04 15.6; 2004/05 16.3; 2005/06 15.2; 2006/07 15.4; 2007/08 15.2; 2008/09 15.1; 2009/10 15.0; 2010/11 14.8
- Budget balance: 2003/04 0.8; 2004/05 0.1; 2005/06 1.0; 2006/07 1.0; 2007/08 0.7; 2008/09 0.1; 2009/10 0.2; 2010/11 0.4
- Planned debt reduction: 2005/06 1.0; 2006/07 1.0; 2007/08 0.7; 2008/09 0.2; 2009/10 0.2; 2010/11 0.2
- Planning surplus: 2003/04 0.8; 2004/05 0.1; 2005/06 1.0; 2006/07 0.0; 2007/08 0.0; 2008/09 0.0; 2009/10 0.0; 2010/11 0.3
- Net lending: 2003/04 0.3; 2004/05 0.8; 2005/06 0.1; 2006/07 0.6; 2007/08 0.4; 2008/09 -0.1; 2009/10 -0.2; 2010/11 0.0
- Net debt: 2003/04 40.9; 2004/05 38.3; 2005/06 35.0; 2006/07 32.3; 2007/08 30.0; 2008/09 28.6; 2009/10 27.2; 2010/11 25.7

### Use of budget overperformance and risks
- This year’s budgetary overperformance is to be used for tax relief and debt reduction.
- The budget surplus based on current policies is expected to be substantial (¾ percentage points of GDP) this fiscal year.
- The Economic Statement proposes using overperformance to finance tax relief (¼ percentage point of GDP) and a one-off additional debt reduction (½ percentage points of GDP).
- Next fiscal year the overperformance would be used to finance the full annual cost of the tax relief measures, and the projected surplus remains around the debt reduction target.
- There is a risk that some recent revenue gains (particularly from commodity industries) may be more temporary than expected, underscoring the importance of expenditure restraint given relatively rapid recent spending growth.
- Staff calculations suggest that nominal GDP would need to slow by 1 percentage points more than in the baseline to push the federal government into deficit in fiscal year 2008–09.

### Tax policy recommendations and measures
- Staff viewed the reduction in the federal GST tax rate by a percentage point to 5 percent in the Statement as a missed opportunity to achieve larger efficiency gains by cutting other taxes.
- Suggested priorities for tax relief to reduce high marginal effective rates (METRs) on capital, saving, and labor income (in that order):
  - Welcome the 1 percentage point cut in the general corporate income tax rate in 2008 and its further reduction to 15 percent tax rate by 2012; this will help make corporate taxes more neutral with regard to firm size.
  - Harmonizing remaining provincial sales taxes with the GST base, thereby exempting business inputs, is central to lowering METRs on capital; staff suggested a more explicit offer of assistance to provinces might be effective.
  - Marginal effective taxes on most forms of saving remain high; additional measures such as protecting all types of saving from taxes up to a cap could help support wealth creation by moving personal income taxes closer to a consumption tax. Officials noted the importance of neutrality across saving vehicles and recent rise in the pension income amount eligible for tax relief.
  - Welcome the reduction in the lowest personal income tax rate by half a percentage point to 15 percent and the introduction of the Working Income Tax Benefit (a negative income tax).
- Staff suggested increasing the relative importance of indirect to direct tax revenues to lower high marginal tax rates on income and to help maintain the tax base in the face of commodity cycles and population aging.
- One option for creating room for income tax relief would be to explore introducing a carbon tax (as in British Columbia); officials responded that the government had chosen to reduce carbon emissions through other means.

### Equalization transfers and transparency
- Staff supported the reformed system of equalization transfers but noted some areas where transparency is still lacking.
- Key elements: return to including all provinces in the formula determining transfer payments, partial inclusion of revenue resources, cap on Equalization transfers so no receiving province has a higher fiscal capacity than a nonreceiving one.
- Agreements allowing some provinces to obtain additional transfers implied by the old system increase complexity and could gradually undermine the rules-based approach.

### Long-term sustainability and health spending risks
- The team welcomed the renewed commitment in the October Statement to eliminate net general government debt by 2021.
- Fund analysis finds fiscal surpluses have helped ensure Canada is closer to long-term budget sustainability than other G-7 countries.
- Staff and officials agreed on the importance of continuing to run surpluses and lower federal and general government debt to prepare for costs associated with population aging and health innovation.
- Staff suggested that on current policies public health care spending would likely continue to expand rapidly, driving a rise in general government debt after 2021.
- Officials explained they were supporting provincial and territorial efforts to make health care delivery more efficient, including developing indicators for cross-jurisdictional outcome comparisons, and observed little case for reducing services given academic studies suggesting the social return on health spending is high.

_Italicized source: IMF staff report content provided in the supplied PDF excerpt._

### 59.      The government’s structural reform agenda focuses on boosting productivity.

### 59.      The government’s structural reform agenda focuses on boosting productivity.

### Productivity performance and challenges
- Canada’s productivity performance in recent years has been disappointing.
- Fast growth has primarily reflected increased labor participation, while both business investment and total factor productivity growth have lagged behind U.S. rates.
- Pressures increasing the need for productivity gains include dollar appreciation and gradual population aging.
- Chapter 5 of the Selected Issues paper finds that labor market churning through firm creation and destruction is significantly lower in Canada than in the United States.

### Advantage Canada: objectives and measures
- Advantage Canada (released in late 2006) is aimed at raising productivity.
- The blueprint recognizes the importance of:
  - Reducing high marginal effective tax rates—some tax relief measures proposed in the Statement would contribute.
  - Creating a dynamic and globally competitive financial system to provide broader access to finance.
  - Encouraging interprovincial labor mobility.
  - Facilitating immigration of skilled labor.
- Officials formed an expert panel to report on the impact of FDI restriction on competition by mid-2008.

### Product market reform recommendations (staff emphasis)
- Product markets should be a focus of structural reform because product market restrictions remain relatively high compared to other industrial countries, most notably in the financial sector and network industries (airlines, telecommunication, utilities, and media).
- Specific recommendations:
  - Lower current restrictions on inward foreign direct investment, most notably in network industries, to stimulate competition and international transfer of best practices.
  - Reduce barriers to interprovincial trade in goods and services, and to mobility in regulated professions, to enhance competition and innovation.
  - Use TILMA (Trade, Investment, and Labor Mobility Agreement between Alberta and British Columbia) as a model: it presumes mobility is free unless specifically excluded and has prompted Ontario and Quebec to start discussions on their own trade deal.

### Labor supply, aging, and immigration
- The transition from labor abundance to scarcity focuses attention on:
  - Increasing participation of older workers.
  - Successful integration of foreign immigrants.
- Disincentives for older workers include lower expected income for older retirees from the Canada/Quebec Pension Plans and the structure of many private pension plans.
- Staff suggested that the current approach to economic migration is too inflexible relative to changing labor demand; officials noted provinces with particular skill needs were increasingly using established mechanisms to hire needed workers and that the existing system represents a long-term social contract.

### Macroeconomic outlook and risks (Staff Appraisal)
- After five years of strong growth, the economy is forecast to slow in the next few quarters.
- Key near-term influences:
  - A weakening U.S. economy and recent currency appreciation are likely to reduce external demand.
  - Domestic demand expected to moderate as financial conditions tighten and real income growth normalizes.
- Balance of risks to growth is tilted to the downside, reflecting external risks (possible U.S. recession and global financial strains), though domestic demand could slow by less than expected if commodity prices maintain upward momentum.
- Monetary policy:
  - Monetary policy has shifted to guard against increasing near-term downside risks; the December interest rate cut was welcomed.
  - Bank measures to inject term liquidity in coordination with other central banks and to expand eligible collateral are welcome given persistent money market strains.
- Exchange rate and commodities:
  - At near parity against the U.S. dollar and with oil prices of $90-100 a barrel, the currency appears broadly in line with fundamentals, although some measures suggest modest overvaluation.
  - The floating exchange rate acts as a shock absorber to terms-of-trade changes.
  - Rapid appreciation in 2007 partly reflected momentum buying and general U.S. dollar weakness; the Canadian dollar subsequently fell from November’s record high, when it was modestly overvalued by most measures.
- Labor market adjustment:
  - Flexible labor markets, employment gains in services, construction, and mining, and interprovincial migration have more than offset manufacturing job losses in central provinces, though competitiveness has suffered.

### Financial system resilience and reform
- The financial system appears positioned to weather further turbulence, but balance sheet strains are likely to slow financing and growth.
- Observations:
  - Current capital positions allow Canadian banks to absorb substantial balance sheet losses.
  - Banking system exposure to the U.S. subprime market and structured credit products is generally considered more limited than in other major markets.
  - Funding conditions have tightened; credit risk from a slowing domestic economy and banks’ exposure to U.S. markets will put pressure on balance sheets.
- ABCP:
  - The agreement in principle to restructure the frozen third-party ABCP has lowered a major risk to financial conditions.
  - The ABCP shutdown reflected weak investor due diligence, ratings that neglected liquidity risks, and a lack of transparency; staff welcome the agreement in principle and the government support for the private-sector process.
- Regulation and competition:
  - Bank regulation and supervision largely meet best practice, but securities markets would benefit from a single regulator.
  - The proposed passport system’s automatic interjurisdictional recognition of decisions of the home regulator (except for Ontario) is significant progress.
  - Staff view a single regulator as most effective for timely policy responses, lower costs, and consistent enforcement.
  - Regulators should address transparency challenges from financial innovation.
  - The “widely-held” rule prevents market entry on a large scale, leading to low-risk balance sheets and high returns on equity, limiting incentives for financial innovation and serving higher-risk borrowers; removing barriers to acquisition of large banks, including by foreign entities, would foster contestability and innovation.

### Fiscal policy, tax measures, and long-term sustainability
- Fiscal position and objectives:
  - A sound fiscal framework has produced a strong fiscal position that makes eliminating general government net debt by 2021 feasible.
  - Canada is closer to long-term budget sustainability than other major industrial countries, but provincial public health care spending is set to increase rapidly.
  - The federal government reaffirmed its objective to eliminate general government net debt by 2021.
- Budgetary stance:
  - Budgetary overperformance provides room for tax relief while maintaining small budget surpluses.
  - Staff welcome proposed tax relief and planned one-off additional debt reduction, noting some recent revenue gains may not be permanent.
  - The related demand stimulus in 2008 is small but fortuitous given weaker growth prospects.
- Recommended use of fiscal room:
  - To foster efficiency, fiscal room should be used to reduce high marginal effective tax rates on capital, saving, and labor (in that order).
  - The main tax relief measure in the Statement is a one percentage point cut in the federal GST rate to 5 percent.
  - Staff welcome progress in reducing high marginal effective tax rates on business investment, particularly the federal corporate tax rate cut which will gradually bring the rate to 15 percent by 2012.
  - Harmonization of some provincial sales tax bases with the federal GST would further reduce marginal effective tax rates on capital and justify more explicit incentives than the government’s existing commitment to work with provinces.

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2008/_cr0869.pdf*

### 77.      It is expected that the next Article IV consultation with Canada will be held on

### _cr0869 - 77.      It is expected that the next Article IV consultation with Canada will be held on

### Article IV consultation timing
- It is expected that the next Article IV consultation with Canada will be held on the regular 12-month cycle.

### Fund policy advice (Table 1)
- Fiscal Policy
  - Staff: The agreement to lock in federal health transfers over the next 10 years provides provinces with opportunities to improve the efficiency and quality of health care.
  - Staff: Allowing provinces greater flexibility in using price and other market-based mechanisms could help align the demand and supply for health care and reduce costs over time.
  - Authorities: The Canada Health Act allows for private service delivery, and provinces are actively exploring different approaches to improve competition. Even low user fees could significantly reduce access to health care by the poor.
- Financial Policy
  - Staff: The funding of Canada's defined benefit plans has deteriorated over the past several years, but has stabilized over the past year.
  - Staff: Entry into public consultation on reform is welcome and early action is warranted to better align the incentives of plan sponsors and members.
  - Authorities: In 2006, the federal government implemented temporary relief measures to re-establish full funding in an orderly fashion. The federal government will continue to examine the broader challenges facing defined benefit pension plans.
- Labor Markets
  - Staff: Canada has high labor participation rates, but the boom in the commodity and construction sectors has led to tight labor markets especially in the Western provinces.
  - Staff: Priorities are reducing welfare walls, amending immigration systems to address skills shortages, and simplifying recognition of occupational qualifications.
  - Authorities: The federal government has committed to improving labor market efficiency, and has enacted a working income tax benefit and is studying plans for phased retirement. Progress has also been made in removing obstacles to labor mobility under the Agreement on Internal Trade.
  - Staff: Canada maintains an Employment Insurance system that offers generous seasonal, regional, and family leave benefits, funded by a payroll tax.
  - Staff recommendation: Consideration could be given to funding social benefits of the Employment Insurance system through general revenues and to curbing extended regional benefits.
  - Authorities: Recent reforms to the Employment Insurance System have improved the system's funding. No significant changes in benefits are currently being considered.
- Trade Policy
  - Staff: Canada can play an important leadership role in the Doha negotiations.
  - Staff: Canada needs to widen market access for agricultural goods, including those subject to “supply management” schemes.
  - Authorities: Canada is pursuing an ambitious Doha outcome and will continue to support supply management.

### Macroeconomic performance and projections (selected indicators from Tables 2 and 3)
- Per capita real GDP (annual percent change)
  - Canada: 2001: 2.4; 2002: 0.7; 2003: 1.8; 2004: 0.9; 2005: 2.0; 2006: 2.1; 2007: 1.7; 2008: 1.5; 2009 (Proj): 0.6
  - United States: 2001: 2.0; 2002: -0.3; 2003: 0.6; 2004: 1.5; 2005: 2.7; 2006: 2.1; 2007: 1.9; 2008: 1.0; 2009: 0.9
- Real GDP (annual percent change)
  - Canada: 2001: 3.5; 2002: 1.8; 2003: 2.9; 2004: 1.9; 2005: 3.1; 2006: 3.1; 2007: 2.8; 2008: 2.6; 2009: 2.0
- Real domestic demand (annual percent change)
  - Canada: 2001: 4.0; 2002: 1.2; 2003: 3.2; 2004: 4.6; 2005: 4.3; 2006: 5.1; 2007: 4.4; 2008: 3.8; 2009: 3.7
- GDP deflator (annual percent change)
  - Canada: 2001: 2.1; 2002: 1.1; 2003: 1.1; 2004: 3.3; 2005: 3.2; 2006: 3.4; 2007: 2.4; 2008: 3.0; 2009: 1.9
- General government financial balance (percent of GDP)
  - Canada: 2001: 0.9; 2002: 0.7; 2003: -0.1; 2004: -0.1; 2005: 0.8; 2006: 1.6; 2007: 1.0; 2008: 0.8; 2009: 0.5
- Gross national saving (percent of GDP)
  - Canada: 2001: 21.8; 2002: 22.2; 2003: 21.0; 2004: 21.2; 2005: 22.9; 2006: 23.8; 2007: 24.2; 2008: 23.9; 2009: 24.0
- Fixed investment (percent of GDP)
  - Canada: 2001: 20.1; 2002: 19.6; 2003: 19.5; 2004: 19.6; 2005: 20.3; 2006: 21.0; 2007: 22.0; 2008: 22.4; 2009: 23.2
- Current account balance (percent of GDP)
  - Canada: 2001: 1.2; 2002: 2.3; 2003: 1.7; 2004: 1.2; 2005: 2.3; 2006: 2.0; 2007: 1.6; 2008: 1.0; 2009: 0.1

### Quarterly and near-term indicators (selected from Table 3)
- Real GDP (seasonally adjusted, quarterly series)
  - Q1–Q4 (series excerpt): Q1: 3.5; Q2: 3.8; Q3: 2.9; Q4: 1.8; subsequent quarters show variations with recent quarters around 3.1, 3.2, 3.2.
- Unemployment rate (percent)
  - Series: 6.1, 6.1, 6.0, 5.9, 6.1, 6.2, 6.3, 6.3, 6.3, 6.2, 6.2, 6.1
- CPI inflation (y/y)
  - Series: 1.9, 2.0, 2.1, 2.5, 1.5, 1.1, 1.6, 1.6, 2.0, 2.0, 2.0, 2.0
- Three-month treasury bill (percent)
  - Series: 4.2, 4.3, 4.3, 3.9, 3.8, 3.8, 3.9, 4.0, 4.1, 4.3, 4.5, 4.7
- Ten-year government bond yield (percent)
  - Series: 4.1, 4.4, 4.5, 4.2, 4.0, 4.0, 4.1, 4.2, 4.3, 4.5, 4.7, 4.9

### External accounts and financial flows (selected from Table 4)
- Current account balance (billions of C$)
  - 2002: 19.8; 2003: 14.7; 2004: 29.1; 2005: 27.9; 2006: 23.6; 2007: 14.8; 2008 (Est.): 1.5; 2009 (Proj): 1.2; 2010: 1.6; 2011: 1.2; 2012: 1.2
- Merchandise trade balance (billions of C$)
  - 2002: 57.3; 2003: 56.4; 2004: 65.8; 2005: 63.5; 2006: 51.3; 2007: 50.7; 2008 (Est.): 32.4; 2009 (Proj): 31.3; 2010: 32.8; 2011: 34.9; 2012: 35.8
- Exports, goods (billions of C$)
  - 2002: 414.0; 2003: 399.1; 2004: 429.1; 2005: 451.8; 2006: 455.7; 2007: 468.0; 2008 (Est.): 454.0; 2009 (Proj): 464.2; 2010: 483.9; 2011: 504.5; 2012: 524.0
- Imports, goods (billions of C$)
  - 2002: 356.7; 2003: 342.7; 2004: 363.3; 2005: 388.3; 2006: 404.4; 2007: 417.3; 2008 (Est.): 421.6; 2009 (Proj): 432.9; 2010: 451.1; 2011: 469.6; 2012: 488.1
- Net international investment position (billions of C$)
  - 2002: -208.7; 2003: -216.7; 2004: -180.1; 2005: -166.4; 2006: -99.0; 2007: -78.6; 2008 (Est.): -71.4; 2009 (Proj): -64.1; 2010: -56.2; 2011: -48.5; 2012: -40.4
- Official reserves (in billions of US$)
  - Series: 28.6, 32.4, 34.2, 37.2, 36.3, 34.5, 33.0, 35.1, 39.4

### Financial sector and vulnerability indicators (Table 5 highlights)
- Banking sector metrics (based on six largest chartered banks)
  - Total loans to assets (percent): recent values around 53.8, 53.9
  - Total loans to deposits (percent): recent values around 81.7, 82.3
  - Impaired assets/total assets: 0.59, 0.60, 0.84, 0.90, 0.65, 0.39, 0.27, 0.22, 0.22
  - Loan loss provision (percent of total assets): 0.23, 0.27, 0.39, 0.56, 0.22, 0.06, 0.09, 0.10, 0.13
  - Total capital ratio: 11.3, 11.9, 12.3, 12.4, 13.4, 13.3, 12.9, 12.5, 12.0, 7 (table continues series)
  - Tier 1 capital ratio: 8.2, 8.6, 9.0, 9.2, 10.3, 10.6, 10.2, 10.5, 9.8
- Profitability (selected)
  - Return on total shareholders' equity (percent): 15.7, 15.2, 13.9, 9.3, 14.7, 16.7, 14.6, 21.7, 22.6
  - Return on average assets (percent): 0.7, 0.7, 0.7, 0.6, 0.4, 0.6, 0.7, 0.9, 0.93

### Fiscal indicators (Table 6 selected)
- Federal government (PA basis, in billions of dollars)
  - Revenue: 2001/02: 183.9; 2002/03: 190.6; 2003/04: 198.6; 2004/05: 211.9; 2005/06: 222.2; 2006/07: 236.0; 2007/08 (Est.): 242.5; 2008/09 (Proj): 242.4; 2009/10 (Proj): 252.3; 2010/11 (Proj): 265.0
  - Program spending: 2001/02: 136.2; 2002/03: 146.7; 2003/04: 153.7; 2004/05: 176.4; 2005/06: 175.2; 2006/07: 188.3; 2007/08 (Est.): 198.1; 2008/09 (Proj): 207.2; 2009/10 (Proj): 216.4; 2010/11 (Proj): 224.6
  - Interest payments: 39.7, 37.3, 35.8, 34.1, 33.8, 33.9, 33.8, 32.9, 33.0, 32.9
  - Budgetary balance (accruals basis): 8.0, 6.6, 9.1, 11.5, 13.2, 13.8, 10.6, 2.3, 2.9, 7.5
  - Net lending (calendar year basis): 12.0, 9.4, 4.1, 9.8, 2.0, 8.5, 6.0, -1.1, -2.9, 0.5
- Federal government (percent of GDP)
  - Revenue: 16.6, 16.5, 16.4, 16.4, 16.2, 16.3, 15.9, 15.3, 15.2, 15.2
  - Program spending: 12.3, 12.7, 12.7, 13.7, 12.7, 13.0, 13.0, 13.0, 12.9
  - Budgetary balance (accruals basis): 0.7, 0.6, 0.8, 0.1, 1.0, 1.0, 0.7, 0.1, 0.2, 0.4
- General government (national accounts, in percent of GDP)
  - Revenue: 42.4, 40.9, 40.8, 40.4, 40.6, 40.1, 40.0, 39.5, 39.2, 39.1
  - Expenditure: 41.7, 41.0, 40.9, 39.7, 39.0, 39.1, 39.2, 39.0, 38.8, 38.6
  - Balance: 0.7, -0.1, -0.1, 0.8, 1.6, 1.0, 0.8, 0.5, 0.4, 0.5
  - Gross public debt (percent of GDP): 91.5, 89.4, 85.2, 80.2, 73.5, 68.8, 65.7, 62.4, 58.9, 55.8

### Key thematic findings from figures and narrative
- Household sector
  - Real incomes have grown at a robust rate; household debt has risen less than in some other countries; credit quality indicators remain broadly favorable; saving rate has dropped substantially since the 1980s partly reflecting a rise in household wealth.
- Corporate sector
  - Canadian businesses have enjoyed high profit margins; falling prices of capital goods reflect currency appreciation; volatility of business investment growth has increased; returns strong in energy and nontradable sectors; corporate balance sheets have strengthened.
- Commodity price gains and regional adjustment
  - Mining, construction and services have been boosted by commodity price gains, benefiting resource-rich provinces; employment gains in services have been broad-based; unemployment has fallen in all provinces; migration to resource-rich provinces has helped, driven in part by favorable wage differentials.
- Monetary and inflation dynamics
  - Energy price volatility has subsided and core inflation has declined recently; unit labor costs are high but inflation expectations have remained well anchored; exchange rate appreciation has tightened financial conditions; Bank of Canada reversed its July hike in December despite low unemployment and a positive output gap.
- Fiscal sustainability scenarios (Figure 5 notes)
  - "Baseline" path assumptions: for the first ten years federal government achieves its ten-year debt reduction target, provinces run balanced budgets, and public health care inflation equals the growth in all prices through 2046.
  - "No-debt ratio reduction" path assumes federal and provincial debt ratios remain unchanged over the next ten years.
  - "Debt reduction and high health inflation" path illustrates the impact of public medical costs rising 2 percent per year faster than all prices, with the additional costs offset only through (text truncated in source).

*Source: IMF staff report content as provided in the supplied PDF excerpt.*

### 2016.  In all cases, the fiscal system is assumed unchanged after 2016. More details on the model are provided in "Asses

### 5. Several major Canadian banks have announced significant further write-downs

### 5. Several major Canadian banks have announced significant further write-downs

### Bank losses, exposures, and capital actions
- Several major Canadian banks have announced significant further write-downs on their holdings of structured products, including ABCP, CDOs and RMBSs.
- Write-downs reflect both reductions in the value of underlying assets and the downgrading of some of the banks' hedging counterparties (e.g., financial guarantors).
- Canadian banks are exposed to market turbulence through multiple channels:
  - liquidity support commitments;
  - participation in LBO transactions; and
  - the management of SIVs.
- Despite these exposures, Canadian banks remain well capitalized.
- One of the banks has raised additional capital from domestic and international investors.

### Financial conditions and market developments
- Interbank spreads for major Canadian banks rose, although not as much as in other major markets.
- The average cost of borrowing for households and businesses had risen by 15-25 basis points relative to October 2007, according to the Bank of Canada’s January 2008 Monetary Policy Report Update.
- An agreement in principle in late December to restructure the local frozen third-party ABCP reduced contagion risks in other domestic financial markets.
- The extent of financial vulnerabilities has been limited owing to relatively low exposures to asset-backed securities, but uncertainties remain regarding further deterioration in U.S. financial market conditions.

### Macroeconomic backdrop and projections
- Real GDP growth was around 2½ percent in 2007, driven by robust domestic demand—particularly private consumption and residential investment—of close to 4 percent.
- Growth slowed toward the end of the year and is expected to decelerate further to 1.8 percent in 2008 reflecting a sharp downturn in the United States, past currency appreciation, and a tightening of financial market conditions.
- Core inflation declined in the second half of 2007 owing to stronger-than-expected exchange rate pass-through, although headline inflation remained elevated due to rising gasoline prices.
- The external current account surplus narrowed to 1 percent of GDP in 2007 as real net exports declined sharply.
- The Canadian dollar appreciated by 45 percent in real effective terms since 2002; domestic adjustment to the appreciation has been very smooth thanks to flexible labor markets.

### Monetary and fiscal policy actions
- The Bank of Canada reduced its policy rate to 4 percent—in two consecutive cuts of 25 basis points in December 2007 and January 2008—in response to deteriorating economic prospects and declining core inflation.
- In its January statement, the BoC noted that the weak U.S. economic outlook and tighter credit conditions in Canada would likely continue to pose challenges, and that further monetary easing might be needed in the near term.
- A prudent fiscal policy framework over the last decade produced 10 consecutive years of budget surpluses and declining public debt ratios.
- The budget surplus for fiscal year 2006/07 was estimated at 1 percent of GDP, half a percentage point above the budget forecast.
- Tax relief measures noted: the federal goods and services tax rate was cut by 1 percentage point to 5 percent, effective January 1, 2008; corporate and personal income taxes were also reduced.

### Executive Board assessment and policy recommendations
- Directors commended Canada’s macroeconomic track record: strong GDP growth, declining unemployment, low and stable inflation, and consecutive fiscal surpluses with reductions in the federal debt-to-GDP ratio.
- Near-term risks identified by Directors:
  - a potential sharp slowing of the U.S. economy;
  - effects of past currency appreciation; and
  - tighter credit conditions.
- Directors welcomed the measured easing of policy and noted room for supportive policy actions given Canada’s strong monetary framework and exemplary budgetary performance.
- On monetary policy:
  - Directors commended the Bank of Canada’s rate reductions in December and January.
  - Some Directors noted there may be room for further reductions in the overnight rate in the near term.
  - Directors concurred that compelling evidence would be required before changing the inflation-targeting regime to price level path targeting.
  - Directors welcomed the Bank’s commitment to increasing transparency of decision-making.
- On fiscal policy:
  - Directors considered it appropriate to allow automatic stabilizers to operate.
  - They emphasized the importance of maintaining expenditure restraint over the medium term, noting some revenue gains underlying the budget surplus could prove temporary.
  - Directors welcomed the authorities’ objective to eliminate general government debt by 2021.
- On structural policy and competitiveness:
  - Directors supported the authorities’ focus on structural reforms to boost productivity as outlined in Advantage Canada.
  - Recommended reforms included reducing high marginal effective tax rates, enhancing business productivity, creating a dynamic and globally competitive financial system, and enhancing interprovincial labor mobility.
  - Several Directors noted benefits from lowering marginal effective tax rates on saving and capital.
  - Directors welcomed planned reductions in the general corporate income tax rate and reforms to the equalization system toward a more rules-based approach.
- On financial sector regulation:
  - Directors were reassured by the Financial Sector Assessment Program Update finding that the Canadian banking system is sound, profitable, and largely robust to adverse shocks.
  - Directors welcomed the agreement in principle to restructure the non-bank ABCP market as mitigating a major risk.
  - Directors urged continued vigilance and noted that further opening of the Canadian banking system to takeovers could boost market flexibility and innovation, though some Directors weighed this against the resilience benefits of the current system.
  - While acknowledging improvements from the “passport plus” system of provincial market regulation, many Directors believed that adopting a single securities regulator would further improve efficiency and effectiveness.

### Selected key statistics from the source
- Real GDP: 2007 = 2.5; projected 2008 = 1.8; projected 2009 = 2.4 (from the projections table header series).
- Net exports contribution to growth: 2007 = -1.2.
- Final domestic demand (annual change): 2007 = 3.9.
- Private consumption (annual change): 2007 = 4.2.
- Unemployment rate: 2007 = 6.0.
- Consumer price index (annual change): 2007 = 2.2.
- U.S. cents/Canadian dollar (period average): 2007 = 0.93; percent change = 6.0.
- Three-month treasury bill: 2007 = 4.2.
- Ten-year government bond yield: 2007 = 4.3.
- Current account balance (as a percent of GDP): 2007 = 1.0.
- Gross national saving (as a percent of GDP): 2007 = 23.9.
- Gross domestic investment (as a percent of GDP): 2007 = 22.9.

*Source: IMF staff report material for the 2008 Article IV Consultation with Canada.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2008/_cr0869.pdf_