Transcript of a Conference Call on Canada

February 3, 2014

Washington, D.C.
Monday, February 3, 2014

Roberto Cardarelli, Mission Chief for Canada, Monetary and Capital Markets Department
Aditya Narain, Head of the IMF's FSAP Mission to Canada, Western Hemisphere Department
Raphael Anspach, Communications Officer, Communications Department

MR. ANSPACH: Good morning and thank you very much for joining us today. This is Raphael Anspach from the IMF's Communication Department. This is the conference call on the staff report from the IMF's Article IV Consultations, and the Financial Sector Assessment Program with Canada.

Joining us today to speak about those reports, which I trust you had access to via our online media briefing center are Mr. Roberto Cardarelli who is the Mission Chief for the IMF on Canada, and the head of the IMF's FSAP Mission to Canada, Mr. Aditya Narain. They will have short introductory remarks and then we'll be happy to take your questions.

Let me then hand it over to Roberto and Aditya for preliminary comments. Thank you.

MR. CARDARELLI: I'll start with a quick description of the outlook. So we expect GDP to accelerate in 2014 to about 2.2 percent from 1.7 percent 2013, mainly thanks to a stronger, positive contribution from net exports as the U.S. GDP growth picks up to about 3 percent next year.

This will, of course, benefit Canada exports and will in turn have a positive effect on business investments. The pickup in export growth and business investment will offset a more moderate pace of growth of private consumption and residential investment as the housing market continues to cool off, and households gradually reduce their debt burden.

With GDP growth [accelerating slightly above potential, and with a gradual waning of the temporary factors that have pushed inflation downward , we expect inflation to slowly return to the middle of the BoC target band by the end of 2015.

Now, the risks around this outlook are predominately on the downside even though not uniquely on the downside. In particular there are risks surrounding the acceleration of external demand which is, as I said, very important for the pickup in growth in Canada.

For example, a faster than expected increase in long-term rates in the context of the exit from unconventional monetary policy in the U.S. could hurt growth prospect in the U.S., and have repercussions more globally, and of course, hurt the demand for Canadian exports. Lower than anticipated growth in emerging markets would also hurt Canada through lower commodity prices.

On the domestic front, something that we talk about in the report, it's the risk that this long period of low productivity growth and strong Canadian dollar may have left a deeper dent on Canada's export potential, limiting the economy's ability to benefit from our projected strengthening in external demand.

So against the background of low inflation, slowly growing inflation, moderation in the housing market, and these downside risks, we think that the Bank of Canada can afford to wait before beginning to raise policy rates towards more normal levels. The monetary policy stance should remain accommodative until there are firmer signs that the pickup in growth is [taking place], and especially that there is a sustainable transition from residential investment and housing spending to exports and business investments.

On a fiscal side we remain on the message we left at the time of the concluding statement, a couple of months ago. It's important to strike the right balance between supporting growth and rebuilding the fiscal space. This means different things for different levels of government.

On the federal level, we think there is room to delay the adjustment needed to return the budget to balance in 2015 if there is no meaningful pickup in growth. While the room is lower for those provinces that are finding more challenging to return to a balanced budget mainly because of disappointing economic growth so far. Some of these provinces may need to consider additional measures to return to balance, including on the revenue side.

Addressing long-term fiscal challenges remains an important priority. Long-term fiscal challenges are especially related to healthcare spending. And while important steps have been taken recently at a provincial level to limit healthcare spending growth, it is important to ensure that this recent moderation is maintained into the future, and the savings are obtained through efficiency gains rather than through only merely budget restrictions.

I'll conclude by saying that the Canadian financial sector is healthy. Authorities have continued to progress on international financial reform agenda over the past year. Still it's essential to remain vigilant against the potential risk from prolonged period of low interest rates, and there are a few areas where the resilience of Canadian financial sector could be strengthened further.

On this note I'll leave it to Aditya Narain to say more about the conclusion of the financial sector missions.

MR. NARAIN: Thank you, Roberto. Let me just begin with a few lines about the financial sector assessment program. The FSAP, which was established in 1999 is intended to provide a comprehensive and in-depth analysis of a country's financial sector, and is a key instrument of fund surveillance and provides input into to the Article IV as in this case.

As part of our stability assessments, the FSAP's are built around three pillars. One is the financial stability policy framework, which includes the compliance with international standards.

The second pillar is the financial safety nets and [risk assessment], and the third is a risk assessment including the stress test. And just as a caveat, while FSAPs do not evaluate the health of individual financial institutions and cannot predict or prevent financial crisis, they are intended to identify the main vulnerabilities that could trigger one.

To date more than three quarters of our membership has undergone FSAP's updates. This is Canada's second update. The last FSAP update was in 2008, and there are no major outstanding recommendations from the earlier FSAPs or reviews which have been conducted since then.

As part of the mission we have evaluated in great detail the compliance of the (inaudible)[supervisory] and regulatory framework with three international standards. One, the bottom [Basel]core principles of banking supervision. Second, the IAIFS core principles and of insurance regulation and supervision. And the third, the IAISCO standards [of] security regulations.

As [has] been noted in the FS update, the FSAP update mission found the financial system in Canada to continue in its strong health. It has successfully navigated the global financial crisis. The financial intermediaries remain well capitalized, conservatively managed, and profitable.

More importantly, [the report] found the regulatory and supervisory framework to demonstrate strong compliance with international standard, and well-coordinated, at least the federal oversight body structure.

Canada is, as Roberto pointed out, proceeding well under the international finance and reform agenda. It's among the first advanced economies to adopt the BASEL III capital standard, that's on an all in basis, as well as a domestic [SIFI] surcharge. The strong supervisory framework is complemented by a credible federal safety net.

In the provincially regulated security market, regulators have made significant progress in implementing [a] robust and harmonized framework, but challenges remain and we have referred to them in the recommendations.

So despite the [strength]of [the] system which I've spoken about, the FSAP did identify a range of gaps and potential weaknesses, and has made some recommendations to future proof the success of the system. Our recommendations are based around a couple of things. One has to do with enhancing the cooperation between the various actors involved in the oversight of the financial sector.

The second, approve making some moderate changes to the legal and regulatory frameworks to clarify [roles and responsibilities] within and strengthen existing oversight arrangements.

With that I pass it back to our moderator.

MR. ANSPACH: Thank you very much. we would be happy to take your questions.

QUESTIONER: I've two questions. They probably go to each of you. One, I would ask for some elaboration on your recommendation that Canada have a, I guess a single body or a more defined body that's responsible for overall systemic oversight.

The second question I had relates to the housing issues that crop up so often in Canada. I wondered if one of you could comment on the -- the aspect of the Canadian housing market where the risks seem to be isolated in big cities like Toronto or Vancouver, and explain if there's really a national risk as due to -- or from issues in these specific locations.

MR. NARAIN: Okay. I'll elaborate on the recommendation that we made. As we mentioned, what we do find is that at the federal level there is strong coordination, cooperation, and collaboration among the agencies. There are [several] committees and forums where the agencies get together and therefore better inform both the [emerging] risks as well as any issues which may affect their[remit].

But what we did not find was, and I'll say, there are three aspects of this recommendation which might be useful to keep in mind. First, there is no forum which brings together the federal and provincial agencies in a manner that allows for a discussion of emerging risks or risk which might be [] emnating in [other] parts of the system. Accordingly, nobody is therefore in a position to have at any one point in time a comprehensive view of risk across the system.

The other recommendation which we have made which is related to this is to do with their role with the crisis preparedness and management. Just as there is no one forum which has been tasked or given the mandate or have the membership to be all to have this kind of a bird's eye view, there is similarly no single body or entity which can therefore engage in an exercise of either crisis preparedness or management if the need were to arise, which would cover all parts of the entire system.

So these are the areas in which we have mentioned that there is a lack of [clarity]-- there is no one entity which has been tasked with this. There are, of course, many structures which are possible, and we don't elaborate on what should be the right structure or which should be the body, forum, committee or institution which should be doing this because the existing structures, at least to the extent of fulfilling their mandates are being able to do so.

What we have focused on the missing mandate rather on elaborating any particular structure. Now, let me pass on to Roberto for the second part of the question.

MR. CARDARELLI: Thanks. Let me also say that we have Ms. Lusine Lusinyan and Mr. Julien Reynaud who are economists working on Canada with us today as well. Julien in particular is the expert on the housing sector. So I'll leave it to him to answer the question about housing.

MR. REYNAUD: Is it important for us to have a look at the whole housing market in a sense that we look at systemic issues. So when we address the market we basically want to have an idea about where our price is going in terms of a national level.

Of course, the average house price for Canada is an average of a house price across Canadian region and provinces. It is a fact that there is a quite a strong concentration in particular in not metropolitan areas in here, of course.

When you look at the importance of Toronto, for example, just as a city, Toronto is about a third of even more of the south in all of Canada, so there are cities, metropolitan areas which basically are our most important [focus]. With that we actually cover and we do an intensive survey on some of these cities.

Having said that, because the Canadian provinces are also very diverse. In particular when you look at (inaudible) provinces, the housing cycle in Canada are almost specific to which provinces. So as of now if we look at our analysis at the provincial level, we are seeing that house price gains are pretty high in Alberta, for example, particularly in Calgary. Whereas they have been coming down in Vancouver, but actually they were on the high side in Vancouver two years ago.

There is certainly a certain amount of concentration, in particular in Toronto, and in Ontario because of the specific demographics also, but we are looking not only at big cities, but also at the provincial level in terms of the housing cycles.

QUESTIONER: I have a couple of questions. One is, you say here that the Canadian dollar is overvalued, now we have this pullout of currencies from emerging markets, and that kind of worsened things for the so called risk currencies. Do you see this overshoot at the other extreme?

The second question is, you say that the Bank of Canada can wait until early next year to hike rates, and you said you'd expect to see the policy rate at 4 percent. I'm wondering, could you specify at what point you expect it to reach 4 percent?

Mr. CARDARELLI: Sorry, at 4 percent you mean the long-run rate?

QUESTIONER: That's correct. You said you expect to see it go to 4 percent over projection period. I'm not clear when that is.

Mr. CARDARELLI: That's 2019.

QUESTIONER: Okay. All right. Thank you. And to the question about the Canadian dollar, please?

Mr. CARDARELLI: Well, when we say 10 percent overvalued we're referring to the real effective exchange rate. Our analysis is based on the real effective exchange rate, and our benchmark is the average over the last 10 months of 2013. So January, October. I guess we didn't have November when we did the latest estimate.

The November data on the real effect of exchange has just been published. November was lower than, of course, then the other rates. It's been coming down. I mean, in the whole year the real effective exchange rate has lost about 5 percent.

So in October -- in November relative to January. So it is moving in the right direction. Let's see how, you know, we know that relative to the U.S. dollar, the Canadian dollar has lost again further ground recently in January. So it's moving in the right direction.

Our 10 percent overvaluation analysis is probably right now a little bit lower because of the November data. But the last two, three months may have reduced the real overvaluation, but not totally erased,if that was the question.

QUESTIONER Hi, good morning. Just a follow-up on the Canadian dollar question. You do mention in the report that despite the depreciation in the Canadian dollar their exports have not really recovered, and there's completive challenges there. Could you elaborate a little bit more on how the Canadian economy is reacting or not reacting to the lower Canadian dollar, and how that might be different from past periods of a weak currency here?

MR. CARDARELLI: Well, you know, experts in terms of, you know -- we always distinguish with non-urgent and urgent. They sort of have a completely different trajectory as you know. You know, it may well be too early to see sort of an important impact of the depreciation of the Canadian dollar over in export growth so far.

As you know, there are other headwinds, there's still work that are more structural in nature. This loss of competiveness is something that concerns us. It's something that concerns the authorities as well. It remains to be seen. It's something that we were following with great attention, the extent to which the pickup in the U.S. growth is going to enter -- the interest from the U.S. are going to sort of help Canada exports pick up.

We have like elasticities that are based on the average dollar of the last 10, 20 years. When we do our quarters we sort of get the lower end of those estimates because we think that the -- because of structural challenges from low productivity and very high exchange rates over the last 10 years may have, as I said before, may have done some sort of structural damage. They may need time to reverse.

So our forecast in terms of export growth are very sort of conservative. That's maybe what puts us a little bit on the lower side of the consensus range for growth next year, certainly relative to the Bank of Canada.

In terms of are we seeing any sort of positive from the exchange rate depreciation so far in export growth? I'm not sure we're seeing a lot, but certainly we expect some boost from the exchange rate with depreciation going forward.

I mean, as I said, U.S. growth is going to go finally to 3 percent in our forecast next year, and that's going to be an even more important boost. That is certainly an even more important boost than the exchange or depreciation.

Exchange depreciation is going to help. It remains to be seen, again as I said, how much help it's going to be given sort of these 10 year period of low productivity, high exchange rate which may have lashed sort of more structural damage to the manufacturing base to begin with.

QUESTIONER: Second question, you say that the federal government in its balancing budget path there's room for it to delay the return to balance if there is no meaningful pickup in growth, I think the words were. Just wondering what you mean by meaningful pickup in growth. I mean, what do you consider to be below, like, not meaningful?

MR. CARDARELLI: Well, you know, it very much depends on where you put potential. I think we have different views maybe what potential is. But if you put potential around, 2 percent, a little bit below 2 percent, maybe right now in Canada, we think that, there's like 2.25, 2.5 percent in next year, in 2015, should be enough to absorb and close the upper gap in a couple years -- by two, three years' time.

That's fine. I mean, you know, there's no, optimal pace of closing the upper gap. I think that anything below, I mean, if this kind of slow absorption of the slack that we see in our forecast, anything slower than that would probably call for, for service bonds from policy. Monetary policy is doing its part the way we see it. QUESTIONER: So just lower than 2 percent roughly would be okay?

MR. CARDARELLI: You know, I think lower than we have in our forecast. And we have2 a.2 in '14, 2.4 in '15 and in '16, so the upper gap closing in two, three years' time. And again, it's not an exceptionally rapid pace. If we put potential around 2 percent it's still going to take some time to absorb the economic slack in the economy.

I would say anything, slower than that we may, you know, raise the question, is there any room for the federal level to delay the return to balance budget by one year? We have a discussion on that with the federal authorities to be sure we do.

I mean, they argue that the impact on the economy from delaying the return to balance, even by one year, may be a negative more than upsetting the positive from slowing the return. That's a legitimate concern if there are negative effects on consumer confidence from delaying the return to balanced budget. That's something that needs to be taken into account.

But on that point it's really a tug-of-war between this negative impact of confidence and the fiscal drag on growth that we’ll need to carefully access, and this is something that we're always concerned about.

QUESTIONER: My question was about inflation. Can you say when you expect inflation to reach 2 percent or so? Related to that, to which extent will the depreciation of the Canadian dollar boost inflation this year?

MR. CARDARELLI: I'm going to let Lusine Lusinyan take this one.

MS. LUSINYAN: Good morning. As Roberto mentioned, our projection is that inflation will slowly pickup and reach about 2 percent by end 2015, so that's where we see. I think this is in line with most of the forecast as well.

As to the depreciation, the pass through for Canada is estimated to be quite low, so we do not expect much of a push coming from there, but there would be some, however not much. So it's not a very significant factor.

MR. CARDARELLI: There's some sort of uncertainty about the degree to which the exchange rate deprecation impacts inflation, but we think it's not going to be very high. We're in line with the Bank of Canada. It's going to be positive, but it's not going to be, that high. It's going to be one factor among the many that are going to push inflation slowly up over the next few years.

The most important one being, as I said, it's absorption of the remaining duty of the economic slack. This pickup in growth is certainly going to play the most important role.

Other factors are this sort of leaning impact of this temporary sort of effects on CPI that, like, this increased competition at the retail sector that has contributed to low inflation so far. This is a temporary impact. We don't see it, and nobody sees it, actually to persist over the next few years. We may be wrong on that, but certainly it's something we take into account.

The depreciation of the exchange rates is a factor, but not a huge important one.

MR. ANSPACH: All right. So if there are no additional questions we will conclude this teleconference.

With that I'd like to thank the speakers again, and thank you for joining this teleconference.


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