Canada: Staff Concluding Statement of the 2017 Article IV Mission
IMF News, May 31, 2017
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- Published: May 31, 2017
Context
- The economy has regained momentum, supported by expansionary fiscal and monetary policies, but complex adjustments continue: personal consumption strong; business investment weak; non-energy exports underperformed; housing market imbalances have risen.
- Potential growth forecasts have been gradually marked down since the oil shock. Structural problems noted: low labor productivity growth and population aging have reduced competitiveness and job creation. Without bold action, medium-term growth will struggle to rise above 2 percent.
- Housing market imbalances have increased. The Can$1.5 trillion mortgage market has been important in sustaining private consumption but households are highly indebted and housing affordability—particularly in Vancouver and Toronto—has become a social issue with many first-time buyers priced out. Credit ratings of Canada’s six largest banks were lowered recently due to concerns about high household debt and rapid house-price appreciation.
Outlook and Risks
- 2016 performance and short-term outlook:
- GDP growth strengthened to 1.4 percent in 2016, up from 0.9 percent in 2015.
- Employment growth accelerated to 1.3 percent, the fastest annual job growth since mid-2013.
- Recovery expected to gain momentum: GDP growth is projected to rise to 2.5 percent in 2017 and 1.9 percent in 2018.
- The negative output gap of 1 percent of GDP is projected to close in the first half of 2018.
- Medium-term outlook:
- Potential growth limited to about 1.8 percent because of low labor productivity growth and population aging—lower than the historical average of 2.6 percent (2000-2008).
- Risks (interconnected and potentially mutually reinforcing):
- Domestic: A sharp housing-market correction could impair bank balance sheets, trigger negative feedback loops, and lead to contingent claims on the government; financial-stability risks if correction accompanies a severe recession.
- External: Higher uncertainty about U.S. policies (renegotiation of NAFTA, tax reform, climate policy) could:
- If U.S. growth is stronger than expected (because of planned tax cuts), provide a near-term boost to Canadian exports and investment.
- If it prompts faster U.S. interest-rate hikes and tighter global financial conditions, lead to abrupt market shifts, re-pricing of risk, higher funding costs for Canadian businesses and households, and dampened domestic demand.
- If the U.S. moves toward greater protectionism (including non-tariff barriers or higher tariffs in a revised NAFTA), undercut Canadian growth, causing a permanent reduction in investment and consumption.
- If U.S. corporate tax cuts are large, make Canada less attractive for investment and intellectual property, discouraging FDI inflows.
- Other risks: structurally weaker growth in key advanced and emerging economies and a further decline in oil prices.
Key Messages and Policy Takeaways
- General approach: Policy coordination required across accommodative fiscal and monetary policy, tight macroprudential policy, and bold trade and structural reform to secure stronger, inclusive, self-sustaining growth and prevent further housing-market imbalance build-up.
- Fiscal policy:
- Fiscal policy should secure the cyclical recovery while fostering long-term growth and promoting inclusion.
- Government actions already taken: tax cuts for the middle class; increased child benefits; subsidized child care spaces; flexible leave benefits to encourage more women into the workforce; infrastructure spending.
- The government’s medium-term fiscal trajectory is appropriate given the current environment.
- As the output gap is expected to close in 2018, no further increase in the deficit resulting from discretionary spending or tax cuts will be required.
- Provincial governments should be more cautious due to higher debt burdens and growing health-care costs; in highly indebted provinces, fiscal consolidation should continue but gradually to avoid offsetting federal support.
- Fiscal discipline and framework:
- Maintaining fiscal discipline is important to keep funding costs low and rebuild buffers.
- The government’s commitment to set debt-to-GDP on a declining path is welcome.
- Once the economy stabilizes around its potential, reinstating a fiscal rule to anchor the medium-term fiscal framework would help ensure sustainability.
- Infrastructure:
- Infrastructure investment is a cornerstone of growth strategy; the proposed Canada Infrastructure Bank (CIB) expected to be effective for large, complex, revenue-generating projects that otherwise would not attract private investors or be feasible for the federal government alone.
- CIB role: take subordinate equity stakes, leverage private capital, limit government borrowing, reduce budget-financing pressure, free fiscal resources for other priorities, and attract private technical competence.
- Success of CIB depends on transparent project selection and balancing public and private interests; government and CIB must address public resistance to user fees and skepticism over private involvement with education and a clear statement of benefit.
- Monetary policy:
- Monetary policy should stay accommodative and be gradually tightened as signs of durable growth and inflation pressures emerge.
- The Bank of Canada’s cautious approach is justifiable given considerable uncertainty.
- The Bank could aim to achieve a small and temporary overshoot of the inflation target to better manage downside risks and reinforce target symmetry.
- Contingent policy response:
- If downside risks materialize, additional fiscal stimulus should be the first line of defense, as Canada has some fiscal space.
- Fiscal policy is more potent with slack and when monetary policy is constrained by the effective lower bound; government should have on-standby fiscal measures that could be easily brought forward.
- Further easing of monetary policy could complement fiscal stimulus but risks exacerbating household balance-sheet vulnerabilities and housing imbalances; deeper policy-rate cuts or unconventional measures may become necessary if contraction is significant.
- Macroprudential policy and housing:
- Macroprudential policy must protect household and banking-sector resilience.
- Tackling housing-market imbalances should be joint federal-provincial responsibility given regional differences.
- Consider further tightening of macroprudential and tax-based measures to mitigate speculative and investment activity.
- Improve coordination between federal and provincial regulators and collect more comprehensive real-estate transaction data and beneficial-ownership information to improve surveillance and measure calibration.
- Macroprudential measures complement existing safety nets: strengthened supervision, a resilient banking system, full-recourse loans, and government-backed mortgage insurance.
- The property transfer tax introduced by British Columbia and Ontario targets capital flows and discriminates against non-resident buyers; non-resident activity is not the sole driver of housing prices. Authorities are encouraged to replace the tax with alternative measures effective at addressing systemic financial risk—possible combination of prudential and tax-based measures that discourage speculative activity without discriminating between residents and non-residents.
- Structural reform and competitiveness:
- Revitalizing productivity is key for higher sustainable medium-term growth.
- Positive steps: Canadian Free Trade Agreement (effective July 2017) reduces barriers to internal trade, investment, and labor mobility; “Innovation and Skills Plan” targets superclusters, skills through education and training, smart immigration policies, and empowering women—aligning with Fund and OECD advice.
- Caveats and recommendations:
- Innovation policies should be transparent and well targeted to create an “innovation- and competition-friendly” business environment and avoid picking winners and losers.
- A holistic review of the tax system would help assess scope to reduce distortions, lower administration and compliance costs, enhance equity, and generate sufficient revenues—supporting labor-market participation, investment, and innovation to preserve tax competitiveness.
- Shared responsibility for structural reform requires coordination across jurisdictions to reduce overlaps, competing objectives, and inefficiencies from too many small-scale programs; federal and provincial authorities should coordinate policies, establish uniform metrics of success, and institute transparent regular reporting to monitor progress.
- Progress has been slow in improving the regulatory environment and reducing FDI restrictions in telecommunications, broadcasting, and transportation. Lowering these restrictions is crucial to reduce costs, improve business efficiency, hasten technology adoption, and expand exports of services and high-value, information-intensive products.
- Trade diversification:
- Diversifying export markets will facilitate integration into global supply chains and reduce dependence on the U.S. market.
- The CETA agreement with the EU is a major step; Canada should also pursue bilateral trade agreements with China, India, and Japan.
Canada: Staff Concluding Statement of the 2017 Article IV Mission — May 31, 2017.