## CANADA — Staff Report for the 2010 Article IV Consultation (Staff Supplement)

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### Recent developments and near-term data
- Q3 real GDP grew at 1 percent (s.a.a.r.), below staff’s forecast (1½ percent).
- Employment rose in November; unemployment fell to 7.6 percent (lowest since January 2009).
- Current account deficit widened to 4⅓ percent of GDP in Q3.
- Headline and core inflation edged up but remained within the Bank’s control range.
- Bank of Canada overnight rate unchanged at 1 percent on December 7.
- Canadian dollar broadly unchanged vis-à-vis the U.S. dollar; stock market continued to rebound; interbank spreads rose slightly; long-term government bond yields picked up, trailing U.S. treasury rates.
- Bank’s December Financial System Review: risks to Canada’s financial system remain elevated and had increased since June.

### Macroeconomic performance and drivers
- Recession ended in 2009Q2; GDP recovered pre-crisis level by end 2010Q2, cumulative growth since trough 3.4 percent (non-annualized) vs peak-to-trough decline of about 3¼ percent.
- Household debt rose to 143.6 percent of disposable income (vis-à-vis 148.6 percent in the United States on a comparable basis).
- Federal and provincial stimulus totaled about 4 percent of one year’s GDP over two years; Canada’s stimulus around 2 percent of GDP per year in 2009 and 2010 (staff estimates exclude auto-sector financing of around 0.9 percent of GDP).
- Bank of Canada policy rate: reduced to ¼ percent in April 2009 and raised to 1 percent by September 2010.
- Labor market: 270,000 jobs lost in 2009; unemployment rate at 7.9 percent (peak of 8¾ percent in August 2009).
- Residential investment stalled after policy changes and tax-credit expiration; Q2 GDP expanded only 2 percent (q/q, s.a.a.r.); average real GDP growth over July and August near zero.
- Core inflation: around 1½ percent; headline CPI around 1¾ percent. Staff estimate an output gap of around 2½ percent.
- Unit labor costs picked up slightly in 2010Q2 after a pause in productivity gains.

### Fiscal developments and policy stance
- Infrastructure project deadline under stimulus extended by seven months to October 31, 2011.
- Staff estimate: extension smoothes change in general government structural balance for CY2011 from 1.1 percent of GDP to 0.9 percent of GDP (and possibly lower).
- Provincial consolidation plans remain on track; sub-national and total government net lending improved notably since Q2 release.
- Authorities target a return to balance at the federal level over the medium run with an ambitious and growth-friendly plan; near-term adjustment is substantially frontloaded.
- Staff view: smoother near-term adjustment could have been contemplated given heightened risks; long-run challenge is stabilizing health-care costs.

### Monetary policy assessment
- Given benign inflation, forthcoming fiscal drag, and mounting domestic growth challenges, Bank of Canada appropriately paused further rate hikes; withdrawal of accommodation should be cautious.
- Authorities considering, in the statutory review, steps including a shift to price-level path targeting (PLPT) in 2012; staff see existing inflation targeting as serving Canada well and note benefits of PLPT are uncertain.

### Financial sector resilience and risks
- Canadian banks remained profitable with adequate provisioning and sound asset quality.
- Nonperforming loans rose to 1.3 percent of total loans (compared with 5.4 percent in the United States, 3.5 percent in the United Kingdom and 3 percent in the euro area).
- Capital adequacy improved to about 15½ percent (total regulatory capital/risk-weighted assets).
- Major banks’ CDS spreads declined sharply to around pre-Lehman levels.
- Staff: Canadian financial institutions well positioned for international post-crisis reform; national securities regulator remains an important priority.
- Financial markets largely normalized: stock market up almost 50 percent since March 2009; 3-month CAD LIBOR-OIS narrowed to pre-Lehman levels; overall conditions stimulative.

### Outlook and risks
- Staff projections:
  - GDP growth: rebound from -2½ percent in 2009 to 3 percent in 2010, then slow to around 2⅓ in 2011.
  - Potential growth recover gradually to around 2 percent.
  - Staff estimate stimulus adds 1 percentage point to growth in 2010.
  - Output gap about 2½ percent at 2010Q3, closing in 2015 under staff baseline.
- Key downside risks:
  - High household debt and cooling housing markets.
  - Global risks: weaker U.S. outlook or renewed global financial deterioration.
- Staff CGER: REER slightly above medium-term fundamentals but within reasonable margin of uncertainty.
- In staff view, absent a U.S. double-dip recession and/or renewed global financial deterioration from sovereign credit strains, Canada should enjoy comfortable near-term growth.

### Staff recommendations and analytical work
- Pace exit from macro stimulus to balance support for recovery and medium-term deficit reduction.
- Withdraw monetary accommodation cautiously given subdued inflation and domestic headwinds.
- Fiscal consolidation: target return to balance at federal level over medium run while considering smoother near-term adjustment.
- Financial regulation: adapt to international reform agenda and prioritize a national securities regulator.
- Ongoing analytical work: exchange rate dynamics during the crisis; housing market trends; housing finance framework; potential post-crisis growth; outlook for Canadian auto-sector vis-à-vis NAFTA partners.

### Corporate balance sheets and business lending
- Corporate leverage ratios have fallen; profits rebounded but remain below pre-crisis levels.
- Senior Loan Officer Survey: widespread easing in business-lending conditions during 2010Q3; easing for corporate borrowers for fifth consecutive quarter.
- Small business lending conditions unchanged in 2010Q3.

### Growth outlook, key macro projections, and selected statistics
- Staff growth projections (selected years):
  - Real GDP: 2010: 3.0; 2011: 2.3; 2012: 2.7; 2013: 2.4; 2014: 2.4; 2015: 2.2.
- Output gap (percent of potential): 2007: 1.7; 2008: 0.1; 2009: -3.8; 2010: -2.5; 2011: -2.0; 2012: -1.2; 2013: -0.7; 2014: -0.3; 2015: 0.0.
- Unemployment rate (percent): 2009: 8.3; 2010: 8.1; 2011: 7.9; 2012: 7.4; 2015: 6.1.
- CPI inflation (percent): 2009: 0.3; 2010: 1.7; 2011: 2.0; 2015: 2.0.
- Federal government budgetary balance (fiscal years, in billions): 2009/10: -55.6; 2010/11: -49.7; 2011/12: -33.6; 2012/13: -26.4; 2013/14: -18.3; 2014/15: -10.1; 2015/16: -5.4.
- General government balance (NA basis, percent of GDP): 2009: -5.5; 2010: -6.1; 2011: -4.6; 2015: -1.6.
- Gross public debt (OECD consistent, percent of GDP): 2009: 82.5; 2010: 84.0; 2011: 84.8; 2015: 80.1.
- Current account balance (percent of GDP): 2009: -2.8; 2010: -3.1; 2011: -3.5; 2015: -2.4.
- Net international investment position (mem. item): 2009: -10.0; 2010: -12.3; 2015: -22.1.

### Housing market vulnerability (Box 1 highlights)
- Residential real estate cycle may have peaked: sales volumes fell and price increases moderated.
- Residential investment in 2010 Q2: +1.3 percent; new homebuilding up 30 percent while renovation activity dropped.
- Price-to-income and price-to-rent ratios: 1 standard deviation above historical averages.
- Staff model-based overvaluation estimate: around 13 percent (exceeds 10 percent threshold).
- Predicted house-price path suggests a decline of almost 6 percent through 2015.
- Mortgage term structure: 66 percent of borrowers have terms of four to five years; 8 percent have terms of more than 5 years; 26 percent have terms of less than 5 years — implying rollover exposure to future rate increases.
- Policy implication: monitor EWE/VEA indicators, mortgage term structure, and renovation/new-building dynamics for early stress detection.

### Risks to the outlook — domestic and external
- Domestic:
  - Main risk: stretched household balance sheets; debt-to-income ratios: 143.6 in Canada and 148.6 in the United States (comparable basis).
  - Housing valuations at multi-decade highs; model-based moderate overvaluation in key provinces.
  - A 10-percent house price correction would deduct CAD148.2 billion from household balance sheets, with marginal propensity to consume around 6 percent.
  - Crisis initially deducted CAD24.6 billion in aggregate households’ residential wealth; since 2009Q1 trough, real estate household wealth increased by around CAD90 billion.
  - If residential investment grew at half the projected rate in H2 2010, this would deduct some 0.2 percentage points from 2010 average growth.
- External:
  - Weaker U.S. outlook and worsening global financial conditions pose largest downside external risks.
  - With U.S. accounting for three-fourths of Canadian exports, staff estimate a 1 percentage point drop in U.S. growth reduces Canada’s growth by ½ to ¾ of 1 percentage point.
  - Sovereign debt strains limited to a few European countries would have limited effects; worst-case contagion would be more serious.
  - Upside: stronger emerging-market momentum, notably Asia, would exert positive but modest effects, partly offset by a stronger currency.

### Fiscal consolidation plans and flexibility
- Consolidation profile under FY 2010–11/FY 2014–15 Update:
  - Slightly smaller deficit in FY 2010–11 (by 0.1 percent); marginally worse deficits in outer years (by around 0.35 percentage points of GDP from FY 2011–12 through FY 2013–14).
  - Authorities now expect to balance the budget by FY 2015–16 with a slight surplus (0.1 percent of GDP).
- Staff estimates of fiscal down payment and impulse:
  - Fiscal down payment for FY 2011–12 about ¾ percentage point of GDP at federal level.
  - About ⅓ of a percentage point of GDP per year in subsequent years up to FY 2014–15.
  - Calendar-year change in structural balance (general government) amounted to 1.1 percentage points of GDP in 2011.
  - Overall adjustment of 2 percentage points of GDP through 2015.
- Fiscal impulse (selected general government calendar-year figures):
  - Pre-Fiscal Update fiscal impulse: 2009 3.2; 2010 0.1; 2011 -1.3; 2012 -0.3; 2013 -0.4; 2014 -0.6; 2015 -0.5.
  - Post-Fiscal Update fiscal impulse: 2009 3.3; 2010 1.3; 2011 -1.1; 2012 -0.5; 2013 -0.5; 2014 -0.5; 2015 -0.4.
- Flexibility to respond to downside risks:
  - Options include front-loading Building Canada infrastructure spending (about ⅓ percent of GDP per year for FY 2010–11 up to FY 2013–14) and bringing forward corporate income tax cuts planned over next 2 years (staff estimate: a ½ percentage point decrease in the CIT rate reduces revenues by roughly 0.1 percent of GDP).
  - Authorities committed to revisit plans if outlook deteriorates.

### Cementing fiscal stabilization — credibility and long-term risks
- International standing:
  - Canada’s overall fiscal outlook post-crisis among the best in the G-20; net debt lowest in the G-7.
  - Projected general government budgetary position for 2015 is the best in the G-7 after Germany.
- Long-term risks:
  - Population ageing and health-care inflation significant for fiscal sustainability.
  - Budget 2010 sensitivity: a sustained increase in the yield curve by 100 basis points decreases the budgetary balance by CAD 1 billion in year 1, CAD 2.1 billion in year 2 and CAD 3.0 billion by year 5 (cumulative impact about -0.3 percentage points of GDP).
  - Parliamentary Budget Officer projections (gross effective interest rate around 7 percent from FY 2013–14): federal net debt-to-GDP climbs from about 33¾ percent in FY2013–14 to 100 percent of GDP in 2050–51 and 365 percent of GDP by FY 2084–85; lower debt charge assumptions (around 5 percent) halve projected debt-to-GDP by end of horizon though remain sizeable.
- Recommendations:
  - Increase transparency and communication about long-run fiscal challenges.
  - Develop provincial arrangements to share health-care cost-management experiences, potentially when renewing federal transfers (current arrangements expire on April 1, 2014).
  - Consider additional measures if program spending restraint proves difficult, including restraining transfer growth to provinces or enhancing revenues.

### Financial regulation, stability record, and supervisory priorities
- Strengths:
  - Prudent leverage ratio including off-balance-sheet exposures; low reliance on wholesale funding; well regulated mortgage market with incentives for low LTV ratios and comprehensive mortgage insurance coverage; consolidated supervision; effective inter-agency cooperation.
- Regulatory capital (selected):
  - Total Regulatory Capital (Canada): 2006 12.5; 2007 12.1; 2008 12.2; 2009 14.7; 2010Q2 15.4.
  - Tier 1 Capital (OSFI): 2006 10.4; 2007 9.9; 2008 9.9; 2009 11.3; 2010Q2 12.9.
- Remaining risks:
  - Elevated household debt and potential housing correction; Bank of Canada stress tests show households with debt service ratio exceeding 40 percent could rise from 5 percent in 2010Q1 to 7.4 percent by 2012Q2 under assumed scenarios.
  - CMHC insurance in force at year-end 2009: CAD$473 billion with CAD$1.3 billion set aside for expected claims and CAD$6.7 billion in unearned premiums and fees.
  - Significant U.S. exposures: 118 CAD billion as of March 2010 (BIS).
- International regulatory stance:
  - Authorities support stronger international capital and liquidity standards, cautious on standardized OTC derivatives implementation to avoid unintended consequences for smaller jurisdictions, prefer countercyclical capital buffers and contingent capital over a global financial sector levy, and emphasize cross-border resolution improvements.
  - Staff: emergent regulatory standards not a high hurdle given Canada’s high requirements.

### National securities regulator and institutional coordination
- Transition Office working with participation of 10 provinces and territories toward mid-2012 launch; regulator to have a stability mandate and work closely with national authorities.
- Creation expected to bridge supervision gaps in national markets and integrate securities regulation into national financial-stability initiatives.

### Executive Board and mission views (key points)
- Commended credible macro framework, strong crisis response, and resilient financial system.
- Supported Bank of Canada’s decision to hold further rate increases; accommodative stance appropriate with room for stimulus if needed.
- Welcomed authorities’ aim to return to fiscal balance over medium term with growth-friendly measures (infrastructure and corporate income tax cuts).
- Emphasized importance of restraining health-care spending growth, vigilance on household debt and U.S. exposures, and progress toward a national securities regulator.
- Recommended next consultation on the usual 12-month cycle.

*Source: IMF staff report (content unit: _cr10377).*

### 1.  This supplement reports on developments since the staff report (SM/10/304) was

### CANADA — Staff Report for the 2010 Article IV Consultation (Staff Supplement)

### Recent developments and near-term data
- Q3 real GDP grew at 1 percent (s.a.a.r. annualized), below staff’s forecast (1½ percent), reflecting weaker-than-expected residential construction and net exports.
- Employment rose in November, but by less than expected; the unemployment rate fell to 7.6 percent, the lowest since January 2009.
- Canada’s current account deficit widened to 4⅓ percent of GDP in Q3.
- Headline and core inflation edged up but remained within the Bank’s control range.
- The Bank of Canada left the overnight rate unchanged at 1 percent on December 7.
- The Canadian dollar was broadly unchanged vis-à-vis the U.S. dollar; stock market continued to rebound; interbank spreads rose slightly; long-term government bond yields picked up, trailing U.S. treasury rates.
- The Bank’s December Financial System Review noted that risks to Canada’s financial system remain elevated and had increased since the prior report in June.

### Macroeconomic performance and drivers
- The recession ended in 2009Q2; GDP recovered its pre-crisis level by end 2010Q2, growing by a cumulative 3.4 percent (non-annualized, compared with a peak-to-trough decline of about 3¼ percent).
- Household debt rose to a new high of 143.6 percent of disposable income (vis-à-vis 148.6 percent in the United States on a comparable basis).
- The federal and provincial stimulus totaled about 4 percent of one year’s GDP over two years; Canada’s stimulus is around 2 percent of GDP per year in 2009 and 2010 (staff estimates exclude auto-sector financing of around 0.9 percent of GDP).
- The Bank of Canada reduced its policy rate to ¼ percent in April 2009 and raised it to 1 percent by September 2010 as liquidity operations were wound down.
- Labor market: 270,000 jobs lost in 2009; unemployment rate at 7.9 percent (compared with a peak of 8¾ percent in August 2009 and 9½ percent in the United States); significant share of job creation in part-time and temporary work.
- Q2 GDP expanded by only 2 percent (q/q, s.a.a.r); average real GDP growth over July and August was near zero.
- Residential investment stalled after the Federal Home Renovation Tax Credit expired end-January 2010, mortgage insurance qualification rules strengthened in April 2010, and HST introduction in Ontario and British Columbia in July.
- Current account: negative for a seventh straight quarter; 2010 Q2 at -2¾ percent of GDP (pre-crisis surpluses averaged around 1¾ percent of GDP).
- Core inflation around the middle of the control range: headline CPI around 1¾ percent; core inflation averaged around 1½ percent. Staff estimate an output gap of around 2½ percent.
- Unit labor costs picked up slightly in 2010Q2 after a pause in productivity gains.

### Fiscal developments and policy stance
- Recent government measure: extended by seven months the deadline for infrastructure projects under the economic stimulus to October 31, 2011.
- Staff estimate: extension smoothes the change in the general government structural balance for CY2011, reducing it from 1.1 percent of GDP to 0.9 percent of GDP (and possibly lower).
- Provincial budget consolidation plans remain on track; third-quarter provincial economic accounts and Quebec’s 2009–10 Public Accounts indicate sub-national and total government net lending improved notably since the Q2 release.
- Executive Summary fiscal guidance:
  - Authorities target a return to balance at the federal level over the medium run with an ambitious and growth-friendly plan.
  - Near-term adjustment is substantially frontloaded; staff suggests a smoother adjustment could have been contemplated given heightened risks.
  - Long-run challenge: stabilizing health-care costs.

### Monetary policy assessment
- Given benign inflation, forthcoming fiscal drag, and mounting domestic growth challenges, the Bank of Canada appropriately paused further rate hikes; accommodation should be withdrawn cautiously going forward.
- Authorities are considering, as part of the statutory review of the monetary framework, steps including a shift to price-level path targeting (PLPT) in 2012; staff and authorities see the existing inflation targeting framework as serving Canada well, while the benefits of PLPT in practice are uncertain.

### Financial sector resilience and risks
- Canadian banks remained profitable with adequate provisioning and sound asset quality.
- Nonperforming loans rose to 1.3 percent of total loans (compared with 5.4 percent in the United States, 3.5 percent in the United Kingdom and 3 percent in the euro area).
- Capital adequacy improved to about 15½ percent (total regulatory capital/risk-weighted assets).
- Major banks’ CDS spreads declined sharply from crisis highs, around pre-Lehman levels.
- Staff view: Canadian financial institutions are well positioned for international post-crisis reform; a national securities regulator remains an important priority.
- Financial markets largely normalized: stock market up almost 50 percent since March 2009; 3-month CAD LIBOR-OIS narrowed to pre-Lehman levels; overall financial conditions remain stimulative.

### Outlook and risks
- Growth expected to be muted in H2 2010 and in 2011 as household debt is high, housing markets are cooling, and fiscal stimulus wanes; risks are tilted to the downside, with a key risk that the global recovery stalls.
- In the absence of a U.S. double-dip recession and/or renewed global financial deterioration from sovereign credit strains, Canada should enjoy a comfortable near-term growth rate.
- Staff CGER analysis: REER is slightly above what is suggested by medium-term fundamentals, but within a reasonable margin of uncertainty.

### Staff recommendations and analytical work
- Exit from macro stimulus should be paced to balance supporting recovery and starting medium-term deficit reduction.
- Monetary accommodation withdrawal should be cautious given subdued inflation and domestic headwinds.
- Fiscal consolidation: target return to balance at the federal level over the medium run while considering a smoother near-term adjustment given heightened risks.
- Financial regulation: adapt to international reform agenda and prioritize a national securities regulator.
- Ongoing analytical work includes studies on exchange rate dynamics during the crisis; housing market trends; housing finance framework; potential post-crisis growth; and outlook for the Canadian auto-sector vis-à-vis NAFTA partners.

*Prepared by the Western Hemisphere Department; approved by Rodrigo Valdés and Tamim Bayoumi; November 24, 2010.*

### 11.      Corporate balance sheets remain healthy. Corporate leverage ratios have fallen,

### 11.      Corporate balance sheets remain healthy. Corporate leverage ratios have fallen,

### Corporate balance sheets and business lending
- Corporate leverage ratios have fallen, and profits have rebounded, but they remain below pre-crisis levels.
- The Senior Loan Officer Survey points to a widespread easing in business-lending conditions during 2010Q3.
- For corporate borrowers, borrowing conditions eased for the fifth consecutive quarter thanks to a better outlook for these firms and the economy, as well as growing competition among lenders.
- Small business lending conditions were unchanged in 2010Q3, following a modest easing in the second quarter.

### Growth outlook and key macro projections
- Staff projects GDP growth to rebound from -2½ percent in 2009 to 3 percent in 2010, then to slow to around 2⅓ in 2011.
- Staff estimates that the stimulus will add 1 percentage point to growth in 2010.
- Staff’s analysis suggests the positive impact on domestic demand from rising commodity prices is only partially mitigated by an appreciating Canadian dollar, with larger effects on domestic demand observed in the resource-rich western provinces.
- Inflation is expected to remain contained throughout the projection period thanks to a slowly-closing output gap.
- Staff’s estimates imply an output gap of about 2 ½ percent at 2010Q3, which would close in 2015.
- Potential growth would recover gradually to around 2 percent.

### Provincial outlook and sectoral notes
- The outlook for provinces will depend on the evolution of commodity prices and trade.
- Resource-rich western provinces: ongoing strength of commodity prices implies a favorable outlook.
- Ontario: outlook more closely linked to U.S. economic developments given high reliance on U.S. exports.
- Automotive products represented 12 percent of Canadian goods exports in 2009, down from about 20 percent in the last decade.
- The manufacturing sector employed directly and indirectly almost 660,000 Canadians, i.e., 4 percent of total employment.
- Two Canadian banks are the first and second largest in the Caribbean.

### Risks to the outlook
- Domestic risks
  - Stretched household balance sheets are the main domestic risk.
  - Debt-to-income ratios: 143.6 in Canada and 148.6 in the United States (expressed on a comparable basis).
  - Housing markets: price-to-income and price-to-rent ratios are at the highest level in over 30 years; model-based estimates suggest a moderate overvaluation in some key provinces.
  - Under the staff’s baseline, housing activity will moderate in the second half of 2010 and early 2011.
  - A 10-percent house price correction would deduct CAD148.2 billion from household balance sheets, taking into account a marginal propensity to consume of around 6 percent.
  - The crisis had initially deducted CAD 24.6 billion in aggregate households’ residential wealth, and since the trough in 2009Q1 real estate household wealth increased by around CAD 90 billion.
  - If residential investment grew at half the rate projected in the staff’s baseline scenario in the second half of 2010, this would deduct some 0.2 percentage points from 2010 average growth rate.
- External risks
  - A weaker U.S. outlook and worsening global financial conditions (if overseas sovereign strains intensified) pose the largest downside external risks.
  - With the United States accounting for three-fourths of Canadian exports, staff estimates that a 1 percentage point drop in U.S. growth reduces Canada’s growth by ½ to ¾ of 1 percentage point.
  - Sovereign debt strains limited to a few European countries would have limited output, trade and financial effects on Canada, though output losses could be more serious in a worst case scenario.
  - Upside: unexpectedly stronger momentum in emerging markets, notably Asia, would exert positive but modest effects, partly offset by a stronger currency.

### External spillovers and remittances
- Canada’s economic performance has important spillovers for small countries in the Western Hemisphere.
- Canada is one of the world’s main recipients of immigrants—accounting for almost one fifth of its population.
- Government data shows that in 2008 about 4 in 10 Canadians wired money back home to family and/or friends; the majority of these funds go to the Philippines and Haiti.
- Pre-crisis, Haiti’s flow of remittances was approximately 25 percent of its GDP, whereas the Philippines received remittances equivalent to 13 percent of their GDP.
- Canadians accounted for around 17 percent of arrivals in the Caribbean so far in 2010.

### Policy discussions and recommendations
- Overall policy stance
  - Discussions focused on measures to cement Canada’s strong macroeconomic and financial policies, and to deal with the deteriorated risk scenario.
  - The pause in the reduction of monetary stimulus is appropriate given the risks to the outlook.
  - On the fiscal front, the near-term adjustment is substantially frontloaded, while the authorities’ plan to return to balance over the medium term relies inter alia on significant restraint of program spending.
  - Sound regulation and supervision helped maintain financial stability during the crisis; Canada is playing an important role in shaping international regulatory reform.
- Three priority areas discussed:
  - Pacing the exit from extraordinary monetary and fiscal stimulus to balance rising domestic imbalances and hedging downside risks.
  - Cementing fiscal stabilization to put Canada’s net debt-to-GDP ratio on a declining path over the medium term.
  - Adapting financial regulation, with the key objective to strengthen securities regulation through further progress toward the creation of a national regulator.
- Monetary policy
  - The Bank of Canada maintained its target for the overnight rate at 1 per cent.
  - Staff supported a cautious pace of return to a neutral stance; the pause reflected weakening global recovery, deceleration in Canadian household spending, elevated household debt, and softening inflation.
  - Variable and adjustable rate mortgages are about 30 percent of the total.
  - Monetary policy should be the first line of defense if the outlook deteriorates, given the room to ease quickly, although fiscal policy has room to respond as well in a downside scenario.
  - Staff supported the Bank’s vigilance on housing market developments and favored use of regulation rather than monetary policy as a first line of defense against financial imbalances.
  - The 2011 statutory review of the Bank’s framework would examine: whether the inflation target should be lowered; whether to adopt Price-Level-Path Targeting (PLPT); and the weight given to financial stability. Any revisions would become operational in 2012.
- Fiscal policy
  - The mission praised the fiscal response to the crisis during 2009-10 and supported the authorities’ medium-term plans under the March 2010 Budget.
  - In 2010–11, the Economic Action Plan is on track to deliver a further CAD22 billion in federal stimulus spending, complemented by CAD 7 billion in stimulus funding from provinces, territories, municipalities and other partners.
  - Funding for the Action Plan in 2010–11 is 98 per cent committed.
  - In its first year of implementation, the Economic Action Plan has delivered over CAD 33 billion in stimulus to the economy.
  - The 2010 stimulus package for FY 2010–11 included infrastructure capital investments, tax relief, employment insurance (EI) and training measures, industry specific measures and support for research and development.

*Source: IMF staff report (content unit: _cr10377 - 11.      Corporate balance sheets remain healthy. Corporate leverage ratios have fallen, PDF chapter).*

### 26.      Consolidation plans under the budget for FY 2010–11/FY 2014–15 remained

### 26.      Consolidation plans under the budget for FY 2010–11/FY 2014–15 remained

### Consolidation plans and fiscal profile
- Consolidation plans under the budget for FY 2010–11/FY 2014–15 remained largely unchanged following the Update of Economic and Fiscal Projections, though the pending withdrawal is now less frontloaded.
- Profile changes:
  - Slightly smaller deficit in FY 2010–11 (by 0.1 percent).
  - Marginally worse deficits in outer years (by around 0.35 percentage points of GDP from FY 2011–12 through FY 2013–14).
- Drivers of revisions:
  - Upward revisions to near-term revenues since March.
  - Recent changes to Employment Insurance (EI) program funding.
  - Downward revisions to real GDP growth in 2010 and 2011 from a worsened global scenario.
  - Accounting adjustments that pushed up slightly the fiscal deficit for 2009–10 (see note 13).
- Structural implications:
  - Accounting adjustments largely contribute to a bigger fiscal withdrawal in 2010 but a slightly smaller withdrawal in 2011 than anticipated in the March Budget at both the federal and general government levels.
  - Authorities now expect to balance the budget by FY 2015–16 with a slight surplus (0.1 percent of GDP).

### Fiscal down payment, fiscal impulse, and timing of adjustment
- Staff estimates:
  - Fiscal down payment for FY 2011–12 at about ¾ percentage point of GDP at the federal level.
  - About ⅓ of a percentage point of GDP per year in subsequent years up to FY 2014–15.
- On a calendar year basis:
  - Change in the structural balance, at a general government level, amounted to 1.1 percentage points of GDP in 2011.
  - Overall adjustment of 2 percentage points of GDP through 2015.
- Mission view:
  - Given heightened risks to the outlook, a smoother adjustment could have been contemplated.
  - Government measures that move toward smoothing:
    - Delay hikes in the EI premium until after 2011.
    - Allow flexibility in funding ongoing infrastructure projects.

### Numerical fiscal impulse and related tables (selected figures preserved)
- General Government (Calendar year, NA basis) — Fiscal impulse, Pre and Post Update:
  - Pre-Fiscal Update: 2009 3.2; 2010 0.1; 2011 -1.3; 2012 -0.3; 2013 -0.4; 2014 -0.6; 2015 -0.5
  - Post-Fiscal Update: 2009 3.3; 2010 1.3; 2011 -1.1; 2012 -0.5; 2013 -0.5; 2014 -0.5; 2015 -0.4
  - Change in Impulse between Pre and Post Update: 0.0; 1.2; 0.3; -0.2; 0.0; 0.1; 0.1
- Federal Government (Fiscal year, PA basis) — Fiscal impulse and contributions:
  - Pre-Fiscal Update: 2009/10 2.0; 2010/11 0.3; 2011/12 -1.0; 2012/13 -0.3; 2013/14 -0.3; 2014/15 -0.2; 2015/16 -0.2
  - Post-Fiscal Update: 2009/10 2.3; 2010/11 (blank in table) -0.3; 2011/12 -0.8; 2012/13 -0.3; 2013/14 -0.3; 2014/15 -0.4; 2015/16 -0.2
  - Post-Fiscal Update (without accounting change): 2.0; 0.3; -0.9; -0.4; -0.3; -0.4; -0.2
  - Change in Impulse between Pre and Post Update: 0.3; -0.6; 0.2; 0.1; 0.0; -0.1; 0.0
  - Of which due to accounting change: 0.4; -0.6; 0.1; 0.1; 0.0; 0.0; 0.0
  - Other (incl. E.I. Premium reduction): 0.0; 0.0; 0.1; 0.0; 0.0; -0.1; 0.0
- Provincial Governments (Calendar year, NA basis) — Adjustment: 2009 -0.3; 2010 1.7; 2011 0.1; 2012 -0.3; 2013 0.0; 2014 0.2; 2015 0.1

### Flexibility to respond to downside risks
- Fiscal policy space:
  - Room exists to respond should downside risks materialize.
  - Possible responses discussed:
    - Front-loading infrastructure spending planned under Building Canada (scheduled to imply outlays equal to about ⅓ percent of GDP per year for FY 2010–11 up to FY 2013–14).
    - Bringing forward corporate income tax (CIT) cuts planned over the next 2 years.
      - Staff estimate: a ½ percentage point decrease in the CIT rate reduces revenues by roughly 0.1 percent of GDP.
- Authorities committed to revisit plans if the outlook deteriorates sufficiently.

### Cementing fiscal stabilization — comparative standing and plan credibility
- International perspective:
  - Canada’s overall fiscal outlook post-crisis stands out as among the best in the G-20.
  - Net debt is the lowest in the G-7, reflecting an 11-year string of federal surpluses prior to the crisis.
  - Canada’s combined federal-provincial budget shortfall and projected net debt accumulation between 2007 and 2015 are among the lowest of the group.
  - Projected general government budgetary position for 2015 is the best in the G-7 after Germany.
- Selected fiscal indicators (G-20 excerpt preserved):
  - Debt increase, 2007-2015: 38.0; 11.9; 14.9; 40.0; 48.6 (selected entries as in table)
  - 2010 Net Debt, percent GDP: 69.5; 5.4; 33.4; 68.8; 65.8
  - 2015 Projected General Government Fiscal Balance, percent GDP: -4.6; 0.7; -1.6; -2.4; -6.5
- Mission assessment:
  - Supported authorities’ aim to return to balance over the medium term, given long-term costs of aging and healthcare.
  - Plan centered on bold reduction of non-transfer government payments while protecting major transfers to persons and other levels of government.
  - Budget envisions no hikes in taxes on consumption or personal or corporate income.
  - Spending restraint plans imply zero real future program spending growth to return spending to historically low pre-crisis ratio to GDP.
    - At the federal level, total program spending growth under the Update is expected to average 2.3 percent per annum starting in FY 2012–13, well below recent trend rate of about 7 percent per year.

### Risks to medium- and long-term sustainability and policy recommendations
- Key long-term risks:
  - Population ageing and health-care inflation pose significant risks to fiscal sustainability.
  - Public debt charges are sensitive to interest rate assumptions; Budget 2010 estimates a sustained increase in the yield curve by 100 basis points decreases the budgetary balance by CAD 1 billion in the first year, CAD 2.1 billion in the second year and CAD 3.0 billion by the fifth year (implying a cumulative total impact on the federal balance of about -0.3 percentage points of GDP).
  - Parliamentary Budget Officer projections (using a gross effective interest rate around 7 percent from FY 2013–14 onwards) indicate federal net debt-to-GDP ratio climbs from about 33¾ percent in FY2013–14 to 100 percent of GDP in 2050–51, reaching 365 percent of GDP by FY 2084–85; lower debt charge assumptions (around 5 percent) halve the projected debt-to-GDP ratio by the end of the horizon though it remains sizeable.
- Recommendations and options:
  - Increase transparency and communication about long-run fiscal challenges to foster public debate and awareness.
  - Develop arrangements for provinces to share experiences in managing health-care costs and realizing efficiency gains, potentially in the context of renewing federal transfers (current arrangements expire on April 1, 2014).
  - Consider additional measures if program spending restraint proves difficult to implement, including restraining growth in transfers to provinces or enhancing revenues (including tax increases).

### Growth-friendly adjustment and structural measures
- Budget 2010 measures intended to boost productivity and long-run growth potential:
  - Reduce marginal effective tax rates on capital accumulation.
  - Strengthen infrastructure.
  - Eliminate all remaining tariffs on manufacturing inputs and machinery and equipment.
- Other suggested priorities to boost growth potential:
  - Phase out restrictions on foreign direct investment.
  - Increase flexibility of the immigration system.
  - Continue eliminating interprovincial barriers to trade in goods and labor mobility.

### Provincial fiscal positions
- Provincial trends and policies:
  - Crisis led to deterioration of provincial fiscal positions with significant variation across provinces.
  - Provinces east of Manitoba saw substantial increases in deficits and debt; Ontario has the largest deficit.
  - Québec and Nova Scotia have smaller deficits but higher debts.
  - Western provinces have lower debt burdens; resource royalties helped cap deterioration.
  - Provincial measures to reduce shortfalls include caps on spending growth, freezing salaries, curbing health care expenditure (e.g., facilitating lower generic drug prices, increasing health system efficiency, establishing hospital accountability systems).
  - Provinces also plan revenue measures, notably hikes in indirect taxes, excises and utilities rates.

### Financial regulation, stability record, and emerging risks
- Strengths of Canadian financial stability framework:
  - Strong regulation with a prudent leverage ratio that includes off-balance-sheet exposures.
  - Low reliance on wholesale funding due to robust retail deposit base.
  - Well regulated mortgage market with incentives for low loan-to-value (LTV) ratios and comprehensive mortgage insurance coverage.
    - Most securitized loans and those with LTVs above 80 percent made by regulated depository institutions (75 percent prior to April 2007 must be insured for the full amount).
  - Consolidated supervision of wholesale and retail banking activities.
  - Effective cooperation among authorities via forums such as the Financial Institutions Supervisory Committee and Senior Advisory Group.
- Regulatory capital (selected table entries preserved):
  - Total Regulatory Capital (Canada): 2006 12.5; 2007 12.1; 2008 12.2; 2009 14.7; 2010Q2 15.4
  - Tier 1 Capital (OSFI): 2006 10.4; 2007 9.9; 2008 9.9; 2009 11.3; 2010Q2 12.9
- Remaining risks and supervisory priorities:
  - Elevated household debt and potential housing market correction.
    - Debt-service ratios contained by low interest rates but would rise as rates normalize.
    - Bank of Canada stress tests show proportion of households with debt service ratio exceeding 40 percent could rise from 5 percent in 2010Q1 to 7.4 percent by 2012Q2 under assumed interest rate and credit scenarios.
    - About two thirds of mortgages are insured; origination practices are prudent; CMHC contingent liabilities could impose fiscal pressures in a worst-case housing correction.
    - CMHC insurance in force at year-end 2009 amounted to CAD$473 billion with CAD$1.3 billion set aside for expected claims and related settlement expenses, and CAD$6.7 billion in unearned premiums and fees covering potential future claims.
  - Significant exposures to U.S. markets (118 CAD billion as of March 2010 according to the BIS) that could be pressured by a double-dip recession.
  - Limited direct exposure to stressed European sovereign debt so far, but contagion scenarios could pose larger risks.
- International regulatory changes and Canada’s stance:
  - Authorities support stronger international capital and liquidity standards and see substantial net benefits from Basel Committee measures.
  - Caution urged in implementing G-20 commitments on standardized OTC derivatives to avoid unintended consequences for smaller jurisdictions’ access to central counterparties.
  - Authorities did not favor a global financial sector levy and prefer countercyclical capital buffers and contingent capital over capital surcharges for systemic institutions.
  - Emphasis on improving cross-border resolution and active involvement in international committees.
  - Staff view: emergent regulatory standards do not pose high hurdles for the Canadian financial system given high regulatory requirements.

*Source: IMF staff report excerpt as provided.*

### 37.       The mission saw continued progress toward establishing a national securities

### The mission saw continued progress toward establishing a national securities

### National securities regulator and financial stability
- Continued progress toward establishing a national securities regulator was observed; the Transition Office was working with the participation of 10 provinces and territories toward the mid-2012 deadline for launch.
- Authorities agreed the national regulator should have a stability mandate and work closely with other relevant national authorities on financial stability issues.
- The creation of a national securities regulator will bridge potential gaps in supervision and regulation of essentially national markets and bring securities regulation into national coordinating initiatives for promoting financial stability.

### Economic recovery and monetary policy
- The Canadian economy exited the crisis on a strong footing after extraordinary monetary and fiscal stimuli: policy rates cut to virtually zero, emergency liquidity facilities launched, and timely, targeted and temporary fiscal injections by federal and provincial governments.
- Recovery drivers highlighted: firm commodity prices, resilience of the financial system, Bank’s inflation targeting regime, and prudent fiscal planning.
- Incoming data indicated a slowdown in the pace of expansion in recent months, with a deceleration in Q2 2010 amid slowing global demand and a strengthening Canadian dollar; household spending growth eased and the housing market cooled.
- Recommendation: Monetary policy should remain highly accommodative absent inflationary pressures; a pause in the Bank’s interest rate hike will support growth against fiscal withdrawal and avoid undue upward pressure on the currency. With rates now above zero, monetary policy has room to respond if conditions warrant.
- Regulation should continue to serve as the first line of defense for dealing with emergent financial imbalances.

### Fiscal stance, medium-term consolidation, and long-term challenges
- The government’s course to fiscal balance over the medium term is appropriate; it would put net debt-to-GDP on a downward trajectory from already low levels, maintaining Canada’s standing as the strongest fiscal position in the G-7.
- The fiscal plan includes growth-friendly measures: infrastructure spending and cuts in the corporate income tax rate; federal general corporate income tax rate legislated to decline from more than 22 percent in 2007 to 15 percent in 2015.
- Restraint in health care spending is identified as essential for long-run fiscal stability given population ageing and health-care inflation.
- Medium-term consolidation plans are appropriately ambitious; if freezing program spending in inflation-adjusted terms proves difficult, alternatives include restraining program spending (notably transfers to provinces) or enhancing revenues.
- If downside risks materialize, fiscal policy has room to respond, including providing additional fiscal support for labor markets, bringing forward infrastructure spending under the Building Canada program, and frontloading planned cuts in corporate income taxes.
- The near-term budgeted adjustment is substantially front-loaded; smoothing options (recent proposals) include reducing the rise in EI premia and allowing some flexibility around deadlines for unfinished infrastructure projects.

### Financial system resilience and regulatory reform
- Canada’s financial system maintained the ability to intermediate funds during the crisis and avoided systemic strains evident elsewhere.
- Although measures of financial stress such as arrears and nonperforming loans have risen, they remain at modest levels, and capitalization is strong by international comparison.
- Contributing factors to resilience: well-regulated mortgage market, limited reliance on wholesale funding, consolidated supervision of commercial and investment banking activities, a conservative leverage ratio, close cooperation among financial stability entities, and high prudential standards.
- Ongoing priorities: continued stress-testing for downside risk scenarios; authorities have tightened mortgage standards in 2008 and early 2010.
- Transition to Basel III framework should be smooth given already high requirements and sound bank balance-sheet positions.
- Going forward emphasis: strengthening infrastructure for OTC derivatives markets, improving the resolution mechanism via contingent capital, and calibrating macroprudential tools such as countercyclical capital buffers.

### Key medium-term projections and fiscal indicators (selected figures preserved exactly as in source)
- Real GDP (projections, selected years): 2010: 3.0; 2011: 2.3; 2012: 2.7; 2013: 2.4; 2014: 2.4; 2015: 2.2 (Table 3: "Real GDP2.20.5-2.53.02.32.72.42.42.2"—projections span 2007–2015 as presented).
- Output gap (in percent of potential output): 2007: 1.7; 2008: 0.1; 2009: -3.8; 2010: -2.5; 2011: -2.0; 2012: -1.2; 2013: -0.7; 2014: -0.3; 2015: 0.0.
- Unemployment rate (percent): 2007: 6.0; 2008: 6.2; 2009: 8.3; 2010: 8.1; 2011: 7.9; 2012: 7.4; 2013: 7.0; 2014: 6.6; 2015: 6.1.
- CPI inflation: 2007: 2.1; 2008: 2.4; 2009: 0.3; 2010: 1.7; 2011: 2.0; 2012: 1.9; 2013: 2.0; 2014: 2.0; 2015: 2.0.
- Three-month treasury bill (percent): 2009: 0.4; 2010: 0.6; 2011: 1.4; 2012: 2.7; 2013: 3.6; 2014: 4.2; 2015: 4.3 (Table 3 / Table 4 memorandum items).
- Federal government budgetary balance (fiscal years, in billions): 2009/10: -55.6; 2010/11: -49.7; 2011/12: -33.6; 2012/13: -26.4; 2013/14: -18.3; 2014/15: -10.1; 2015/16: -5.4.
- General government (NA basis) balance (in percent of GDP): 2009: -5.5; 2010: -6.1; 2011: -4.6; 2012: -3.6; 2013: -2.9; 2014: -2.1; 2015: -1.6.
- Gross public debt (OECD Consistent, percent of GDP): 2009: 82.5; 2010: 84.0; 2011: 84.8; 2012: 84.4; 2013: 83.4; 2014: 81.9; 2015: 80.1.
- Current account balance (in percent of GDP): 2007: 0.8; 2008: 0.4; 2009: -2.8; 2010: -3.1; 2011: -3.5; 2012: -3.3; 2013: -3.2; 2014: -2.9; 2015: -2.4.
- Net international investment position (mem. item): 2007: -8.5; 2008: -1.9; 2009: -10.0; 2010: -12.3; 2011: -14.9; 2012: -17.2; 2013: -19.2; 2014: -20.9; 2015: -22.1.

### Structural reform and competitiveness notes
- Canada has the lowest overall tax rate on new business investment in the G-7 in 2010 following elimination of general capital taxes and reductions in corporate income tax rates.
- Budget 2010 measures: creation of a Red Tape Commission; elimination of all tariffs on machinery and equipment and manufacturing inputs.
- Staff assessment: significant progress on tax competitiveness; however, progress is needed on Competition Policy Review Panel recommendations, reducing interprovincial barriers, and liberalizing FDI, particularly in telecommunications, broadcasting and air transport.
- Canada is taking steps toward establishing a Canadian Securities Regulator by 2012 and committed to implementing Competition Policy Review Panel recommendations.

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

*IMF staff report excerpt as provided in the source content.*

### Box 1. How Vulnerable is Canada’s Housing Market?

### Box 1. How Vulnerable is Canada’s Housing Market?

### Current developments
- Residential real estate cycle may have reached its peak: sales volumes fell as summer moved in and the pace of price increases moderated.
- Residential investment in 2010 Q2: +1.3 percent, effectively stalled as a drop off in renovation activity offset a sharp 30 percent gain in new homebuilding.
- Decline in renovation activity largely linked to the expiration of the Federal Home Renovation tax credit.

### Indicators of vulnerability and model estimates
- Price-to-income and price-to-rent ratios remain 1 standard deviation above historical averages.
- Staff’s model-based estimates from the Early Warning Exercise (EWE) and Vulnerability Exercise for Advanced Countries (VEA) suggest an overvaluation around 13 percent, exceeding the 10 percent threshold used.
- The EWE real estate model combines these three indicators to create a heat map for house price valuation.
- Predicted path of house prices based on WEO income projections suggests a decline of almost 6 percent through 2015.

### Comparative position and broader vulnerability assessment
- These indicators place Canada among advanced countries where a house price correction is most likely to take place.
- The point estimate for the house price disequilibrium is not large by historical standards.
- Canada ranks 7th among 22 advanced economies in the VEA sample in terms of potential overvaluation.
- Other components of residential real estate vulnerability—potential impact on GDP, household balance sheets, and mortgage market characteristics—remain moderate or low in Canada compared to other advanced economies.

### Risks related to mortgage structure
- Most mortgages are rollover mortgages with terms of at most five years, implying exposure to future interest rate increases.
- CAAMP reports mortgage term distribution: 66 percent of mortgage borrowers reported having a term of four to five years; just 8 percent have terms of more than 5 years, and the remaining borrowers (26 percent) have terms of less than 5 years.

### Policy-relevant implications
- Downside risks to house prices are signaled by valuation metrics and model-based overvaluation estimates (13 percent > 10 percent threshold).
- Given the prevalence of short-term rollover mortgages, any future interest rate increases could put additional strains on already highly indebted households.
- Monitoring of renovation- and new-building dynamics, mortgage market term structure, and indicators used in the EWE/VEA models is important for early detection of stress.

*Source: Box 1. How Vulnerable is Canada’s Housing Market? (content as provided).*

### 2.4 p ercen t

### 2.4 percent

### Growth outlook and surveys
- October Consensus for 2011: 2.4 percent.
- Canada: October Surveys — Deviation from Mean (Percentage points) shown in ranges including 0, 0.1, 0.2, 0.3 and scale from -2.25 to 2.25.
- United States: October Surveys — Deviation from Mean (Percentage points) shown similarly.
- Narrative findings:
  - "Growth picked up strongly in late 2009, but is now moderating..."
  - "...as real GDP is back at pre-crisis levels held up by consumer and government spending."
  - "The housing sector is slowing and expected to cool further with jobs shifting away from construction..."
  - "...as housing starts are expected to fall."
  - "Consensus points to above trend growth in Canada... but risks of a slow recovery in the U.S. are mounting."
- Sources: Haver Analytics, IMF World Economic Outlook, Consensus Forecasts, and Fund staff projections.

### Monetary policy and interest rates
- Business lending rates, mortgage interest rates, and real interest rate measures are presented across time series (1/1/2006 to 1/1/2010 and 1/1/2000 to 1/1/2010 scales).
- Observations:
  - "Mortgage rates remain accommodative..."
  - "...as well as business lending rates."
  - "...with long-term rates closely influenced by U.S. developments."
  - "The yield curve partly reflects Canada's higher policy rate in the short-term and its stronger fiscal position over the long run compared to the U.S...."
  - "The Bank of Canada's monetary withdrawal is cautious..."
  - "...as monetary policy remains very accommodative..."
- Specific plotted elements and labels in figures (no numerical series extracted beyond labels):
  - Prime Business Loan Rate (Last Wed, %)
  - Prime Corporate Paper: 3M (AVG, %)
  - 5-Yr Conventional Mtg; 1 Yr Conventional Mtg
  - 3-month OIS spread, real policy rate based on CPIX
  - Yield curves: "Current United States", "Current Canada", "United States", "Canada"
  - Long-term yields: "Canada 10Y Benchmark Yield", "United States 10Y Treasury Yield"
  - Taylor Rule Implied Rate versus Actual Target for the Overnight Rate; Cumulative Annual Changes in Policy Rates (Percentage Points)

### Fiscal policy and consolidation
- 2010/2011 Net Debt vs. Deficit (Percent of GDP) and Net Debt by Province (Percent of GDP) shown (labels include Fed, BCA, BONQ, C, Fed+Pro, G20 Adv).
- Federal Budget Balance Forecasts (Percent of GDP) across years: 2010/11, 2011/12, 2012/13, 2013/14, 2014/15, 2015/16 include multiple projections (Fiscal Update, Staff projection, PBO).
- PBO Long-run Forecasts: timelines 2000 to 2084 with series for Real GDP Growth (left) and Debt/GDP, baseline (right).
- Fiscal Update 2010 Projected & Historical Annual Growth Rate in PIT Revenues (Percent) with series points for 2009/10, 2011/12, 2013/14, 2015/16; labels include "PIT Proj. Growth Rate" and "Historical Average Growth, 1998-2007".
- Fiscal Update 2010 Projected and Historical Expenditure Annual Growth Rate in TPS and CHST (Percent) with series for 2009/10 through 2015/16; labels include "TPS Proj. Growth Rate", "TPS Historical Average Growth, 1996-2007", "CHST Proj. Growth Rate", "CHST Historical Average Growth, 1996-2007".
- Narrative findings:
  - "Federal and provincial fiscal indicators are well below the advanced countries..."
  - "...although some provincial debts are sizeable."
  - "Staff's fiscal forecast is slightly more gloomy than Fiscal Update 2010 in the near-term."
  - "Canada also faces strong fiscal headwinds in the long-term amid an aging population and rising healthcare costs."
  - "A 'Plan B' for medium-term consolidation would help... if the return to balance goes off track given the Fiscal Update's strong assumptions on spending restraint."
  - International comparisons shown: Net Debt, 2009 (Percent of GDP) with country codes NOR NZL AUS CAN GRB DEU FRA USA ITL and Gross Debt, 1990-2009 (Percent of GDP) with series for G7 Avg ex. CAN, USA, CAN.
  - "Canada's debt position is enviable in international comparisons... following an 11 year consolidation path."

### Financial markets
- Interest rates and spreads time series include Overnight rate, CA Libor, OIS spread vs. 3m Canadian LIBOR.
- Canada High Yield Spreads vs. 10 Yr Treasury Rate (Basis points) vs. United States series shown across 4/30/2002 to 10/31/2009.
- Equity and volatility indices:
  - S&P TSX Composite Index, S&P TSX Small Cap Index, S&P TSX Financials Index (Index = 100, 6/04/2007).
  - S&P/TSX Composite and VIX; Bank of Montreal Volatility Index (Index = 100, 06/04/2007).
  - Note: "S&P/TSX Composite is the rolling 10 day standard deviation."
- Corporate bond issuance and interbank market indicators:
  - "The interbank market is calmer after a spate of tension in the second quarter..."
  - "...as well as the corporate bond markets with respect to crisis levels..."
  - "...as equity markets rose from the trough but are still below pre-crisis levels..."
  - "...after a volatility spike was reabsorbed."
  - "Banks are increasingly issuing on the bond markets..."
- Credit growth:
  - "Credit to households is growing fast amidst some uncertainty while credit to business is still feeble."

### Banking sector performance and vulnerabilities
- Bank capitalization and profitability charts include:
  - CAN Tier 1 Capital Ratio and comparators (FRA, GER, ITL, GBR, USA).
  - Return on assets, Provisions/Assets, Taxes/Assets, NPL/Assets.
- Deposits, loans, and loan composition:
  - Canada: Loans/Assets and Canada: Deposits/Assets (Percent of assets) with comparators for US.
  - Loan Composition categories: Consumer, Mortgages, C&I, Other, Securities (Percent of assets).
- Nonperforming loans and provisioning:
  - Provisions lag behind nonperforming loans which "have increased less than elsewhere..."
  - "Provisions are lagging behind nonperforming loans that have increased less than elsewhere... and are largely explained by the business sector."
  - For "other including business nonperforming loans, rise appears to mainly reflect deterioration in US loan portfolio, particularly on acquired assets."
- Summary observations:
  - "Banks are well capitalized and... their profitability is on an upward trend together with provisions."
  - "Deposits and loans are expanding... loans to households in particular."
  - "Provisions are lagging behind nonperforming loans that have increased less than elsewhere... and are largely explained by the business sector."

### Corporate issuance, household balance sheet, and indebtedness
- Firms:
  - Firm Profitability (Return on Equity, Debt/Equity) series from Mar-00 to Mar-10 show improvement: "Firms' profitability rebounded ... as well as bond issuance ..."
  - Corporate Issuance (Gross, Net) in Billions of Canadian dollars for Jan-06 to Jan-10.
  - Business Credit Conditions (Balance of opinion) show pricing and non-pricing conditions with positive values indicating tightening, negative values indicating easing.
- Households:
  - Household Balance Sheet (Percent of disposable income) series for Total liabilities, Total assets, Net worth across 1990–2010; labels include Total liabilities, Total assets, Net worth.
  - Household Assets composition (Percent of disposable income): Other financial, Corporate equities, Other tangible, Real estate across 1990–2010. Narrative: "Households' net worth is ramping up ... especially in real estate..."
  - Household Liabilities (Percent of disposable income): Other household liabilities, Consumer credit, Mortgages, Total household liabilities across 1990–2010. Narrative: "...matched by an increase in mortgage and consumer debt."
  - Overall: "Firms' profitability rebounded ... while business credit conditions continue to ease. Households' net worth is ramping up ... matched by an increase in mortgage and consumer debt."

*Prepared by Western Hemisphere Department (In consultation with other departments), November 24, 2010 — Staff Report for the 2010 Article IV Consultation: Informational Annex.*

### ANNEX I. CANADA—FUND RELATIONS

### ANNEX I. CANADA—FUND RELATIONS (As of October 31, 2010)

### Membership and Fund Accounts
- Membership status: Joined 12/27/1945; Article VIII.
- General Resources Account (Million of Quota):
  - Quota: 6,369.20 (100.00 percent)
  - Fund holdings of currency: 5,025.80 (78.91 percent)
  - Reserve position in Fund: 1,343.48 (21.09 percent)
  - Lending to the Fund: 449.25
- SDR Department:
  - Net cumulative allocation: 5,988.08 (100.00 SDR million; Percent Allocation)
  - Holdings: 5,878.06 (98.16 SDR million; Percent Allocation)
- Outstanding Purchases and Loans: None.
- Financial Arrangements: None.
- Projected Obligations to Fund (SDR Million; based on existing use of resources and present holdings of SDRs):
  - 2010: Principal — (not listed); Charges/Interest — 0.09; Total — 0.09
  - 2011: Principal — (not listed); Charges/Interest — 0.49; Total — 0.49
  - 2012: Principal — (not listed); Charges/Interest — 0.49; Total — 0.49
  - 2013: Principal — (not listed); Charges/Interest — 0.49; Total — 0.49
  - 2014: Principal — (not listed); Charges/Interest — 0.49; Total — 0.49

### Exchange Rate and Article IV Consultations
- Exchange rate arrangements:
  - The authorities maintain a “free floating” exchange rate regime.
  - Regime is free from exchange restrictions and multiple currency practices.
  - Authorities may intervene to maintain orderly conditions in the exchange market.
  - No taxes or subsidies on purchases or sales of foreign exchange.
  - Canada has accepted the obligations of Article VIII, Sections 2, 3, and 4 (a).
  - Canada maintains exchange restrictions for security reasons, based on UN Security Council Resolutions, notified to the Fund (most recently in December 2007) under Executive Board Decision No. 144-(52/51).
- Article IV consultation history and 2010 mission:
  - Last Article IV Consultation considered by the Executive Board on May 11, 2009 (IMF Country Report No. 09/162). Canada is on a 12-month consultation cycle.
  - 2010 Article IV discussions conducted in Ottawa and Toronto from October 12–21; concluding meeting in Ottawa on October 27; press conference held October 28.
  - Mission team: C. Kramer (head), N. Batini, G. Bin Li (all WHD), F. Columba (MCM); advance mission led by Ms. Batini; Ms. Tsounta participated from headquarters; Mr. Purves (Senior Advisor) attended; Mr. Eyzaguirre (WHD) and Mr. Hockin (Executive Director) participated in concluding meeting with Minister of Finance Flaherty and Bank of Canada Governor Carney.

### Findings from Financial and Standards Assessments (FSSA, ROSC, FATF)
- Canada–Financial System Stability Assessment (FSSA) — Volume II: Report on Observance of Standards in the Financial System (summary):
  - Conclusion: Canada has a stable and highly advanced financial system, among the soundest in the world, supported by a well-developed regulatory system with a high degree of compliance with major international standards.
  - Recommendations (most already addressed):
    - 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 deemed not suitable—brought Canada into broad compliance with the Basel Core Principles.
    - Make significant progress in harmonizing securities regulation and improving coordination among provincial securities regulators, including through the Canadian Securities Administrators; a Senate commission was created to develop recommendations on harmonization and streamlining.
- Canada: Report on the Observance of Standards and Codes—Fiscal Transparency Module (IMF Country Report No. 02/51, 03/12/02) (summary):
  - Fiscal management meets the requirements of the fiscal transparency code; in some instances represents best practice (notably use of private sector economic forecasts).
  - Areas for improvement identified (many subsequently addressed):
    - Timely, current year estimates of federal and provincial budgets on a comparable basis.
    - Comprehensive account of procedures for the budget cycle and expenditure management.
    - Systematic reporting of the use of reserves for non-economic contingencies.
    - Resumption of publication of reconciled national and public accounts forecasts of major aggregates.
    - Publication by all governments of quasi-fiscal activities.
  - Actions taken: release by Statistics Canada of consolidated data for federal and provincial budgets for 2001–02; publication of comprehensive budget and expenditure management procedures; publication of reconciled national and public accounts forecasting.
- Canada: Report on the Observance of Standards and Codes—Data Module (IMF Country Report No. 03/328, 10/23/03) (summary):
  - Macroeconomic statistics are comprehensive, timely, and accurate; adequate for effective surveillance.
  - Institutional frameworks protect confidentiality and ensure quality assurance; compilers follow internationally accepted guidelines.
  - Recommendations (priorities, most being addressed):
    - Articulate roles of Statistics Canada and the Bank of Canada in producing financial sector statistics and explore more data sharing of monetary and financial statistics.
    - Estimate consumption of fixed capital at replacement cost rather than historic costs for the corporate sector in the CSNA.
    - Disseminate information on sources and methods used in compiling quarterly public sector statistics for the quarterly CSNA.
    - Reclassify certain transactions to conform with BPM5.
- Canada: Report on the Observance of Standards and Codes—FATF Recommendations for AML/CFT (IMF Country Report No. 08/372, 12/11/08) (summary):
  - 2007 FATF evaluation identified shortcomings in customer due diligence scope, AML/CFT supervision, and the Canadian financial intelligence unit.
  - Since then, steps taken have led to significant improvements.
- Canada: Financial System Stability Assessment—Update (IMF Country Report No. 08/59, 02/13/08) (summary):
  - Conclusion: Financial system mature, sophisticated, well-managed; financial stability underpinned by sound macro policies and strong prudential regulation, deposit insurance, crisis management and failure resolution arrangements.
  - Banking system appeared sound; stress tests indicated major banks could withstand sizeable shocks, despite challenges from global turmoil starting mid-2007.
  - Concerns about banks expanding into highly competitive foreign markets or complex activities.
  - Reiterated advantages of a single securities regulator; noted improvements from creation of the Canadian Securities Administrators and the passport system.

### Statistical and Data Quality Issues
- Overall: Quality, coverage, periodicity, and timeliness of Canada’s economic data are considered excellent for Article IV consultation and ongoing surveillance.
- Canada has subscribed to the Fund’s Special Data Dissemination Standard (SDDS); metadata posted on the Fund’s DSBB. Data ROSC published October 23, 2003.
- Real sector:
  - Statistics Canada provides timely monthly, quarterly, and annual data.
  - In May 2001, transitioned from Laspeyres to Fisher index formulae for real expenditure-based GDP.
- Fiscal sector:
  - Statistics Canada provides quarterly consolidated general government data following GFSM 2001.
  - Department of Finance Canada provides monthly and annual federal budget and policy data.
- Monetary sector:
  - Bank of Canada provides timely daily, weekly, monthly, and quarterly monetary data.
- External sector:
  - Statistics Canada provides quarterly balance of payments, external debt, and IIP data.
  - Finance Canada provides monthly Official International Reserves data in a format comparable to the IMF’s reserve data template.
- Table of Common Indicators Required for Surveillance (selected entries and data quality assessments):
  - Exchange Rates: Date of latest observation — Same day; Frequency of Data — D; Data Quality – Methodological soundness — (not separately listed in excerpt).
  - International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Date of latest observation — Oct 20, 2010; Date received — Oct 25, 2010; Frequency of Data — W; Frequency of Reporting — W; Frequency of Publication — W.
  - Reserve/Base Money: Date of latest observation — Oct 2010; Date received — Oct 2010; Frequency — W; Reporting — W; Publication — W.
  - Broad Money: Date of latest observation — Sep 2010; Date received — Oct 2010; Frequency — M; Reporting — M; Publication — M; Data Quality – Methodological soundness — LO, O, LO, LO; Data Quality – Accuracy and reliability — O, O, O, O, O.
  - Consumer Price Index: Date of latest observation — Sep 2010; Date received — Oct 2010; Frequency — M; Reporting — M; Publication — M; Data Quality – Methodological soundness — O, O, O, O; Data Quality – Accuracy and reliability — O, O, O, O, NA.
  - GDP/GNP: Date of latest observation — 2010 Q2; Date received — Sep 2010; Frequency — Q; Reporting — Q; Publication — Q; Data Quality – Methodological soundness — O, O, O, LO; Data Quality – Accuracy and reliability — O, O, O, O, O.
  - External Current Account Balance: Date of latest observation — 2010 Q2; Date received — Oct 2010; Frequency — Q; Reporting — Q; Publication — Q.
  - Gross External Debt & International Investment Position: Date of latest observation — 2010 Q2; Dates received — Aug 2010 (Gross External Debt) and Oct 2010 (IIP); Frequency — Q; Reporting — Q; Publication — Q.

### 2010 Article IV Consultation — Background, Assessment, and Executive Board Views (Public Information Notice No. 10/161, December 22, 2010)
- Background and macroeconomic assessment:
  - Canada weathered the global recession well due to a strong starting position and a sizeable macro policy response.
  - Fiscal stimulus totaled about 4 percent of one year’s GDP over two years.
  - Robust growth in late 2009 and early 2010; labor markets strong — Canada and Germany virtually recouped recession employment losses by mid-2010; first to record year-over-year increases in employment by the first quarter of 2010.
  - During recovery, the current account deficit expanded due to brisk import growth, subdued U.S. exports, and an appreciating Canadian dollar.
  - Financial system avoided systemic pressures; financial markets largely recovered; overall financial conditions accommodative.
  - Recovery moderating; outlook uncertain with downside risks from stretched household balance sheets and weaker U.S. outlook.
  - Inflation contained; core inflation around middle of Bank of Canada’s control range.
- Policy stance:
  - Monetary policy: tightening paused after rate increases between June and September that brought the overnight rate to 1 percent; further hikes put on hold.
  - Fiscal policy: authorities tabled a return to budgetary balance over the medium term with an ambitious, growth-friendly plan while delivering the last year of stimulus; near-term adjustment smoothed by extending deadline for Economic Action Plan infrastructure projects by seven months (to October 31, 2011).
- Financial stability:
  - Financial system resilient; soundness indicators strong.
  - Near-term risks increased from household balance sheets and U.S. exposures.
- Executive Board Assessment (key points):
  - Commended authorities for credible macro framework, strong crisis response, and resilient financial system.
  - Recovery moderating; risks increased; recommended maintaining prudent, far-sighted policies and strengthening productivity and competitiveness.
  - Supported Bank of Canada’s decision to hold further rate increases; accommodative monetary stance appropriate; monetary policy retains room for stimulus if needed.
  - Welcomed authorities’ aim to return to fiscal balance over the medium term to put net debt-to-GDP on a downward trajectory; consolidation includes growth-friendly measures (infrastructure spending and cuts in corporate income tax); additional measures may be needed if program spending restraint is insufficient.
  - Noted importance of restraining growth in health-care spending over the longer run; encouraged increased communication and provincial sharing of cost-management experience.
  - Welcomed recent moves to reduce near-term rise in employment insurance premia and flexibility in infrastructure deadlines as appropriate smoothing of fiscal adjustment.
  - Emphasized continued vigilance on household debt risks and financial institutions’ U.S. exposures.
  - Observed Canada is well positioned to adapt financial regulatory framework to emerging international initiatives; further progress toward national securities regulation is an essential enhancement.

### Canada: Selected Economic Indicators (Annual change in percent, unless otherwise noted) — Data as available on November 18, 2010
- Projections shown for 2010 and 2011. (Table entries follow.)
  - Real GDP: 2005: 3.0; 2006: 2.8; 2007: 2.2; 2008: 0.5; 2009: -2.5; 2010: 3.0 (Proj.); 2011: 2.3 (Proj.)
  - Net exports 2/: 2005: -1.6; 2006: -1.4; 2007: -1.5; 2008: -1.9; 2009: 0.2; 2010: -2.1 (Proj.); 2011: -0.7 (Proj.)
  - Total domestic demand: 2005: 5.0; 2006: 4.4; 2007: 3.9; 2008: 2.5; 2009: -2.6; 2010: 5.1 (Proj.); 2011: 3.0 (Proj.)
  - Final domestic demand: 2005: 4.4; 2006: 4.6; 2007: 4.0; 2008: 2.8; 2009: -1.8; 2010: 3.9 (Proj.); 2011: 2.7 (Proj.)
  - Private consumption: 2005: 3.7; 2006: 4.2; 2007: 4.6; 2008: 2.9; 2009: 0.4; 2010: 3.3 (Proj.); 2011: 2.5 (Proj.)
  - Public consumption: 2005: 1.4; 2006: 3.0; 2007: 2.7; 2008: 3.9; 2009: 3.5; 2010: 3.1 (Proj.); 2011: 1.5 (Proj.)
  - Private fixed domestic investment: 2005: 9.0; 2006: 7.1; 2007: 3.1; 2008: 0.8; 2009: -16.0; 2010: 5.1 (Proj.); 2011: 5.9 (Proj.)
  - Private investment rate (as a percent of GDP): 2005: 18.6; 2006: 19.5; 2007: 19.7; 2008: 19.6; 2009: 17.6; 2010: 17.5 (Proj.); 2011: 17.9 (Proj.)
  - Public investment: 2005: 11.4; 2006: 6.8; 2007: 6.5; 2008: 5.6; 2009: 15.0; 2010: 11.5 (Proj.); 2011: -3.2 (Proj.)
  - Change in inventories 2/: 2005: 0.5; 2006: -0.2; 2007: -0.1; 2008: -0.2; 2009: -0.9; 2010: 0.9 (Proj.); 2011: 0.3 (Proj.)
  - GDP (current prices): 2005: 6.4; 2006: 5.6; 2007: 5.5; 2008: 4.6; 2009: -4.5; 2010: 5.9 (Proj.); 2011: 4.7 (Proj.)
- Employment and inflation:
  - Unemployment rate: 2005: 6.8; 2006: 6.3; 2007: 6.0; 2008: 6.2; 2009: 8.3; 2010: 8.1 (Proj.); 2011: 7.9 (Proj.)
  - Consumer price index: 2005: 2.2; 2006: 2.0; 2007: 2.1; 2008: 2.4; 2009: 0.3; 2010: 1.7 (Proj.); 2011: 2.0 (Proj.)
  - GDP deflator: 2005: 3.3; 2006: 2.7; 2007: 3.2; 2008: 4.1; 2009: -2.1; 2010: 2.9 (Proj.); 2011: 2.3 (Proj.)
- Exchange rate (period average):
  - U.S. cents/Canadian dollar: 2005: 0.83; 2006: 0.88; 2007: 0.93; 2008: 0.94; 2009: 0.87; 2010: ......; Percent change: 2005: 7.4; 2006: 6.8; 2007: 5.6; 2008: 0.7; 2009: -6.7; 2010: ......
  - Nominal effective exchange rate: 2005: 8.3; 2006: 5.9; 2007: 1.2; 2008: -3.2; 2009: -3.4; 2010: ......
  - Real effective exchange rate: 2005: 7.7; 2006: 5.3; 2007: 0.5; 2008: -4.9; 2009: -3.8; 2010: ......
- Indicators of financial policies (national accounts basis, as a percent of GDP):
  - Federal fiscal balance: 2005: 0.1; 2006: 0.8; 2007: 1.0; 2008: 0.2; 2009: -2.6; 2010: -2.8 (Proj.); 2011: -2.2 (Proj.)
  - Provincial fiscal balance 3/: 2005: 0.7; 2006: 0.0; 2007: -0.4; 2008: -0.7; 2009: -3.7; 2010: -4.0 (Proj.); 2011: -3.1 (Proj.)
  - General government fiscal balance: 2005: 1.5; 2006: 1.6; 2007: 1.4; 2008: 0.0; 2009: -5.5; 2010: -6.1 (Proj.); 2011: -4.6 (Proj.)
  - Three-month treasury bill: 2005: 2.7; 2006: 4.0; 2007: 4.2; 2008: 2.4; 2009: 0.4; 2010: 0.6 (Proj.); 2011: 1.4 (Proj.)
  - Ten-year government bond yield: 2005: 4.1; 2006: 4.2; 2007: 4.3; 2008: 3.6; 2009: 3.2; 2010: 3.3 (Proj.); 2011: 4.2 (Proj.)
- Balance of payments:
  - Current account balance (as a percent of GDP): 2005: 1.9; 2006: 1.4; 2007: 0.8; 2008: 0.4; 2009: -2.8; 2010: -3.1 (Proj.); 2011: -3.5 (Proj.)
  - Merchandise trade balance (as a percent of GDP): 2005: 4.5; 2006: 3.4; 2007: 3.1; 2008: 2.9; 2009: -0.3; 2010: -0.5 (Proj.); 2011: -0.7 (Proj.)
  - Export volume: 2005: 2.0; 2006: 0.8; 2007: 1.3; 2008: -5.1; 2009: -15.3; 2010: 7.4 (Proj.); 2011: 3.2 (Proj.)
  - Import volume: 2005: 7.5; 2006: 5.1; 2007: 5.5; 2008: 1.0; 2009: -15.2; 2010: 14.0 (Proj.); 2011: 5.7 (Proj.)
  - Invisibles balance (as a percent of GDP): 2005: -2.7; 2006: -2.0; 2007: -2.3; 2008: -2.5; 2009: -2.6; 2010: -2.6 (Proj.); 2011: -2.8 (Proj.)
- Saving and investment (as a percent of GDP):
  - Gross national saving: 2005: 24.0; 2006: 24.4; 2007: 24.1; 2008: 23.6; 2009: 18.1; 2010: 18.9 (Proj.); 2011: 19.3 (Proj.)
  - General government saving: 2005: 4.4; 2006: 4.6; 2007: 4.5; 2008: 3.2; 2009: -1.5; 2010: -1.9 (Proj.); 2011: -0.6 (Proj.)
  - Private saving: 2005: 19.6; 2006: 19.8; 2007: 19.6; 2008: 20.4; 2009: 19.6; 2010: 20.8 (Proj.); 2011: 19.9 (Proj.)
  - Personal saving: 2005: 4.2; 2006: 5.0; 2007: 4.6; 2008: 5.2; 2009: 6.2; 2010: 7.1 (Proj.); 2011: 6.9 (Proj.)
  - Business saving: 2005: 15.4; 2006: 14.9; 2007: 14.5; 2008: 15.1; 2009: 13.1; 2010: 13.7 (Proj.); 2011: 13.0 (Proj.)
  - Gross domestic investment: 2005: 22.1; 2006: 23.0; 2007: 23.2; 2008: 23.1; 2009: 21.0; 2010: 22.1 (Proj.); 2011: 22.7 (Proj.)
- Sources for the Selected Economic Indicators table: Statistics Canada; and IMF staff estimates.

*ANNEX I. CANADA—FUND RELATIONS (As of October 31, 2010).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10377.pdf_