## _cr16146 ## Source details **Canonical URL:** [_cr16146](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16146.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16146.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16146.pdf.json) --- ### Macroeconomic context and near-term outlook - Oil prices fell by 60 percent since 2014; spot WTI touched a low of US$27 in January 2016. - Real GDP growth: 2.5 percent in 2014; 1.2 percent in 2015. - Output gap: narrowed from over 3½ percent of GDP in 2009 to almost zero in 2014; widened to 1 percent of GDP at the end of 2015. - Terms-of-trade decline of 8 percent in one year. - Unemployment rate rose slightly above 7 percent; unemployment (average) projected: 2016: 7.4; 2017: 7.5. - Inflation: CPI inflation (average) projections: 2016: 1.4; 2017: 2.0. - Near-term growth projection: GDP growth recover gradually to 1.7 percent in 2016 and 2.2 percent in 2017. - Early-2016 developments: better-than-expected housing expenditure and exports boosted Q1 growth; Fort McMurray fires could dampen Q2 growth though overall impact for the year is likely limited. ### Macro-financial transmission of the oil shock - Key channels: - First-round: oil industry profitability down; investment down; funding costs up; jobs cut. - Transmission to banks and non-energy corporates: limited direct impact on non-energy corporates but significant indirect exposures in resource provinces and adverse household wealth effects. - Second-round: house price declines; deterioration in asset quality; adverse feedback via mortgage guarantees and securitization markets. - Drivers of 2015 slowdown: - Business investment: oil companies cut investment spending by 40 percent. - Private consumption: slowed due to employment and house price impacts in resource-rich provinces. - Lost export market share linked to a 57 percent appreciation of the real effective exchange rate during 2002–12. ### Financial sector resilience, exposures, and vulnerabilities - Banking sector structure and metrics: - Six banks account for 93 percent of bank assets. - Big six banks average 16 percent return on equity; common equity Tier 1 ratios above 10 percent. - NPLs remain below ½ percent; Tier 1 ratio (2015): 12.1; Total capital ratio (2015): 14.2. - Total assets (2015): 4,657.4 (Can$ billions); Percent of GDP: 233.3. - Bank exposures to oil and resource provinces: - Direct lending to oil and gas sector: 2 percent of total loans on average. - Undrawn credit lines: 2 percent. - Indirect exposure through household and business lending in resource-rich provinces: 13–15 percent. - Credit quality and provisioning: - Oil companies’ stock prices have fallen by 35 percent. - Operating margin declined by almost 15 percentage points. - Median PD for 72 exploration and production companies projected to peak at about 1.2 percent in H1 2016 (rating deterioration of about four notches). - BuDA baseline: PDs for overall nonfinancial corporate sector projected to rise to only 0.3 percent. - Moody’s EDF comparison: median 12-month EDF average of 4.5 percent in H1 2016 for a similar sample; Moody’s EDFs typically 2 to 4 times BuDA PDs for a given sample. - Projected increase in BuDA PDs suggests banks may need to at least double provisions against energy loans compared to the average 2015 level; potential impact on earnings could range between 1 to 3 percent of annual net income, leaving capital unaffected. - Household sector and housing vulnerabilities: - Household credit growth slowed to 5 percent in 2015 from double digits in 2010–11. - Household debt: 165 percent of disposable income. - Staff estimates national house prices to be about 10–30 percent above their fundamental values. - Highly indebted households (debt to income of 350 percent or more) rose from 13 percent to 21 percent. - Insured mortgage loans account for 50 percent of banks’ mortgage loan portfolio. - Government guarantees of insured mortgages equal 36 percent of GDP as of 2015. - Moving accounting standards: Canada will move from IAS 39 to IFRS9 in 2018 requiring more timely recognition of expected losses. ### Regional housing markets — "trifurcation" and statistics - Resource provinces (Alberta and Saskatchewan; 23 percent of national GDP): - Alberta’s economy contracted by an estimated 4 percent in 2015 and projected to shrink by another 1.6 percent in 2016. - House prices in Calgary and Regina fell by 3–4 percent from peak in 2014; rental vacancies quadrupled (Oct 2014–2015). - Alberta and Saskatchewan account for 21 percent of total household debt (2012–14); consumer insolvencies in Alberta increased by 40 percent year-on-year. - Non-resource provinces (British Columbia and Ontario; 49 percent of national GDP): - Growth expected 2–3 percent in 2016. - House prices growing by 10–20 percent year-on-year. - Ad hoc data: Chinese investors accounted for 14 percent of total sales volume ($9 billion) in Toronto and 33 percent of total sales ($12.7 billion) in Vancouver in 2015. - British Columbia and Ontario account for 55 percent of total housing debt. - Rest of Canada (28 percent of national GDP): - Quebec: GDP growth about 1 percent; Montreal house prices rising 1–2 percent. - Quebec and Atlantic provinces account for 24 percent of total household debt. ### Stress scenarios and selected stress parameters - BOC stress scenario key assumptions: - Unemployment rate rises by three percentage points. - Household borrowing rate rises by 200 basis points. - Both stay at elevated levels for three years. - FSAP tail stress scenario (2014 FSAP): - 50 percent drop in oil prices; unemployment rate peak of 13.2 percent; 34 percent decline over 3 years (22 percent in the first year) in house prices — all banks would fall below the supervisory threshold under that scenario, but recapitalization needs would be manageable. - Public Debt Sustainability Analysis (Annex III) highlights: - Gross debt-to-GDP ratio will peak at about 93 percent in 2016 and gradually decline to 83 percent by 2021. - Net debt (authorities’ definition) stood at 27 percent in 2015; net debt expected to decline to below 20 percent by 2021. - Gross financing needs around 20 percent and will decline to below 18 percent by the end of the projection period. - Severe housing contingent shock: assuming 5 percent of outstanding government-backed insurance is called, government non-interest expense would increase by 1¾ percent of GDP; debt-to-GDP would rise above 100 percent and gross financing needs would reach 25 percent of GDP at peak. ### Fiscal, monetary, and structural policy recommendations - Near-term policy mix: - Monetary and fiscal policy should work together to support the economy; monetary policy remain accommodative until recovery is firmer. - With policy rate near zero, fiscal policy becomes more potent; fiscal stimulus expected to boost growth by ¼ to ½ percentage points in 2016 and 2017, respectively. - Allow automatic stabilizers to operate fully at the provincial level, particularly Alberta. - Bank of Canada can provide liquidity as needed. - Ensure adequate loss absorbing buffers in the banking system and conduct regular stress testing. - Macroprudential policy may be tightened further if housing imbalances intensify; may be eased as counter-cyclical where appropriate. - Housing and mortgage insurance reforms: - Recent measures (April 2015–2016) include higher CMHC premiums, restrictions on substitution in portfolio insurance pools, increases in guarantee fees for NHA MBS and CMB, higher minimum down payment above Can$ 500,000, and requiring portfolio-insured loans be funded only through CMHC securitization programs (effective July 1, 2016). - Further options to reduce government contingent liability: narrow scope of guarantees to low and middle-income households; introduce lender risk sharing/higher deductibles; fine-tune insurance premiums and securitization fees — proceed gradually to preserve countercyclical role and social objectives. - OSFI actions: three percent leverage ratio (2015); one percent capital surcharge for domestic systemically important banks (January 2016); plan to introduce Net Stable Funding Ratio by 2018; risk-based floor for internal capital models for uninsured mortgages welcomed. - Structural reforms to raise productivity and competitiveness: - Rebalance R&D incentives: general R&D tax credit 15 percent; enhanced rate 35 percent for SMEs on first $3 million — recommendation to evaluate size-based subsidies and consider targeting to new firms. - Boost female labor force participation (gap of 10 percentage points) via better targeting of Canada Child Benefit and more generous child care subsidies. - Increase vocational and specialized skills training; Canada spends about half of OECD average on publicly funded training. - Lower interprovincial barriers to trade and promote competition in network sectors. - Use federal infrastructure plan (New Infrastructure Initiative: $60 billion over 10 years, 2¼ percent of GDP) to catalyze private investment and raise potential growth; Phase 1 totals include Public transit infrastructure (3.4), Clean water and wastewater (2.0), Water/waste management for First Nations (2.2), Affordable housing (1.5), Social infrastructure in First Nations, Inuit, and northern communities (1.2), among other items (Can$ billions, FY16-FY20 totals). - External competitiveness and trade: - Exchange rate depreciation has aided competitiveness but lost manufacturing capacity during 2002–12 constrains export recovery. - Policies to improve non-energy exports: improve labor productivity; invest in R&D and physical capital; promote FDI; diversify export markets. - Panel regression results: Relative export price has the largest impact on export growth (coefficients preserved in underlying regressions); a 1 percentage point higher growth of capital investment translates to almost 2 percentage points more rapid real export growth. - Industry-specific: supply-constrained industries (automotive, wood products) need capacity-restoring investment; demand-constrained industries need demand recovery and structural measures. ### Implementation, data, and supervisory recommendations - Data and stress-testing enhancements: - DOF now collects loan-level data from three mortgage insurers on quarterly loan originations; shared with Bank and OSFI. - CMHC expanded publicly available information and will collect data on sales to foreign buyers in Toronto, Montreal and Vancouver. - Bank and IIROC implemented Market Trade Reporting System (MTRS) for transaction-level fixed-income data. - Institutional and supervisory recommendations: - Regular, common stress testing including federal and provincial entities is recommended; Bank of Canada providing technical assistance. - Recommendation to give OSFI sole decision-making authority on prudential criteria was not adopted by authorities; authorities consider OSFI's current toolkit sufficient. - Active monitoring by OSFI of correspondent banking relationships and Caribbean exposures urged. - Increase ex-ante funding of CDIC; minimum target 100 basis points of insured deposits. ### Key numeric projections and indicators (selected, preserved exactly) - Real GDP: 2014: 2.5; 2015: 1.2; 2016: 1.7; 2017: 2.2 - Unemployment rate (average): 2014: 6.9; 2015: 6.9; 2016: 7.4; 2017: 7.5 - CPI inflation (average): 2014: 1.9; 2015: 1.1; 2016: 1.4; 2017: 2.0 - Current account balance (percent of GDP): 2014: -2.3; 2015: -3.3; 2016: -3.4; 2017: -3.0 - Nominal GDP (2015): Can$ 1,986 billion (US$ 1,553 billion); GDP per capita (2015): US$ 43,316; Population (2015): 35.8 million - Financial Soundness Indicators (2015): NPLs to Gross Loans: 0.5; Return on equity: 20.7; FX loans to total loans: 33.4; FX liabilities to total liabilities: 48.4 - Public debt projections (selected): Gross debt-to-GDP peak about 93 percent in 2016; projected 83 percent by 2021. General government overall deficit (percent of GDP): 2015: -1.7; 2016: -2.8; 2017: -2.4. *Source: IMF staff report content from _cr16146 (IMF).* ### 1. Macro-Financial Linkages from Oil Shock ______________________________________________________ 5 ### 1. Macro-Financial Linkages from Oil Shock ### Macroeconomic and political context - Oil prices have fallen by 60 percent since 2014, with the spot WTI touching a low of US$27 in January 2016. - The economy slipped into recession in the first half of 2015 as oil companies slashed investment spending; the stock market fell by 17 percent. - The Bank of Canada (BOC) cut the policy rate twice in 2015. - A new government led by Prime Minister Trudeau took office in late 2015 and announced a Budget in March 2016 emphasizing infrastructure investment and strengthening the middle class. ### Growth, inflation, and labor market - Real GDP growth: 2.5 percent in 2014; 1.2 percent in 2015. - Headline and core inflation were within the BOC’s target range (1–3 percent). - Terms-of-trade decline of 8 percent in one year. - Unemployment rate rose slightly above 7 percent. - Output gap: narrowed from over 3½ percent of GDP in 2009 to almost zero in 2014; widened to 1 percent of GDP at the end of 2015. - Business Outlook Survey: incidence of labor shortages remains low; involuntary part-time workers at 4.5 percent of the labor force; no signs of wage pressures. ### Adjustment dynamics and near-term outlook - Oil sands producers face high “all-in break-even” costs; long-term viability at stake. - The economy recovered in the second half of 2015 and is likely to gain strength in 2016, but the complex adjustment to lower oil prices continues to weigh on the near-term outlook. - Early-2016 developments: better-than-expected housing expenditure and exports boosted Q1 growth but slowed thereafter; Fort McMurray fires could dampen Q2 growth though overall impact for the year is likely limited. ### Key channels of transmission (Box 1: Macro-Financial Linkages) - First-round effects: oil industry profitability down; investment down; funding costs up; jobs cut. - Transmission to banks and non-energy corporates: limited direct impact on non-energy corporate sector but significant impact on banks and households in resource provinces through indirect exposures and adverse wealth effects. - Second-round effects: house price declines, deterioration in asset quality, adverse feedback loops via mortgage guarantees and securitization markets. ### Drivers of the 2015 slowdown - Business investment: oil companies cut investment spending by 40 percent. - Private consumption: slowed due to impacts on employment and house prices in resource-rich provinces; consumer sentiment for big-ticket purchases fell to its worst level since the 2008–09 recession. - Non-energy exports: weaker-than-expected performance despite a more competitive Canadian dollar and a U.S. recovery; erosion of manufacturing capacity during 2002–12 when the real effective exchange rate appreciated by 57 percent contributed to lost market share. --- ### Bank exposure and financial sector resilience - Canadian banking system dominated by six banks accounting for 93 percent of bank assets. - Big six banks average 16 percent return on equity; common equity Tier 1 ratios above 10 percent; non-performing loans (NPLs) remain below ½ percent. - Household credit growth slowed from double digits in 2010–11 to 5 percent. - Insured mortgage loans account for 50 percent of banks’ mortgage loan portfolio. - Banks’ exposure to oil and gas sector: - Direct lending: 2 percent of total loans on average. - Undrawn credit lines: 2 percent. - Indirect exposure through household and business lending in resource-rich provinces: 13–15 percent. - Credit quality and provisioning: - Oil companies’ stock prices have fallen by 35 percent. - Operating margin declined by almost 15 percentage points. - Median probability of default (PD) increased sharply (see Box 2). - Loan delinquencies gradually rising from low levels; insolvencies filed by consumers in Alberta increased by almost 40 percent from a year ago. - Estimated increase in provisions likely substantial but from a low base; impact likely to hit banks’ earnings rather than capital. ### Financial system vulnerabilities and housing risks - Household debt: 165 percent of disposable income. - Staff estimates national house prices to be about 10–30 percent above their fundamental values. - Regional dynamics: house prices declining in Alberta and other resource provinces; rapidly rising in British Columbia and Ontario. - Highly indebted households (debt to income of 350 percent or more) rose from 13 percent to 21 percent; bulk of this debt is mortgages held by younger and low- to middle-income households. - Business and housing cycles beginning to diverge; BOC estimates higher debt under a stress scenario leads to 27 percent greater mortgage loan arrears after three years. - Canada will move from IAS 39 to IFRS9 in 2018, which will require more timely recognition of expected losses. --- ### Bank solvency risk assessment (Box 2: BuDA and provisioning scenarios) - BuDA (Bottom-up Default Analysis) used to forecast median PDs by incorporating economy-wide effects, firm balance sheets, and market-based factors; BuDA is preferred because the default database and calibration methodology are available and it augments contingent-claims approaches. - Baseline scenario for 108 oil and gas companies: projected PDs increase and stay elevated through most of 2016, then subside with a rebound in external demand and gradual oil price recovery. - For a sample of 72 exploration and production companies, median PD projected to peak at about 1.2 percent in the first half of 2016 (implying rating deterioration of about four notches, from Ba1 to B2, compared to second half 2014). - PDs for the overall nonfinancial corporate sector projected to rise to only 0.3 percent, indicating limited spillover to non-oil sector. - Moody’s EDF comparison: Moody’s EDF suggests median 12-month EDF average of 4.5 percent in the first half of 2016 for a similar sample — larger than BuDA projections. - EDFs tend to overestimate default risk for low- and medium-risk firms; Moody’s EDFs are typically 2 to 4 times BuDA PDs for a given sample. - Impact on bank provisions and earnings: - Projected increase in BuDA PDs suggests banks may need to at least double provisions against energy loans compared to the average 2015 level. - Given end-2015 provisions, potential impact on earnings could range between 1 to 3 percent of annual net income, leaving capital unaffected. --- ### Selected stress parameters and scenario inputs - BOC stress scenario assumptions: - Unemployment rate rises by three percentage points. - Household borrowing rate rises by 200 basis points. - Both stay at elevated levels for three years. - Corporate bond spreads rose by 40 basis points in the face of the shock. *Source: IMF staff report, "Canada: Macro-Financial Linkages from Oil Shock", IMF.* ### Box 3. Canada: A Spotlight on Regional Housing Markets ### Box 3. Canada: A Spotlight on Regional Housing Markets ### Regional housing market trends and key statistics - The oil shock has caused housing market trends to “trifurcate”. - So far, there has been no contagion risk between the diverging markets. - Resource provinces (Alberta and Saskatchewan, accounting for 23 percent of national GDP) - Alberta’s economy has contracted by an estimated 4 percent in 2015 and is projected to shrink by another 1.6 percent in 2016. - House prices in Calgary and Regina have fallen by 3–4 percent from their peak in 2014 and rental vacancies have quadrupled within the span of one year (October 2014–2015). - The decline in house prices followed a massive housing market boom in the mid-2000s when house prices soared by 200 percent (2004–07). - With little prospect for a quick recovery in oil prices in the near term, house prices in these regions are likely to continue to trend downward. - Alberta and Saskatchewan account for 21 percent of total household debt (2012–14) and uninsured mortgages are non-recourse loans. So far, strategic defaults have not occurred in any significant way. - Consumer insolvencies have increased by 40 percent over the past year but remain small as a share of total loans. - Non-resource provinces (British Columbia and Ontario, accounting for 49 percent of national GDP) - British Columbia and Ontario are expected to grow by 2–3 percent this year. - House prices have been growing by 10–20 percent year-on-year, fueled by cheap borrowing costs, demographic pressures, land supply constraints and foreign demand. - Ad hoc survey data suggest that in 2015 Chinese investors accounted for 14 percent of total sales volume ($9 billion) in Toronto and 33 percent of total sales ($12.7 billion) in Vancouver. - Both British Columbia and Ontario account for 55 percent of total housing debt. - Rest of Canada (accounting for 28 percent of national GDP) - In Quebec where the economy has been growing at about 1 percent, house prices (Montreal) have been rising at a more moderate pace of 1–2 percent. - Quebec and the Atlantic provinces account for 24 percent of total household debt. ### Macro-financial context and public finances - External and exchange rate developments - The Canadian dollar has fallen 33 percent against the U.S. dollar since the beginning of 2014. - In real effective terms, the exchange rate is now about 20 percent lower than its 2010-peak. - The current account deficit rose from 2.3 percent of GDP in 2014 to 3.3 percent of GDP in 2015. - Staff estimates the current account gap to be between -2 and -1 percent of GDP. - The real effective exchange rate is estimated to be overvalued by 0 to 5 percent relative to medium-term fundamentals and desirable policy settings. - Fiscal position and provincial divergence - General government overall deficit narrowed from 4¾ percent of GDP in 2010 to 0.5 percent of GDP in 2014, then widened to 1.7 percent in 2015. - The federal government delivered a surplus (¼ percent of GDP) in 2014, but slipped into a small deficit (¼ percent of GDP) in 2015. - Alberta: oil royalty revenues were 20 percent of total revenues in 2014; Alberta is expecting an operational deficit of 2¾ percent of GDP in FY2015–16 after two consecutive years of surpluses. - British Columbia and Quebec are expected to maintain operational balance. - Ontario is expected to narrow its operational deficit to 2 percent in FY2015–16. ### Outlook - Near term - GDP growth is projected to recover gradually to 1.7 percent in 2016 and 2.2 percent in 2017. - Projection assumptions: - another 30 percent decline in investment spending by the energy sector in 2016; - a gradual pick up in non-energy exports as manufacturing regains competitiveness and U.S. demand remains strong; - growth in business investment expected to strengthen starting in 2017 as drag from cuts in energy-related investment dissipates; - imports projected to increase over the medium term and real business credit gradually recovers; - private consumption expected to remain solid, supported by easy monetary policy and steady increase in household credit; - fiscal stimulus is expected to boost growth and facilitate a faster return to potential. - On a calendar year basis, the fiscal stimulus is expected to boost growth by ¼ to ½ percentage points in 2016 and 2017, respectively. - Medium term - The oil shock has prompted structural adjustment with capital and labor reallocated from the resource to the non-resource sectors. - Staff assumes a smooth transition that will enable Canada to take advantage of shifting global trade patterns and raise potential growth to about 2 percent in the medium term (versus an annual average of 2¼ percent over the past 15 years). ### Risks (tilted to the downside) and stress scenarios - Major downside risks - Persistently low energy prices - Could force firms to permanently shut down production, trigger second-round effects on investment and growth, lead banks to shed bad loans and curtail lending, and impair ability to ramp up production when markets rebalance. - Higher uncertainty about global growth prospects and lack of effective policy response - Could lead to persistent weakness in global trade and investment. - Spillovers from China - Mostly felt through a slowdown in trade and weaker commodity prices; little direct exposure of Canadian banks to China. - Bank of Canada estimate: if Chinese growth slows by one percentage point Canadian growth would slip one-tenth of a percentage point. - By comparison, if the same decline happened to the U.S., the impact on Canada's GDP would be six times greater. - Tighter global financial conditions or a significant depreciation of the renminbi - Could be disruptive to global financial system and financial conditions in Canada. - Key domestic risk: a sharp correction in the housing market - A severe recession raising unemployment could destabilize housing markets and trigger adverse feedback loops, increasing financial stability risks. - Given extensive government-backed mortgage insurance, a severe housing downturn could have considerable fiscal impact. - Tail risk scenario - Concurrent realization of multiple risks could be highly significant though probability is low. - 2014 FSAP stress test scenario: 50 percent drop in oil prices, increase in the unemployment rate to a peak of 13.2 percent, and a 34 percent decline over 3 years (22 percent in the first year) in house prices. All banks would fall below the supervisory threshold, but recapitalization needs would be manageable. - Since the FSAP, banks have improved their capital position. CMHC and private mortgage insurers' own earnings and loss absorption capacity provide an additional cushion. - Upside potential - A better than expected recovery in Canadian exports would strengthen business investment and facilitate faster reallocation of resources from energy to non-energy sectors. - Mitigating factors - Canada’s strong institutions, track record of consistent policies, positive net international investment position, and flexible exchange rate act as shock absorbers. - Despite rising short-term external debt, Canada owns substantial assets overseas, providing a natural hedge. ### Spillovers and external linkages - Outward spillovers to the Caribbean - Canadian banks have a historical connection to the region; low returns and bad debts have led to scaling back operations. - A materialization of downside risks could exacerbate rationalization of Canadian banks’ operations in the region and reduce tourism revenues from Canadian visitors. - World Bank perception survey indicated pressure on correspondent banking relationships (CBRs) of local/regional banks in the Caribbean but did not indicate a material reduction in Canadian banks’ CBRs. - OSFI does not presently collect data on this trend; recommendation that OSFI should actively monitor trends in CBRs provided by Canadian banks. - Canadian banks are choosing not to fill gaps left by retreating global banks, partly because higher regulatory compliance costs have made the risk-reward equation challenging; banks seek greater clarity in national and international standards, including regulations to counter money laundering and offshore tax evasion and avoidance. ### Policy recommendations and responses (from Risk Assessment Matrix and text) - For persistently lower energy prices (High likelihood, High impact) - Monetary and fiscal policy should be expansionary. - At the provincial level, allow automatic stabilizers to operate fully. - The Bank of Canada can step in to provide liquidity as needed. - Ensure adequate loss absorbing buffers in the banking system and conduct regular stress testing. - Accelerate structural reform policies to facilitate reallocation of resources to manufacturing and services; measures should focus on raising productivity and enhancing long-term growth. - For a sharp asset price decline and decompression of credit spreads (Medium/High likelihood, Low/Medium impact) - Recognize that higher interest rates would raise debt servicing costs and reduce business investment; financial institutions relying on wholesale funding would be adversely affected. - For structurally weak growth in key advanced and emerging economies (Medium/High likelihood, Medium/High impact) - A structural slowdown abroad would reduce demand for Canadian exports and lower potential growth. - For a sharp house price correction (Medium likelihood, High impact) - Banking system impact would be severe but mitigated by mortgage insurance and CMHC and private insurers' loss absorbing capacity. - Macroprudential policy may need to be eased as a counter-cyclical measure. - Additional suggested actions - Provide liquidity support as needed (BOC). - Ensure banks have adequate loss-absorbing buffers and conduct regular stress testing. - Active monitoring by OSFI of correspondent banking relationships and Caribbean exposures. *Source: IMF staff compilation from “Box 3. Canada: A Spotlight on Regional Housing Markets” in the provided IMF country report content.* ### Box 4. Canada: Correspondent Banking Relationships with the Caribbean ### Box 4. Canada: Correspondent Banking Relationships with the Caribbean ### Canadian banking presence and market share - Canadian banks have been in the Caribbean since the 19th century. - Royal Bank of Canada (as Merchants Bank of Halifax), Scotiabank, and Canadian Imperial Bank of Commerce have numerous branches across the archipelago. - These banks account for 75–80 percent of all banking assets in Barbados, Grenada and the Bahamas, and 60 percent of the assets of the ECCU banking system. - Scotiabank has the largest footprint with C$32 billion in total loans to the region. ### Recent trends in correspondent banking relationships (CBRs) - Global banks have recently been terminating or restricting their corresponding banking relationships (CBRs) with local/regional banks across the world. - The Caribbean has been potentially affected by declining CBRs, with even central banks not being immune. - Evidence: a recent World Bank perception survey indicated pressure on CBRs of local/regional banks in the Caribbean. - Potential drivers behind withdrawal of CBRs include business strategy and/or cost/benefit analysis related to: capital and liquidity rules, AML/CFT, economic and trade sanctions, and tax transparency (e.g., implementation of the 2010 U.S. Foreign Account Tax Compliance Act). - In some instances, withdrawals can result from unclear, poorly communicated, or conflicting regulatory expectations. - To date, there is no evidence of a macroeconomic impact from withdrawals of CBRs; most institutions have found replacements for lost CBRs with varying degrees of difficulty. - Concerns exist that withdrawal pressure may be leading to higher costs for remittances and related services, but supporting evidence is still lacking. ### Canadian banks’ risk–reward assessment - Canadian banks have no immediate plans to significantly cut CBRs but are reassessing the risk-return tradeoffs. - Cost of regulatory compliance has increased, notably as U.S. regulators have taken a more concerted approach to enforcing AML/CFT regulations and bilateral initiatives like the 2010 U.S. Foreign Account Tax Compliance Act. - Caribbean consumer businesses have low profit margins and the target consumer population in the region could not bear higher fees; re-pricing of bank services to boost profit margins is not a feasible option. - At present, Canadian banks see little scope for expanding their presence to fill gaps left by retreating global banks. *Source: IMF staff summary of Box 4 in the IMF staff report.* ### 25. As a longer-term reform agenda, the authorities should consider the impact of ### _cr16146 - 25. As a longer-term reform agenda, the authorities should consider the impact of ### Provincial finances: aging and health care cost pressures - Fiscal gaps at the provincial level could emerge and widen over time, with material implications on provincial debt burdens within a 15–20 year time frame. - Recommendation: provinces should adjust their spending priorities to address escalating health care costs and aging pressures. ### Canada: New Infrastructure Investment Initiative (Box 6) - 2016 Budget: Federal government announced a new infrastructure plan, totaling $60 billion (2¼ percent of GDP) over 10 years. - Implementation: two phases; baseline medium-term projections incorporate only Phase 1 spending plans. - Phase 1: - Focus: shovel ready infrastructure projects, amounting to $12 billion over the 2–3 years. - Main objectives: - (i) upgrade and improve public transit; - (ii) modernize water, and wastewater systems, and address climate change (“Green Infrastructure”); - (iii) provide affordable housing (including for seniors and the homeless) and improve housing conditions in First Nations’ communities (“Social Infrastructure”). - Phase 2: - Launched over the medium term to invest in larger-scale projects to improve productivity growth and boost potential output. - Specific aims: - expand trade corridors (connecting highways and rail linking major commercial centers in the Canada and the U.S.); - improve transportation networks in urban areas to reduce congestion and commute time; - reduce the carbon footprint of the national energy system. - Details of Phase 2 to be announced next year. - Financing: - Government considering innovative financing to reduce costs at local government levels. - Actively considering engaging public pension funds and global institutional investors to take the lead in planning, building, and operating infrastructure projects while allowing government involvement to reduce the government’s direct financial costs. - Composition of Phase I Infrastructure Plan (FY16-FY20 total, Can$ billions): - Social infrastructure in First Nations, Inuit, and northern communities (1.2) - Cultural and recreational (0.3) - Early learning and child care (0.4) - Affordable housing (1.5) - Public transit infrastructure (3.4) - Climate change mitigation and adaptation infrastructure projects (0.5) - Supporting municipal capacity building (0.3) - Clean water and wastewater (2.0) - Water, wastewater, and waste management infrastructure for First nations communities (2.2) - Canada: New Infrastructure Spending (Can$ billions) timeline distinguishes Phase 1 and Phase 2 (chart data source: Government of Canada, Growing the Middle Class, Budget 2016). ### Financial sector policies: housing-related risks and macroprudential measures - Housing is the most significant macro-financial vulnerability for Canada; authorities (federal government, CMHC, OSFI) introduced multiple measures since April 2015 to reduce risk taking and limit taxpayer exposure. - Effectiveness: - Slowed mortgage credit expansion from above 10 percent in 2010–2011 to about 5 percent in 2015. - Improved risk profile of new mortgage loans: more than 75 percent of new mortgage originations are uninsured mortgages with maximum LTV of 80 percent. - Recent macroprudential measures (April 2015–2016) and stated primary objectives: - April 2015. CMHC raised mortgage insurance premiums for homebuyers with less than a 10 percent down payment by about 15 percent (effective June 1, 2015) — Strengthen CMHC’s capital position. - May 2015. The DOF prohibited substitution or adding new loans into a portfolio insurance pool one year after insurance commitment — Reduce taxpayer exposure by reducing portfolio mortgage insurance and enhance market discipline. - December 2015. CMHC announced an increase in guarantee fees under the NHA MBS and CMB programs and a restructuring of the CMB program (effective July 1, 2016) — Encourage development of private market funding alternatives by narrowing funding cost differences. - February 2016. The DOF raised the minimum down payment for new insured mortgages for the portion of the house price above Can$ 500,000 from 5 percent to 10 percent — Contain risks, reduce taxpayer exposure, support long-term stability. - February 2016. The DOF required that portfolio-insured loans be funded only through CMHC securitization programs (effective July 1, 2016) — Restore portfolio insurance to its original purpose of supporting mortgage funding through CMHC securitization programs. - Further measures recommended if vulnerabilities intensify: - OSFI introduced a risk-based floor for banks’ internal capital models for uninsured mortgages — welcomed. - Consider introducing a cap on LTI (loan-to-income) as superior to debt service-to-income limits in a low interest rate environment. - If national measures prove inadequate, target measures to specific imbalances in regional housing markets would be warranted. - Government-backed mortgage insurance: - Government guarantees of insured mortgages are still a sizable 36 percent of GDP as of 2015. - Options to reduce government contingent liability: - Narrow scope of government guarantees to low and middle-income households. - Lender risk sharing by introducing higher deductibles for insured mortgages. - Fine-tune insurance premiums and securitization fees. - Any reform should proceed gradually to preserve countercyclical role and social objectives. - Prudential policy strengthening: - OSFI introduced a three percent leverage ratio in 2015 and a one percent capital surcharge for domestic systemically important banks in January 2016. - Quebec Autorite des Marches Financiers started applying an equivalent capital surcharge to Desjardins. - Capital conservation buffer phased in gradually by 2019. - OSFI required banks to fully meet the Liquidity Coverage Ratio and plans to introduce the Net Stable Funding Ratio by 2018. - Systemically important financial institutions required to participate in regular macroeconomic stress tests led by OSFI and the BOC. - FSAP implementation progress and outstanding recommendations: - New Capital Markets Regulatory Authority bringing federal regulator and six provincial regulators together to strengthen national systemic risk identification and management. - BOC providing technical assistance on macro stress testing and model design; CMHC publishing stress test results; BOC considering integrating quantitative analysis into its Financial System Review. - Outstanding legislative and institutional gaps to address: - Senior Advisory Committee (SAC) functions de facto for systemic risk monitoring and crisis preparedness but lacks explicit mandate for crisis management and explicit financial stability mandate for macroprudential oversight. - Legislation should be amended to give OSFI sole decision-making authority on prudential criteria to ensure operational independence consistent with Basel Core Principles. - Legislation should be amended to give OSFI authority to take supervisory measures at the holding company level to enable group-wide supervision consistent with Insurance Core Principles. - Insured and uninsured outstanding mortgage loans (Can$ billions) time series chart source: Office of the Superintendent of Financial Institutions. ### Structural reforms to raise productivity - Challenge: productivity growth has lagged peers for decades; exchange rate depreciation has improved price competitiveness for non-energy exports, but past erosion in manufacturing capacity constrains recovery. - Multi-pronged approach needed to promote innovation and investment in physical and human capital. - Promoting innovation: - Current fiscal regime gives generous tax incentives to SMEs relative to large firms. - R&D tax credit: general rate 15 percent; enhanced rate 35 percent for SMEs on their first $3 million in eligible R&D-related expenditures. - Between 2010 and 2012, 53 percent of SMEs introduced a product or process innovation in Canada. - Concerns with size-based subsidies: - New rather than small firms typically introduce radical innovation; Canada has among the lowest start-up rates in the OECD. - Scaling-up performance: share of start-up microenterprises (1–9 employees) growing into small firms (10–19 employees) after three years is 5 percent. - Size-based tax preferences can create a “small business trap”; about 60 percent of small firms in Canada are more than six years old. - Lack of large innovative firms may negatively impact business innovation through weaker supply-chain anchoring and fewer resources to invest, innovate and export. - Recommendation: evaluate R&D subsidy policies to ensure cost effectiveness and simplicity, minimize compliance costs, facilitate firm entry, and balance direct and indirect support; re-consider preferential tax treatment of small firms; consider tax relief targeted to new firms as in Chile and France. - Boosting labor force participation and talent base: - Female labor force participation gap is 10 percentage points between male and female participation. - Higher female labor force participation could raise productivity growth and labor supply amid demographic stagnation. - The new Canada Child Benefit is a step forward but could be better targeted to boost female participation, including more generous child care subsidies for working parents. - Investment in human capital and skills training: - Canada has a highly educated workforce but spends about half of the OECD average on publicly funded training. - Recommendation: increase vocational and specialized skills training to facilitate labor mobility to high value added activities. - Investment in physical capital: - Federal infrastructure spending planned will help catalyze private business investment. - Lowering interprovincial barriers to trade and promoting competition in network sectors would expand domestic business investment and attract FDI. ### Productivity determinants (Box 7) - Historical trend: - Canada’s productivity growth declined from 1.5 percent in the 1970s–80s to less than 1 percent today. - Canada trailed the U.S. since the 1970s; in the 2000s the productivity gap widened to 20 percentage points. - Provincial panel regression results (estimated elasticities for labor productivity growth; effects noted after one year and after two years): - R&D investment: +0.03 (after one year), +0.05 (after two years). - Capital deepening: -0.25 (after one year), +0.34 (after two years). - Vocational training: +0.05 (after one year), +0.06 (after two years). - Female labor force participation ratio: +0.52 (after one year), +0.50 (after two years). - Interpretation: - A 1 percentage point increase in R&D could lead to a 0.05 percentage point increase in labor productivity growth after two years. - Capital deepening shows delayed positive effects, highlighting the need for complementary skills training. - The strong estimated positive effect of female labor force participation should be interpreted with caution but aligns with IMF analysis showing significant macroeconomic gains from greater gender equity. *Source: IMF staff report content as provided in the supplied PDF excerpt.* ### 37. The authorities agree with staff’s assessment of the near-term growth outlook. In ### _cr16146 - 37. The authorities agree with staff’s assessment of the near-term growth outlook. In ### Near-term growth outlook - The authorities agree with staff’s assessment of the near-term growth outlook. - The Canadian economy is adjusting reasonably well to the sizable commodity price shock, facilitated by accommodative macro policies and exchange rate depreciation. - The contraction of business investment in the commodity sector will continue to be a drag on economic activity, but the effects of the negative factors weighing on the resource sector will become less intense, and the drag on overall GDP growth is expected to wane over 2016. - Activity in the rest of the economy is expanding and is expected to be the main source of growth over the next few years. - Non-commodity exports are expected to trend upward, spurring investment and employment. - The timing and magnitude of these adjustments will determine potential output growth over the medium term. ### Risks to the outlook - Risks around the near-term outlook remain on the downside and are largely external. - Downside risks: uncertainty surrounding the future path of oil prices and global growth. - Upside scenarios: - A faster than expected U.S. growth would increase demand for Canadian exports. - Some upside for oil prices over the medium term if reduced access to financing for highly indebted US shale oil producers and political instability in some oil exporters result in a faster-than-anticipated decline in supply. - As non-OPEC supply declines and demand growth remains steady, the current global supply overhang is expected to diminish. ### Financial stability assessment - Financial stability risks are contained. - Labor market weakness in resource provinces will likely lead to an increase in loan delinquencies in the coming months. - Large banks are viewed as well capitalized and able to absorb credit losses. - Authorities note strong growth in specific segments of some regional housing markets and the degree of leverage in the system as a source of some concern. - As long as interest rates remain low and in the absence of a trigger that would significantly increase unemployment and reduce household income, the risk of a sharp, broad-based house price correction is viewed as being remote. - The government guaranteed mortgage insurance system is seen to help protect the financial system in a downturn, allow mortgage credit to continue to flow, and thus limit the impact from a potential tightening of mortgage credit that could exacerbate a downturn in the housing market. - OSFI confirmed that it has not tightened regulations on CBRs, and any changes to Canadian banks’ CBRs should have reflected their own business decisions. OSFI looks forward to participating in the FSB's efforts on this subject. ### Monetary policy stance and framework - The authorities agree that monetary policy should remain accommodative until the economic recovery has firmed. - If the economy were to weaken, a further cut in the policy rate would be considered. - The BOC does not see a need for unconventional monetary policies unless the economy weakens substantially, and considers the risk of this occurring as very low. - The BOC sees a role for monetary policy to take account of financial stability considerations within its flexible inflation targeting framework. - The BOC is prepared to adjust the horizon for returning inflation to target depending on the nature and persistence of the shocks buffeting the economy. ### Fiscal policy, infrastructure, and structural reform - The 2016 federal Budget is aimed at supporting the economy. - Authorities believe that in an environment of sustained economic weakness and historically low interest rates, fiscal policy has an important role to play in delivering stronger growth today, and in expanding the economy’s growth potential over the long term. - Public infrastructure investment is viewed as critical to spearheading long-term growth and to addressing low labor productivity growth. - Public infrastructure investment that is well designed and executed could redress productivity problems, improve external competitiveness and open up new export markets, and raise potential output. - The government is seeking to engage private investors to create innovative funding structures to increase the long-term affordability and sustainability of infrastructure in Canada. - Fiscal policy recommendations to improve productivity and competitiveness: - Targeted R&D tax incentives to promote innovation and competition. - More generous childcare subsidies to encourage women to join the labor market. - Expanded publicly funded training programs to help workers retool their skills. ### Staff appraisal and policy balance - The oil shock is the first major test of Canada’s economic and financial resilience since the 2008 global financial crisis. - Accommodative monetary policy stance and exchange rate depreciation have helped cushion the effects of the oil shock. - Inflation remains well anchored. - Unemployment has edged up, and the negative output gap has widened to about 1 percent of GDP. - The economy is projected to recover gradually over the next two years and converge to potential growth of around 2 percent over the medium term. - Fiscal stimulus will facilitate a faster return of the economy to potential. - The exchange rate is still moderately overvalued despite depreciating significantly since 2014. - Macro-financial effects of the oil shock have yet to fully play out; financial vulnerabilities have become more apparent, as reflected in rising loan delinquencies, albeit from low levels. - Banking system direct exposure to the energy sector is limited, but indirect exposure to resource rich provinces is more substantial and will require higher provisions against deteriorating credit performance. - Elevated household debt and housing market vulnerabilities pose broader risks. - A significant terms of trade shock or a global recession that triggers a sharp increase in the unemployment rate could destabilize housing markets and lead to greater financial stability risks. ### Policy recommendations and sequencing - Near-term: pursue an appropriate policy mix that is supportive of growth while containing vulnerabilities in the housing market. - Monetary and fiscal policy should work together to support the economy. - With the policy rate near zero, and in the absence of short-term supply constraints, fiscal policy becomes more potent in stimulating demand. - Pursuing greater balance in the policy mix will also help reduce risk taking in a low interest rate environment and discourage households from taking on more debt. - Macroprudential policy can be further tightened if imbalances in the housing market threaten to intensify. - Enhancing financial sector resilience is critical given considerable macro-financial linkages and housing market vulnerabilities. - Long-term: use available fiscal space to accelerate structural reform and diversify Canada’s future sources of growth. - Political resolve and close collaboration between federal and provincial governments are necessary for efficient implementation. - Fiscal policy can play a catalytic role by increasing public infrastructure investment; debt-financed projects could have large output effects without increasing the debt-to-GDP ratio if done correctly. - Setting up a nation-wide infrastructure plan would help raise the quality of infrastructure investment through better project appraisal, selection, financing, execution, and rigorous cost-benefit analysis. - Fiscal credibility and medium-term framework: - The federal government’s commitment to putting the debt to GDP ratio on a downward path is appropriate but a new fiscal rule is needed to anchor fiscal sustainability and sustain market confidence. - Provinces with relatively high debt (Quebec) or a high deficit (Ontario) should continue to consolidate their fiscal positions, but only gradually, so as not to offset the effect of the federal government stimulus. - In Alberta, automatic stabilizers should be allowed to operate fully as there is no immediate fiscal sustainability concern. *Source: _cr16146 - 37. The authorities agree with staff’s assessment of the near-term growth outlook. In* ### 53. It is recommended that the next Article IV consultation take place on the standard ### _cr16146 - 53. It is recommended that the next Article IV consultation take place on the standard 12-month cycle. ### Lower oil prices and real economy outcomes - Real GDP growth (quarterly percent change, seasonally adjusted annual rate, three quarter moving average): Canada shown alongside US and EU in Figure 1 (chart context). - Real private consumption growth has decelerated as disposable income weakened. - Energy prices have slumped; Bank of Canada's Commodity Price Indices (January 2000=100) show declines in the BOC energy price index and WTI (US$/Bbl, rhs). - Business investment fell sharply as corporate profits weakened; energy investment fell sharply in 2015. - Oil exports continue to increase while non-commodity exports remain sluggish. ### Macro-financial channels and regional heterogeneity - Non-resource provinces (Quebec, Ontario and British Columbia) show positive changes in retail trade, wholesale trade, employment (private sector) and unemployment rate (Figure 2). - Resource provinces (Alberta and Saskatchewan, with data reflecting only Alberta and Saskatchewan) show negative outcomes on the same indicators. - Structural reallocation of capital and labor is ongoing; capital expenditures on machinery and equipment and private sector employment contributions display shifting regional patterns. - Chartered banks' exposure to resource provinces is notable (loans in percent of total), implying non-negligible concentration risk. - Market risk measures: EDF of big six banks (average) and EDF of oil companies (best 25 percentile) shown in Figure 2 (one year EDF 25 percentile; total sample, 253 energy companies). ### Labor market - Employment has held up relatively well with more full-time jobs and solid wage growth (Figure 3). - Employment (Y/Y percentage change): full-time, part-time, and combined series shown historically (2004Q4–2014Q4 context in charts). - Average hourly wages (Y/Y percentage change) for Canada and United States indicated; wage settlements (effective base wage increase) series shown. - Unemployment rate has edged up; provincial unemployment rates in 2014 and 2015 show variation (e.g., Alberta, Saskatchewan, Ontario, British Columbia, etc.). - Industry-level unemployment rates and sectoral employment contributions shown (construction, services, manufacturing, mining, oil & gas). ### Financial sector resilience and emerging challenges - Banks remain highly profitable; return on equity and core Tier 1 equity ratios presented but Canada's D-SIBs capital ratios remain below those of G-SIBs (Figure 4). - Funding costs and yields: cost of funding and swap rates have edged down; yields on 10-year Government of Canada bonds fell to historical lows. - Energy sector impairments have increased relative to reserves; impairments/total loans and reserve/loan ratio series shown. - Exposure to oil and gas sector is limited for most banks, but exposure to resource provinces is more significant (loans to oil and gas sector, percent of loan book; drawn/undrawn). - Bank balance sheet composition (Assets and Liabilities, percent of total assets/liabilities) for 2011M12 and 2015M12 provided (cash & deposits, private debt, shares, government securities, consumer loans, business loans, repos, other loans, insured/uninsured mortgages, derivatives, other; liabilities: individual deposits, other deposits, shareholders equity, etc.). ### Housing sector vulnerabilities - Household debt has risen to an all time high while debt service burden continues to fall. - Housing demand is strong in Toronto and Vancouver but weakening in Calgary; Sales to New Listings Ratios (Percent) by metro aggregation shown (2008–2016). - Residential investment increased in Ontario and British Columbia; resource provinces have seen rapid increases in consumer insolvencies (year-on-year percent change). - Household indebtedness as of 2014 (Percent of disposable income) shows high levels in British Columbia, Ontario, and Alberta. - Land area per 1000 persons (Square km.) for selected cities (Vancouver, Toronto, Calgary, Ottawa, Montreal) indicates land supply constraints. ### External sector and trade competitiveness - Lower oil prices slashed energy export value; current account weakened amid a wider trade deficit (Figure 6). - Contributions to Current Account (In percent of GDP) display declines in merchandise trade and current account balance over 2010–2015. - Export value and foreign demand indices (2007Q4=100) show energy commodity exports down while non-commodity exports and foreign activity measure presented. - Real exports growth (Y/Y percentage change) split into Non-energy and Energy series (Dec-10 to Dec-15). - Canada's share in the U.S. non-fuel import market has declined since 2002 due to changes in product-specific market shares and shifts in U.S. demand; cumulative change in Canada's share shown. - Exchange rate depreciation helped boost non-energy exports, but with a delay due to lost competitiveness within product categories. - Real and Nominal Effective Exchange Rates (2005 = 100) and USD/CAN exchange rate series are shown. ### Monetary and financial market conditions - Inflation rate and one-year-ahead expectations: inflation expectations well-anchored at around 2 percent (Figure 7). - Monetary policy: two policy rate cuts in 2015; policy rate and expected rate series shown (estimated rate as of May 2016 using Bloomberg's WIRP). - Yield curve shifted down; Canada: Yield Curve (benchmark bond yields, percent) and 10-Year Government Bond Yields (Percent) series presented. - Effective borrowing costs for households and businesses remain low; effective interest rates and spreads (household borrowing rate spreads, business borrowing rate spreads, corporate bond spreads) displayed, with recent increases in spreads. ### Structural policies and innovation - Generous R&D tax incentives are given to SMEs; R&D tax incentives for small and large firms (Tax subsidy rate as percent of user cost of R&D) shown for 2015. - Private R&D expenditure is relatively low for the economy as a whole; R&D support and expenditure (In percent of GDP, 2014) and fiscal support to private business R&D series provided. - Public expenditure on labor training programs (Percent of GDP) across OECD countries shows room to increase publicly funded training. - Service trade restriction indices (Air Transport, Broadcasting, Telecom, Distribution) indicate areas of relative openness/closure compared to OECD averages. - SMEs have higher share in the economy but are less productive compared to large firms; labor productivity by firm size (2008) and product/process innovation by firm size presented. ### Key macroeconomic projections and indicators (selected figures preserved exactly as in source) - Recommendation on timing: next Article IV consultation to take place on the standard 12-month cycle. - Table 1 selected indicators, 2012–17 (percentage changes or levels as shown): - Real GDP: 2012: 1.7; 2013: 2.2; 2014: 2.5; 2015: 1.2; 2016: 1.7; 2017: 2.2 - Unemployment rate (average): 2012: 7.3; 2013: 7.1; 2014: 6.9; 2015: 6.9; 2016: 7.4; 2017: 7.5 - CPI inflation (average): 2012: 1.5; 2013: 0.9; 2014: 1.9; 2015: 1.1; 2016: 1.4; 2017: 2.0 - Gross domestic investment: 2012: 24.9; 2013: 24.6; 2014: 24.3; 2015: 23.8; 2016: 23.1; 2017: 23.1 - Current account balance (percent of GDP): 2012: -3.6; 2013: -3.2; 2014: -2.3; 2015: -3.3; 2016: -3.4; 2017: -3.0 - Nominal GDP (2015): Can$ 1,986 billion (US$ 1,553 billion); GDP per capita (2015): US$ 43,316; Population (2015): 35.8 million - Table 2 (Balance of Payments, percent of GDP and projections 2014–21 highlights): - Current account balance: 2014: -2.3; 2015: -3.3; 2016: -3.4; 2017: -3.0; 2018: -2.7; 2019: -2.5; 2020: -2.3; 2021: -2.2 - Exports, goods (percent of GDP): 2014: 26.8; 2015: 26.4; 2016: 25.7; 2017: 26.0; 2018: 26.3; 2019: 26.6; 2020: 26.9; 2021: 27.2 - Export volume growth (percentage change): 2014: 5.7; 2015: 3.4; 2016: 3.1; 2017: 3.5; 2018: 4.0; 2019: 4.0; 2020: 4.0; 2021: 4.1 - Imports, goods (percent of GDP): 2014: 26.6; 2015: 27.6; 2016: 27.2; 2017: 27.2; 2018: 27.2; 2019: 27.3; 2020: 27.4; 2021: 27.6 - Terms of trade (percent change): 2014: -1.3; 2015: -6.9; 2016: -4.1; 2017: 1.1; 2018: 0.6; 2019: 0.5; 2020: 0.4; 2021: 0.1 - Table 4 (Medium-Term Scenario 2013–21 highlights): - Real GDP: 2013: 2.2; 2014: 2.5; 2015: 1.2; 2016: 1.7; 2017: 2.2; 2018: 2.0; 2019: 2.0; 2020: 2.0; 2021: 2.0 - Unemployment rate: 2013: 7.1; 2014: 6.9; 2015: 6.9; 2016: 7.4; 2017: 7.5; 2018: 7.3; 2019: 7.1; 2020: 6.9; 2021: 6.7 - CPI inflation: 2013: 0.9; 2014: 1.9; 2015: 1.1; 2016: 1.4; 2017: 2.0; 2018: 2.0; 2019: 2.0; 2020: 2.0; 2021: 2.0 - General government gross debt (percent of GDP): 2013: 86.1; 2014: 86.2; 2015: 91.5; 2016: 92.6; 2017: 91.0; 2018: 89.3; 2019: 87.3; 2020: 85.3; 2021: 83.1 - Table 5 (General Government Fiscal Indicators, 2013–21 highlights): - Consolidated General Government overall balance (percent of GDP): 2013: -1.9; 2014: -0.5; 2015: -1.7; 2016: -2.8; 2017: -2.4; 2018: -2.1; 2019: -1.7; 2020: -1.4; 2021: -1.1 - Net public debt (percent of GDP): 2013: 29.4; 2014: 28.1; 2015: 26.7; 2016: 27.8; 2017: 26.2; 2018: 24.5; 2019: 22.5; 2020: 20.5; 2021: 18.3 - Table 6 (Financial Soundness Indicators, selected 2015 levels): - Total assets (billions of Canadian dollars): 2015: 4,657.4; Percent of GDP: 233.3 - Tier 1 ratio: 2015: 12.1; Total capital ratio: 2015: 14.2 - NPLs to Gross Loans: 2015: 0.5; Return on equity: 2015: 20.7 - Liquid assets to total assets: 2015: 11.4; Customer deposits to loans: 2015: 101.1 - FX loans to total loans: 2015: 33.4; FX liabilities to total liabilities: 2015: 48.4 ### Policy implications and considerations (drawn from analysis in figures and tables) - Macroeconomic policy should account for continued drag from low energy prices and regionally uneven adjustment needs, particularly for resource provinces facing sharp declines in activity and employment. - Financial-sector monitoring is warranted given increased energy-sector impairments, significant exposures to resource provinces, and rising spreads despite low funding costs. - Housing vulnerabilities in Toronto and Vancouver and high household indebtedness in British Columbia, Ontario, and Alberta suggest a need for targeted macroprudential vigilance and consideration of supply-side measures (land supply constraints highlighted). - Structural policies to boost productivity and competitiveness include incentivizing private R&D beyond current SME-focused tax generosity, reducing service-sector trade restrictions in selected sectors, and expanding publicly funded training. *Source: IMF staff report content as provided in the supplied PDF extract.* ### 1. Colors are based on Z-scores, which are calculated on the annual growth rate of nominal house prices, real residentia ### _cr16146 - 1. Colors are based on Z-scores, which are calculated on the annual growth rate of nominal house prices, real residentia ### Data, indicators, and methodology - Colors are based on Z-scores, which are calculated on the annual growth rate of nominal house prices, real residential investment, real residential mortgage loans, on the trend of household debt-to-GDP ratio, and on the level of sales to new listing index. - House prices and sales-to-new listing ratios are those for major cities in the sample provinces, while the other variables are those for provinces. - The data are quarterly, and the sample period is from Q1 1995 to Q4 2015. - Total index is calculated using the principal component methodology. - Z-score range shown: -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 (as presented: -1.5-1.0-0.50.00.51.01.5 z-score) ### Annex I — Traction of Past Fund Advice - Monetary policy: Bank of Canada has continued to maintain an accommodative monetary policy stance to support growth, consistent with Fund recommendations in the 2014 Article IV consultations. - Macroprudential policy: Authorities have tightened macroprudential measures to contain risks in the housing sector. - Fiscal policy: Fiscal policy has become more supportive of growth. - Financial sector oversight: Significant progress has been made in implementing the 2013 FSAP recommendations, but there has been less traction with regard to the recommendation on the institutional framework for macroprudential oversight and regulatory independence. ### Annex II — External Balance Assessment (Canada) - Foreign asset and liability position and trajectory - Background: - Canada posted a positive net international investment position (NIIP), which rose to C$471.9 billion by end-2015, equivalent to 23.8 percent of GDP. - The increase in foreign liabilities exceeded the increase in foreign assets by C$55 billion; the gain in the NIIP resulted entirely from valuation effects of a weaker Canadian dollar. - Gross external debt rose by 18.9 percentage points to 108.9 percent of GDP between 2014 and 2015. - Banks and other private sector hold 71 percent of the external debt, of which a half is short-term. - Assessment: - The NIIP is sustainable with limited near term risk. - External debt has risen sharply but remains modest relative to other advanced economies. - Canada’s foreign assets provide a hedge against currency depreciation. - Overall assessment summary: - The external position in 2015 was moderately weaker than implied by medium-term fundamentals and desirable policy settings. - The depreciation of the currency has helped improve Canada’s external competitiveness, but it will take time for the economy to adjust to the structural reallocation of resources from the energy to the non-energy sector. - Recent developments do not suggest a change in the assessment of the external position in 2015. - In the medium term, the external position is expected to strengthen as non-energy exports gradually benefit from improved price competitiveness and structural improvements in manufacturing capacity. - Potential policy responses: - Significantly boosting Canada’s non-energy exports would require addressing a variety of structural issues in manufacturing and promoting the development of services exports. - Policies that could improve Canada’s trade competitiveness include: - measures geared at improving labor productivity; - investing in R&D and physical capital; - promoting FDI; and - diversifying Canada’s export markets. - A credible medium-term consolidation plan for fiscal policy will also support the external rebalancing. - Current account - Background: - Canada’s current account (CA) deteriorated from -2.3 percent of GDP in 2014 to -3.3 percent of GDP in 2015. - Despite a sharp depreciation of the Canadian dollar (30 percent in the past two years) and a compression in imports, a broad-based pickup in non-energy exports did not materialize to offset the decline in oil exports. - Manufacturing capacity was eroded during the oil boom years (2002-2012) when the real effective exchange rate appreciated by 57 percent. - In terms of the savings-investment balance (S-I), the deterioration in the CA was consistent with a worsening of both the general government S-I balance (by 0.6 percentage points) and the private sector’s S-I balance (0.5 percentage points). - Assessment: - The EBA estimates a cyclically adjusted CA gap of -3.4 percent of GDP for 2015. - Staff assesses that the CA gap is between -2 and -1 percent of GDP. - Real exchange rate - Background: - Canada’s exchange rate is highly correlated with oil prices. - The real effective exchange rate has depreciated by 8.4 percent on an annual average basis between 2014 and 2015. - As of April 2016, the REER has remained stable at its average 2015 level. - Assessment: - Both the EBA REER index and level approaches estimate the currency to be undervalued, by 9.9-19.6 percent respectively in 2015. - Staff notes the extent of undervaluation could be exaggerated because: - given Canada’s lost manufacturing capacity, further depreciation may be needed to restore competitiveness; and - Canada’s competitors in the US market have also seen their currencies depreciate by similar magnitudes, thus limiting any net gain for Canada. - Given the CA gap, staff estimates that the real effective exchange rate is, in fact, overvalued by 0 to 5 percent relative to medium-term fundamentals and desirable policy settings. - Capital and financial accounts: flows and policy measures - Background: - The CA deficit in 2015 has been financed primarily by net portfolio inflows. - Foreign holdings of Canadian stocks declined largely due to stock market capital losses, but this was offset by an increase in foreign holdings of corporate bonds. - Nearly three-quarters of corporate bonds held by non-residents are denominated in foreign currencies compared with one-third of government bonds, and are therefore more sensitive to currency fluctuations. - Foreign direct investment recorded a net outflow in 2015. - Assessment: - Canada has a fully open capital account. - Vulnerabilities are limited by a credible commitment to a floating exchange rate and a strong and credible fiscal position. - FX intervention and reserves level - Background: - Canada has a free floating exchange rate regime, and it has not intervened in the foreign exchange market since September 1998 (with the exception of participating in internationally concerted interventions for other purposes). - Canada has limited reserves but its central bank has standing swap arrangements with the U.S. Federal Reserve and four other major central banks (it has not drawn on these swap lines in the past). - Assessment: - Policies in this area are appropriate to the circumstances of Canada. ### Technical background notes (selected) - Reasons why Canada’s CA norm may be below EBA’s estimated CA norm: - The EBA model adjusts for the business cycle using Canada’s output gap relative to the world (GDP-weighted average) output gap, while a more relevant measure for Canada is the output gap relative to the United States. Using the US as the benchmark would reduce the CA norm for Canada because the output gap for the United States is slightly larger (more negative) than the world output gap. - The EBA overestimates Canada’s trade balance by using the WEO global oil prices rather than the lower market price for Canadian oil, particularly, heavy crude oil from western Canada’s oil sands (the lower price reflects lower quality). - The EBA does not take into account the structural loss in trade competitiveness. - Reasons why the EBA REER approach may not fully capture loss in Canada’s structural competitiveness: - The approach includes commodity terms of trade rather than oil prices as an explanatory variable. Canada’s REER has mirrored movements in oil prices much more closely than its commodity terms of trade. - Protracted structural rebalancing in the non-energy sector, in conjunction with a long-term erosion of market share among US imports, imply a less competitive economy than the EBA fit could account for. - While Canada’s currency has depreciated versus the US dollar, so have the currencies of some of its key competitors on the US market, like Mexico. Estimates of an adjusted REER that take account of Canada’s relative competitiveness in third markets suggest that Canada’s REER has depreciated considerably less than the unadjusted REER. - The EBA’s estimated REER gap would thus be smaller (less negative). More than half the gain in price competitiveness is undone when competitors are taken into account. - Reference cited in the source text: Barnett, Charbonneau and Poulin-Bellisle, “A New Measure of the Canadian Effective Exchange Rate”, Bank of Canada Staff Discussion Paper 2016-1. *Source: IMF staff report content provided in the supplied PDF excerpt.* ### Annex III. Public Debt Sustainability Analysis ### Annex III. Public Debt Sustainability Analysis ### Baseline outlook and key projections - Gross debt-to-GDP ratio: - Will peak at about 93 percent in 2016 and gradually decline to 83 percent by 2021. - General government primary balance: - Projected to increase to 2 percent of GDP in 2016 and decline to 1 percent by 2021 under fiscal consolidation. - Net debt-to-GDP ratio: - Stood at 27 percent in 2015 (authorities’ definition which includes a wider coverage of assets). - If only highly-liquid assets (currency, deposits, and bonds) are included, net debt was around 62 percent in 2015. - Net debt is expected to decline from 27 percent to below 20 percent by 2021. - Gross financing needs: - Around 20 percent (described as high but manageable) and will decline to below 18 percent by the end of the projection period. - Effective interest rates: - Will stay at historic lows. ### Stress tests — scenarios and impacts - Primary balance shock: - A deterioration of the primary balance of about one percent of GDP would raise the gross debt-to-GDP ratio by about 2–3 percentage points over the projection period. - Sovereign risk premium is assumed to increase by 25 basis points for each one percent of GDP deterioration in the primary balance. - Resulting higher gross financing needs of 2–3 percentage points of GDP compared to the baseline. - Growth shock: - A lower real GDP growth by one standard deviation for two years starting in 2017 and 2018 leads to a sharp deterioration in the primary balance, reaching a 4 percent deficit at its peak in 2018. - Gross debt-to-GDP ratio will reach 95 percent of GDP in 2018, then revert to a downward path over the projection period. - Gross financing needs will also be larger. - Interest rate shock: - An increase in the sovereign risk premium by 200 basis points for two years would raise the effective interest rate ½–¾ percentage points higher than the baseline. - The impact on debt and gross financing needs are mild. - Exchange rate shock: - Minimal fiscal impact because almost 90 percent of Canada’s outstanding marketable debt instruments are in Canadian dollars. - Noted substantial exchange rate depreciation of about 33 percent since 2014, yet fiscal impact remains minimal. - Stagnant growth scenario: - If downside risks materialize and GDP growth falls below baseline by ½–1 percentage points for the projection horizon, the gross debt-to-GDP ratio will stay flat at the current level and will not decline. - Housing market and contingent fiscal shock: - Severe recession: real GDP reduced by two standard deviations for three years (to -1½ percent), precipitating a housing market crash. - Assuming 5 percent of the outstanding amount of government-backed insurance is called, the government’s non-interest expense would increase by the equivalent to 1¾ percent of GDP. - Debt-to-GDP ratio would rise above 100 percent of GDP while gross financing needs would reach 25 percent of GDP at its peak. - The debt ratio would decline only in 2020. - Combined and additional stress tests summarized (selected values preserved in scenario tables): - Under the Combined Shock, Primary balance in 2017 and 2018 reaches -3.4 and -4.1 percent respectively; Effective interest rate rises to 3.6 in 2018 and to 3.9 by 2021. - Under the Real GDP Growth Shock, Real GDP growth falls to 0.4 in 2017 and 0.3 in 2018; Primary balance reaches -3.6 in 2018. ### Financial assets and buffers - General government financial assets: - Stood at about 65 percent of GDP in 2015. - Of these, about 45 percent (30 percent of GDP) were highly-liquid assets (deposits, short-term papers, and bonds). - Mortgage insurers and contingent buffers: - CMHC and private mortgage insurers’ earnings and loss absorption capacity mitigate fiscal impact of mortgage insurance losses. - Capitalization under Minimum Capital Test (MCT): - CMHC holds 365 percent of capital available over the minimum capital required. - Genworth holds 234 percent. - CMHC stress test result example: - Under severe global deflation stress (unemployment rises to nearly 16 percent and house prices fall by 44 percent), CMHC’s capital would be depleted to 147 percent of MCT, remaining above the regulatory requirement of 100 percent. - CMHC conducts annual stress tests to set capital levels. ### Debt accounting and comparability - Recent increase in public debt: - Has been driven in part by policy to fund public sector employee pension plans by issuing new debt. - Unfunded pension liabilities: - General government debt as reported here does not include unfunded pension liabilities to allow consistent international comparison. - If unfunded pension liabilities are included, general government debt would be 109 percent of GDP on a gross basis, and 44 percent of GDP on a net basis in 2015. ### DSA numerical highlights and indicators (select figures from IMF staff projections and tables) - As of May 04, 2016 (selected table entries): - Nominal gross public debt: 76.5 (2014), 86.2 (2015), 91.5 (2016), 92.5 (2017), 90.9 (2018), 89.3 (2019), 87.4 (2020), 85.3 (2021), 83.1 (projection endpoint). - Public gross financing needs: 15.6 (2014), 17.6 (2015), 16.2 (2016), 19.7 (2017), 19.9 (2018), 18.9 (2019), 18.5 (2020), 18.3 (2021), 17.7 (projection endpoint). - Net public debt: 25.6 (2014), 28.1 (2015), 26.7 (2016), 27.7 (2017), 26.2 (2018), 24.5 (2019), 22.6 (2020), 20.5 (2021), 18.3 (projection endpoint). - Real GDP growth (percent): 1.8 (2014), 2.5 (2015), 1.2 (2016), 1.7 (2017), 2.2 (2018), 2.0 (2019), 2.0 (2020), 2.0 (2021). - Inflation (GDP deflator, percent): 2.2 (2014), 1.8 (2015), -0.5 (2016), 0.3 (2017), 2.3 (2018), 2.2 (2019), 2.2 (2020), 2.1 (2021), 2.0 (endpoint). - Nominal GDP growth (percent): 4.0 (2014), 4.3 (2015), 0.6 (2016), 2.0 (2017), 4.5 (2018), 4.3 (2019), 4.2 (2020), 4.2 (2021), 4.0 (endpoint). - Effective interest rate (percent): 5.3 (2014), 3.9 (2015), 3.6 (2016), 3.2 (2017), 3.3 (2018), 3.2 (2019), 3.2 (2020), 3.1 (2021), 3.1 (endpoint). - Contributions to change in gross public sector debt (selected flows, percent of GDP cumulative): - Change in gross public sector debt (cumulative projection): 1.5 (2005–2013 actual), 0.1 (2014), 0.5 (2015), 3.1 (2016), 1.0 (2017), -1.6 (2018), -1.6 (2019), -1.9 (2020), -2.1 (2021), -8.3 (cumulative). - Identified debt-creating flows (cumulative projection): 1.3 (2005–2013), 0.2 (2014), 0.4 (2015), 7.3 (2016), 2.1 (2017), 1.0 (2018), 1.0 (2019), 0.8 (2020), 0.5 (2021), 0.3 (cumulative). - Primary deficit (percent of GDP, yearly): 0.5 (2005–2013 actual), 0.0 (2014), 0.7 (2015), 2.1 (2016), 2.1 (2017), 1.9 (2018), 1.6 (2019), 1.4 (2020), 1.1 (2021), 10.3 (cumulative). - Automatic debt dynamics (percent of GDP cumulative): 0.8 (2005–2013), 0.2 (2014), 0.4 (2015), 0.1 (2016), -1.1 (2017), -1.0 (2018), -0.9 (2019), -0.9 (2020), -0.8 (2021), -3.5 (cumulative). - Interest rate/growth differential (percent cumulative): 0.9 (2005–2013), -0.3 (2014), 2.6 (2015), 1.1 (2016), -1.1 (2017), -1.0 (2018), -0.9 (2019), -0.9 (2020), -0.8 (2021), -3.5 (cumulative). - Residual, including asset changes (percent of GDP cumulative): 0.2 (2005–2013), -0.1 (2014), 0.6 (2015), -2.2 (2016), -2.5 (2017), -2.6 (2018), -2.7 (2019), -2.6 (2020), -2.5 (2021), -15.1 (cumulative). ### Policy-relevant implications (from analysis and stress tests) - Debt sustainability: - Canada’s public debt remains on a sustainable trajectory over the medium term under the baseline, with gross debt-to-GDP peaking near 93 percent and declining thereafter. - Debt dynamics are sensitive to adverse growth shocks; significant shocks (e.g., housing market contingent liabilities) can push gross debt above 100 percent of GDP. - Role of financial assets and buffers: - Large general government financial assets (about 65 percent of GDP) and well-capitalized mortgage insurers (CMHC and Genworth) provide significant buffers against shocks. - Fiscal risks and pension funding: - Issuance of new debt to fund public sector pension plans has increased public debt; inclusion of unfunded pension liabilities materially raises reported gross and net debt measures. - Market and currency exposure: - Limited exposure to foreign currency debt (about 10 percent marketable debt in foreign currency) reduces exchange rate shock vulnerability. - Policy takeaway: - Maintaining fiscal consolidation to return primary balance toward surplus or smaller deficits supports continued debt reduction under the baseline, while vigilance is warranted for downside risks, especially contingent liabilities from housing-related guarantees and pension-related funding decisions. *Source: IMF staff — Annex III. Public Debt Sustainability Analysis (Canada).* ### Annex V. Housing-Related Measures to Safeguard Financial ### Annex V. Housing-Related Measures to Safeguard Financial Stability ### Changes in Mortgage Insurance Rules (Table 1) - Maximum amortization for new government backed insured mortgages was lowered (from 40 to 35 years) - Maximum LTV for new mortgages was reduced (from 100 to 95 percent) - Minimum credit score requirement (of 620) was introduced - Maximum of 45 per cent total debt service ratio was introduced (the amount of gross income that is spent on servicing debt and housing-related expenses such as heat or condo fees) - Loan documentation standards strengthened to ensure reasonableness of property value and of the borrower's sources and level of income - Maximum LTV for insured refinanced mortgages was lowered (from 95 to 90percent) - Minimum down payment on properties not occupied by owner was raised (from 5 to 20 percent) - More stringent eligibility criteria were introduced (all borrowers are required to meet the standards for a 5-year benchmark fixed-rate mortgage, even if they choose a mortgage with a variable interest rate and shorter term) - Maximum amortization for new government backed insured mortgages was lowered (from 35 to 30 years) - Maximum LTV for refinanced mortgages was lowered (from 90 to 85 percent) - Government-backed insurance on non-amortizing lines of credit secured by houses (HELOCs) withdrawn in April - Maximum amortization for new government backed insured mortgages was lowered (from 30 to 25 years) - Maximum LTV for refinanced mortgages was lowered (from 85 to 80 percent) - Maximum gross debt service ratio and maximum total debt service ratios were capped at 39 percent and 44 percent, respectively - Government-backed insured mortgages limited to homes with a purchase price of less than $1 million - February 2014 (effective in May 2014): Mortgage insurance premiums were raised - Residential Mortgage Insurance Underwriting Practices and Procedures (Guideline B21) was issued. This guideline: - outlines OSFI’s expectations concerning mortgage insurers’ governance and internal risk management practices - outlines principles for mortgage insurers’ own internal underwriting operations, including setting prudent requirements for lenders and applying appropriate due diligence to lenders’ practices - enhances disclosure requirements, which will support greater transparency, clarity and public confidence in mortgage insurers’ residential mortgage insurance underwriting practices - April 2015 (effective in June 2015): Mortgage insurance premiums were raised - December 11, 2015 (effective in February 2016): The minimum down payment for new insured mortgages increased from 5 to 10 percent for the portion of the house price above $500,000. The 5 percent minimum down payment for properties up to $500,000 remained unchanged - December 11, 2015 (effective in July 2016): Issuance limits for NHA MBS in 2016 will be kept effectively unchanged as part of the ongoing effort to limit government involvement in the mortgage market - December 11, 2015 (effective in July 2016): Guarantee fee for NHA MBS and the CMB program will be increased to encourage the development of private market funding alternatives by narrowing the funding cost difference between government sponsored and private market funding sources - July 2008 (effective in October 2008); February 2010 (effective in April 2010); January 2011 (effective in March 2011); June 2012 (effective in July 2012); November 2014 (full implementation by June 30, 2015): (see timeline of measures above) ### Other Housing Finance Related Regulatory Measures (Table 2) - Protection of Residential Mortgage Hypothenar Insurance Act (PRMHIA) and amendments to the National Housing Act assented: - Formalizes the rules for government-backed mortgage insurance and other existing arrangements with private mortgage insurers - Provision for the Minister of Finance to charge fees to compensate the Government for its exposure to risk represented by loan insurance - November 2011/January 2012: FIRS standards were implemented requiring banks to report debt securitizations on balance sheet - Economic Action Plan 2012 announcements: - Canadian banks prohibited from issuing covered bonds backed by government-insured mortgages (sets strong eligibility criteria for mortgages in the cover pool) - CMHC designated as administrator of the covered bond framework - CMHC's mandate was enhanced to include financial stability as an objective of CMHC's commercial activities - CMHC commercial activities subject to OSFI examination - Guideline on Sound Residential Mortgage Underwriting Practices (B-20): - A guideline for residential mortgage underwriting practices and procedures was issued by OSFI (including assessment of borrower’s background and demonstrated willingness to service debt payment in a timely manner, assessment of borrower’s capacity to service debt, assessment of property value/collateral, effective credit and counterparty risk management, comprehensive residential mortgage underwriting policy) - Maximum LTV on the revolving portion of HELOCs cut (from 80 to 65 percent) - Stated Income mortgages are no longer allowed without some verification of income - Economic Action Plan 2014 announcements: - CMHC will pay guarantee fees to the Receiver General to compensate for mortgage insurance risks (pursuant to NHA 8.2), effective January 1, 2014. Fees are 3.25 percent of premiums written and 10 basis points on new portfolio insurance written - CMHC will reduce its annual limit of issuance of portfolio insurance from $11 billion to $9 billion - For 2014, the Minister of Finance authorized $80 billion for NHA MBS (down from $85 billion in 2013) and $40 billion for CMB (down from $50 billion in 2013) - Revised Minimum Capital Test Guideline for property and casualty insurers: - The guideline introduces new and updated risk factors and margins plus a revised definition of available capital (May 15, 2015) - Amendments to PRMHIA: Substitution of loans in portfolio insurance pools was prohibited to increase market discipline in residential lending and reduce taxpayer exposure to the housing sector - CMHC announced changes to its securitization programs: - Changes in the guarantee fee schedule (effective July 1, 2016). Fees were raised for large MBS issuers - For 2016, the Minister of Finance authorized $105 billion for NHA MBS and $40 billion for CMB - OSFI announced its plan to update the regulatory capital requirements for residential mortgages: - OSFI will propose a risk-sensitive floor for one of the model inputs (losses in the event of default) that will be tied to increases in local property prices and/or to house prices that are high relative to borrower incomes - For federally regulated private mortgage insurers, OSFI will introduce a new standardized approach that updates the capital requirements for mortgage guarantee insurance risk. It will require more capital when house prices are high relative to borrower incomes - February 10, 2016 (effective July 1, 2016): The DOF required that portfolio-insured loans be funded only through CMHC securitization programs - Other dated measures: December 11, 2015; June 2011 (effective on January 1, 2013); March 2012; June 2012; February 2014; September 2014 (effective on January 1, 2015) ### Implementation of 2014 FSAP Key Recommendations (Annex VI) - Recommendation: Reduce government exposure to mortgage insurance gradually. Time Frame: Long term - Update: The authorities introduced a range of measures over the past several years, including more recently in December 2015 (see Section D in the main text). - Recommendation: Include major regulated entities at federal and provincial level in a regular, common stress testing exercise with collaboration between relevant federal and provincial authorities. Time Frame: Short term - Update: The Bank of Canada has provided quantitative scenarios, detailed macro stress testing instructions, advice and technical assistance to the Autorité des Marchés financiers (AMF) (Quebec). The Bank also had detailed technical discussions related to macro stress testing capacity building with the British Columbia Financial Institutions Commission. - Recommendation: Equip OSFI with powers to make its own enforceable rules by administrative means; amend legislation to give OSFI sole decision-making authority on prudential criteria. Time Frame: Medium term - Update: The authorities do not intend to pursue this recommendation. - Authorities’ response: “OSFI’s administrative guidelines are enforceable in practice because its numerous intervention powers and tools are legally enforceable. OSFI’s use of guidelines provides OSFI with the ability to act independently and quickly in the face of emerging risks.” - Recommendation: Replace certain informal and ad hoc reporting requirements by FRFIs with more formal requirements. Time Frame: Medium term - Update: Use of the Regulatory Data Governance Framework to prioritize regulatory data requirements and lifecycle management. In 2016, the existing ad hoc collection of Own Risk and Solvency Assessment (ORSA) Key Metrics will be replaced with a formal regulatory return. - Recommendation: Adopt a transparent and consistent regulatory regime for group-wide insurance supervision; give OSFI authority to take measures at holding company level. Time Frame: Medium term - Update: The authorities do not intend to pursue this recommendation. - Authorities’ response: “Canada is satisfied with OSFI’s current approach to group-wide supervision of the largest insurance companies and will not be seeking legislative amendments.” - Recommendation: Augment OSFI’s top-down stress testing framework for banks with risk-sensitive credit risk inputs and econometric, model-based efforts using longer time series. Time Frame: Short term - Update: The authorities will consider this in the future, as the stress testing framework evolves. - Recommendation: Expand financial sector data collection and dissemination to enhance coverage, regularity, and availability of time-series. Time Frame: Short term - Housing Finance updates: - In 2015, the Department of Finance (DOF) started to regularly collect loan-level data from Canada’s three mortgage insurers on quarterly loan originations covering borrower attributes, dwelling characteristics, and mortgage-loan terms. It is shared with the Bank and OSFI to help agencies conduct policy analysis. DOF is reaching out to industry to obtain loan-level origination data from federally unregulated mono-line mortgage lenders and exploring means to better quantify and understand foreign investment in residential real estate. - Statistics Canada will conduct a triennial Survey of Financial Security and annual estimates of household asset and debt distributions with an enhanced focus on mortgage debt. - Discussions on data availability and gaps are ongoing amongst Senior Advisory Committee agencies and CMHC. In 2015, CMHC held a series of round tables to obtain industry views on data gaps and solutions. - CMHC has expanded publicly available information via its Quarterly Financial Reports and expanded coverage of its surveys. In 2015, CMHC published findings from the survey of foreign ownership of condos in 16 Census Metropolitan Areas and in 2016, CMHC will begin collecting data on sales to foreign buyers in Toronto, Montreal and Vancouver through its starts and completions surveys. - Fixed-Income Markets updates: - The Bank and IIROC have implemented a new version of the Market Trade Reporting System (MTRS) to collect transaction-level data from all IIROC-registered broker-dealers, including prices, quantities and counterparties of all bond, bill and repo trades. IIROC collects the data and will pass a subset to the Bank. MTRS will replace the Bank’s former aggregate-level trade reporting system to be decommissioned in 2016. - Canadian Securities Administrators (CSA) in September 2015 proposed that trade information for all corporate debt securities executed by dealers be made publicly available, subject to delayed dissemination and volume caps, by the end of 2017. The CSA intends to use MTRS data. The public consultation period for the CSA notice ended in November. - OTC Derivatives Trade Reporting: Provincial rules in Manitoba, Ontario and Québec since October 1, 2014 require most OTC derivatives transactions involving a “local counterparty” to be reported to a designated trade repository (DTTC; CME; and ICE TV). Public dissemination of market data is set to begin on January 16, 2017, subject to ministerial approval. Other provinces published a similar rule expected to come into force on May 1, 2016, subject to ministerial approval. Counterparties expected to start reporting before July 29, 2016. - Recommendation: Address shortcomings in risk identification and enforcement in securities regulation. Time Frame: Short term - Update: In July 2015, the Council of Ministers announced Mr. William A. Black as chair of the Capital Markets Regulatory Authority’s initial board. In August 2015, participating jurisdictions released an updated consultation draft provincial and territorial capital markets legislation and draft initial regulations for public comment; comments are being assessed. - Recommendation: Enhance supervisory cooperation among federal and provincial supervisors and subject all systemically significant financial institutions to intensive supervision. Time Frame: Short term - Update: OSFI and the AMF have instituted a new cooperation framework with regularly scheduled meetings. - Recommendation: Provide a clear mandate to an entity to monitor systemic risk and carry out system-wide crisis preparedness. Time Frame: Short term - Update: The authorities do not intend to pursue this recommendation. - Authorities’ response: Responsibility for addressing systemic risk remains with the Senior Advisory Committee, a non-statutory body chaired by the Deputy Minister of Finance. - Recommendation: Increase the ex-ante funding of CDIC and enhance its data collection and analysis of depositor profiles. Time Frame: Medium term - Update: The minimum target level of CDIC’s ex ante funding is 100 basis points of insured deposits. CDIC continues to progressively increase its ex ante fund to reach this target. ### Trade Competitiveness in Canada (Appendix I — Study overview and methodology) - Motivation: - Conventional wisdom: Canada’s non-energy exports were held back primarily because the commodity boom led to a real appreciation of the Canadian dollar (‘Dutch disease’). - Noted sector impacts: forestry products and motor vehicles and parts together account for almost three quarters of Canada’s lost share on the U.S. non-energy imports market during 2002–2014. - Research question: Whether structural factors also explain weak performance of Canadian manufacturing exports since 1997 and whether recent depreciation alone is sufficient to regain competitiveness. - Approach: - The study (Agur, 2016) estimates an export supply regression spanning 8 product categories and 10 provinces over a 17 year sample period (from 1997 to 2014). - Rationale for granular panel: (i) captures divergent provincial trends within the same industry (example: industrial machinery doubled in Quebec since 2003 while unchanged in Ontario); (ii) all provinces trade abroad at the same exchange rate, allowing identification of differences in structural factors affecting competitiveness. - Methodology: - Dependent variable: real export growth. - Independent variables: wages and export prices (relative cost of producing a unit of export good), labor productivity (production efficiency frontier), variables related to physical and human capital formation (availability and quality of factors of production). - To mitigate multicollinearity among capital formation variables, factor analysis is applied to extract a common factor “capital investment” representing physical and human capital accumulation. - The elasticity estimate for capital investment and separate estimates of variables representing this joint factor are reported in the results. Estimation results of the panel regressions are shown in the source table. *Source: _cr16146 - Annex V. Housing-Related Measures to Safeguard Financial Stability (IMF).* ### 4. Panel regression results. Our results show that cost and efficiency, namely relative prices, ### _cr16146 - 4. Panel regression results. Our results show that cost and efficiency, namely relative prices, ### Panel regression findings on competitiveness - Cost and efficiency variables—relative prices, real wages, and labor productivity—have a strong impact on Canada’s trade competitiveness (Table 1). - The relative price of exports is the variable with the largest impact; Canada’s non-energy export performance is quite sensitive to the value of the Canadian dollar. - Exchange rate movements take time to pass on to prices. - Reduced input costs (lower wages) and increased output efficiency (labor productivity) also significantly affect export performance, but: - Wages and labor productivity are slower moving variables. - Their impact on export growth is quantitatively smaller than for exchange rates. - Conclusion: Improving manufacturing export growth requires more than price competitiveness alone. ### Structural variables and policy implications - Collective effect of capital investment: - A 1 percentage point higher growth of capital investment as a whole translates to almost 2 percentage points more rapid real export growth. - Breakdown of capital-investment components and implications: - Physical capital (machinery, factories, etc.): - Has the largest impact among capital factors, with a 1 to 1 increase on real export growth. - Well-targeted projects, especially in infrastructure development, could stimulate (“crowd in”) business investment and improve competitiveness. - In the long run, capital accumulation is a key determinant of labor productivity and can indirectly raise export growth by lifting labor productivity. - R&D spending by businesses: - A 1 percentage point rise in R&D brings about 0.5 percentage point faster export growth. - Company spending on innovation and capacity to innovate continue to score well below levels in the U.S. - “Insufficient capacity to innovate” is ranked as Canada’s most problematic factor for doing business (World Economic Forum 2015–2016 report). - Inward FDI: - A 1 percentage point increase in inward FDI raises export growth by 0.25 percentage point. - Education and training: - Given the already high level of education in Canada, more specialized or job-specific vocational training could effectively improve job skills and job matching in manufacturing. - Government investment: - Has the lowest impact and is not significant; likely captures residual impact of government investment beyond infrastructure investment. - Synthesis: - Exchange rate depreciation will support the rebalancing toward non-energy exports, but external competitiveness does not depend on prices alone. - Quality matters: greater investment in the capital stock, training, and firm-level innovation may raise both capacity and quality of production and exports (double dividends). ### Implications for exporting industries - Analysis draws on a Conference Board of Canada study ranking export industries by supply-side and demand-side constraints. - Key question: Which manufacturing industries are most likely to benefit from structural measures, and which structural measures are most relevant? ### Supply-constrained industries (examples and implications) - Automotive industry and wood products manufacturing: - Face relatively high U.S. demand today. - The increase in demand has been fueled by the exchange rate depreciation of the Canadian dollar over the past two years and by U.S. consumption (automotive) and U.S. residential investment (wood products). - Both sectors have limited capacity to respond because they are already operating at near 100 percent capacity. - The erosion in manufacturing capacity during the early 2000s would need to be restored to take full advantage of increased demand. - Structural reforms to expand capacity—investment in human and physical capital and measures to attract FDI—would help boost exports. *Source: INTERNATIONAL MONETARY FUND (excerpt).* ### 8. Demand constrained. Industries such as the manufacturing of metal products, industrial ### 8. Demand constrained. Industries such as the manufacturing of metal products, industrial ### Major findings on demand constraints - Several industries have ample capacity but declining global demand: manufacturing of metal products; industrial machinery; plastic and rubber products; aircraft and parts; and computer and electronic products. - Metal products: - Highly dependent on global construction demand. - Between 2002 and 2012 Canadian metal products exports to China increased eightfold. - Since the slowdown in the Chinese economy, exports have declined, leaving the industry with low capacity utilization. - Industrial machinery, plastic and rubber products, and aircraft and parts: - Dependent on US business investment, which has seen sluggish growth in recent years. - Computer and electronic exports: - Suffered a setback mainly because BlackBerry, Canada’s prime exporter, saw a deep fall in its share of the global Smartphone market. ### Worldwide Smartphone Operating System Market Share (In percent) — Source: IDC, Aug 2015 - 2015Q2: Android 82.8; iOS 13.9; Windows Phone 2.6; BlackBerry OS 0.3; Others 0.4 - 2014Q2: Android 84.8; iOS 11.6; Windows Phone 2.5; BlackBerry OS 0.5; Others 0.7 - 2013Q2: Android 79.8; iOS 12.9; Windows Phone 3.4; BlackBerry OS 2.8; Others 1.2 - 2012Q2: Android 69.3; iOS 16.6; Windows Phone 3.1; BlackBerry OS 4.9; Others 6.1 ### Empirical evidence from panel regressions (Table 2) - Dependent variable: Log Exports (lagged in model) - Key estimated coefficients (standard errors in parentheses). Significance: *** p<0.01, ** p<0.05, * p<0.1. - Baseline specification: - Relative Export Price: 2.138*** (0.184) - Capital Stock: 0.951*** (0.159) - Labor Productivity: 2.165*** (0.487) - Real Wages: -1.331*** (0.151) - R&D per industry: 0.264*** (0.0514) - R&D per province: 0.129** (0.0608) - Observations: 1,200 - Number of ID: 80 - R-squared: 0.5804 - Full specification: - Relative Export Price: 2.081*** (0.186) - Capital Stock: 0.849*** (0.247) - Labor Productivity: 2.241*** (0.572) - Real Wages: -1.506*** (0.253) - R&D per industry: 0.262*** (0.0531) - R&D per province: 0.158** (0.0681) - Vocational Training: 0.184** (0.0997) - FDI: 0.201*** (0.0408) - Energy Share of provincial GDP: -0.0148** (0.00620) - Population Density per province: 0.0587*** (0.0226) - Observations: 1,200 - Number of ID: 80 - R-squared: 0.6018 - Ex-FDI specification: - Relative Export Price: 2.418*** (0.175) - Capital Stock: 0.910*** (0.194) - Labor Productivity: 1.882*** (0.434) - Real Wages: -1.476*** (0.169) - R&D per industry: 0.344*** (0.0503) - R&D per province: 0.115* (0.0626) - Female Labor Force Participation: 0.0250** (0.0101) - Energy Share of provincial GDP: -0.0170** (0.00731) - Population Density per province: 0.0822*** (0.0219) - Observations: 1,360 - Number of ID: 80 - R-squared: 0.5706 ### Policy implications and recommended priorities - Exchange rate and commodity exposure: - Exchange rate depreciation would help tilt price competitiveness in favor of Canadian exports in demand-constrained industries. - The Canadian dollar is a commodity currency that fluctuates with the oil price; an increase in the oil price would appreciate the currency and wipe out any gain in competitiveness. - Structural measures (essential): - Improve labor productivity. - Improve innovation (R&D), especially for firms at the technological frontier, where innovative success is a prerequisite for sustained growth. - Wage restraint can support competitiveness alongside exchange rate effects. - For industries tied to capital and investment, gains from more capital stock and FDI are important. - Vocational training and R&D investment are highlighted as gains for certain industries. - Industry-specific priorities summarized in the annex figure: - Gain from more: Capital stock; FDI; Government investment. - Gain from more: Exchange rate depreciation; Wage restraint; Labor productivity. - Gain from more: R&D investment; Vocational training. *Source: _cr16146 - 8. Demand constrained. Industries such as the manufacturing of metal products, industrial machinery, plastic and rubber products, and aircraft and parts, and computer and electronic products have plenty of capacity but global demand for these products has declined._ (IMF country report material provided).* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16146.pdf_