Canada: Staff Concluding Statement of the 2017 Article IV Mission

May 31, 2017

A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments.

The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.


1. The economy has regained momentum, supported by expansionary fiscal and monetary policies, but complex adjustments are still at play . While personal consumption has been strong, business investment remains weak, non-energy exports have underperformed, and housing market imbalances have risen. Collectively, they raise uncertainty about the durability of the Canadian recovery.

2. Against this background, the 2017 Article IV consultation focused on policies to secure stronger, inclusive, and self-sustaining growth, while preventing the further build-up of housing market imbalances :

  • Potential growth forecasts have been gradually marked down since the oil shock. Canada’s traditional engines of growth have slowed, hobbled by longstanding structural problems of low labor productivity growth and population aging that have affected the ability of Canadian firms to compete globally and create jobs. Without bold action to tackle these challenges, Canada’s 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 of the markets. Credit ratings of Canada’s six largest banks were lowered recently, reflecting concern that high household debt and the rapid appreciation of house prices could weaken asset quality in the future.

3. These two challenges will dominate the government’s policy agenda at a time of greater uncertainty about policy outcomes in the U.S. and across the Atlantic . While the global economy has improved with stronger manufacturing activity, the renegotiation of NAFTA, U.S. policies on tax reform and climate change, and the timing and form of the U.K.’s withdrawal from the EU could tilt policies toward protectionism and economic fragmentation. This would have significant consequences for Canada, an economy that is highly reliant on trade and cross border flows.

Outlook and Risks

4. GDP growth strengthened to 1.4 percent in 2016, up from 0.9 percent in 2015, in a volatile year marked by the devastation of the Fort McMurray wildfires . Personal consumption was robust as employment growth accelerated to 1.3 percent, the fastest annual job growth since mid-2013. Energy exports rebounded and the service sector performed well. However, low interest rates have yet to energize business investment, while the depreciation of the Canadian dollar has not provided the expected boost to non-energy exports.

5. The recovery is expected to gain momentum in the near term, supported by a fast-growing U.S. economy, expansionary fiscal and monetary policies, and stable oil prices. GDP growth is projected to rise to 2.5 percent in 2017 and 1.9 percent in 2018, allowing the negative output gap of 1 percent of GDP to close in the first half of 2018.

6. The medium-term outlook is less upbeat, however, because of structural impediments

. As the fiscal stimulus fades and the U.S. economy returns to trend, low labor productivity growth and population aging will limit potential growth to about 1.8 percent, lower than the historical average of 2.6 percent (2000-2008).

7.  Risks to the outlook are significant :

  • On the domestic side, a sharp correction in the domestic housing market could impair bank balance sheets, trigger negative feedback loops in the economy, and lead to contingent claims on the government. Financial stability risks could emerge if the housing market correction is accompanied by a severe recession.

  • On the external side, key risks pertain to higher uncertainty about U.S. policies and its impact on global growth. Stronger-than-expected growth in the U.S., because of planned tax cuts, would provide a fillip to Canadian exports and boost investment in the near term. But if this leads to a faster-than-expected-pace of interest rate hikes in the U.S. and a tightening of global financial conditions ensues, potential abrupt shifts in global market sentiment and a re-pricing of risk could raise the cost of funding for Canadian businesses and households, dampening domestic demand. Beyond this, a move by the U.S. towards greater protectionism, including by imposing non-tariff barriers in a revised NAFTA or raising tariffs, would undercut growth prospects in Canada, leading to a permanent reduction in investment and consumption. Similarly, a sharp reduction in the U.S. corporate tax rate may make Canada less attractive as an investment destination, including for intellectual property, and discourage much needed FDI inflows. Other risks include structurally weaker growth in key advanced and emerging economies and a further decline in oil prices.

    These risks are interconnected and can be mutually reinforcing. Policy choices will therefore be crucial in shaping the outlook and reducing risks.

Key Messages and Policy Takeaways

Addressing the complex adjustments that are taking place will require policy coordination on several fronts: accommodative fiscal and monetary policy, tight macroprudential policy, and bold action on trade and structural reform. The authorities are rightly factoring in the challenges Canada faces in their policy decision-making.

8. Fiscal policy should be geared toward ensuring that the cyclical recovery is secure, while fostering long-term growth and promoting inclusion.

To this end, the government has introduced tax cuts for the middle class and increased child benefits. In addition, the government has pursued subsidized child care spaces, flexible leave benefits to encourage more women to enter the workforce, and infrastructure spending. The government’s medium-term fiscal trajectory is appropriate given the current economic 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 need to be more cautious in their approach as they have a higher debt burden and growing health-care costs; in provinces that are highly indebted, fiscal consolation should continue but at a gradual pace so as not to offset the federal government’s efforts to support the economy.

9. Maintaining fiscal discipline will be important to keep funding costs low and to 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 the sustainability of public finances.

10. Infrastructure investment is a cornerstone of the government’s growth strategy and the proposed Canada Infrastructure Bank (CIB) will be an effective instrument in achieving this goal.

The CIB is expected to invest in large, complex, and revenue-generating projects, which would not otherwise be feasible, given the risks involved are too large, and returns too small, to attract private investors while the cost is prohibitive for the federal government to go it alone. By taking a subordinate equity stake and leveraging private capital, the CIB would limit government borrowing and reduce pressure on budget financing, and free up fiscal resources for other high priorities. In addition to capital, private investors will be expected to bring their technical competence, discipline, and creativity, that could help reduce risk and lower the overall project cost. The success of the CIB will depend on ensuring that the project selection process is transparent and balances public and private interests. Given the potential of the CIB to advance long-term growth, the government and the CIB must address public resistance to user fees as well as skepticism over involving private investors in public infrastructure projects, with education and a clear statement of the CIB’s benefit.

11. Monetary policy should stay accommodative and gradually tightened as signs of durable growth and inflation pressures emerge.

The Bank of Canada’s cautious approach is justifiable given the considerable uncertainty around the economic outlook. The Bank could aim to achieve a small and temporary overshoot of the inflation target to better manage the downside risks to the inflation outlook and reinforce the symmetry of the inflation target.

12. If downside risks were to materialize, additional fiscal stimulus should be the first line of defense, as Canada has some fiscal space.

Fiscal policy is more potent when there is slack in the economy and monetary policy is constrained by the effective lower bound. To this end, the government should have on stand-by fiscal measures that could be easily brought forward. While further easing of monetary policy could be a useful complement, there is a risk that such action could exacerbate household balance sheet vulnerabilities and housing imbalances. A further cut in the policy rate or recourse to unconventional measures may, however, become necessary if there is a significant contraction in economic activity.

13. Macroprudential policy needs to protect the resilience of the household and banking sector.

Tackling housing market imbalances should be a joint responsibility of both the federal and provincial authorities given the regional divide in housing imbalances. A further tightening of macroprudential and tax-based measures to mitigate speculative and investment activity should be considered. In this regard, greater coordination between federal and provincial regulators, as well as government efforts to collect more comprehensive data on real estate transactions and improve the availability of beneficial ownership information, would improve surveillance and the calibration of these measures. The macroprudential measures would complement safety nets that are already in place to safeguard the financial system, including strengthened supervision, a resilient banking system, full recourse loans, and government-backed mortgage insurance.

14. The property transfer tax introduced by the governments of British Columbia and Ontario targets capital flows and discriminates against non-resident buyers.

However, non-resident activity is not the sole driver of housing prices, as residents also contributed to the spike in prices. The authorities are encouraged to replace the tax with alternative measures that are effective to address systemic financial risk. This could include a combination of prudential and tax-based measures that discourage speculative activity without discriminating between residents and non-residents.

15.  The government recognizes that revitalizing productivity is key to placing Canada on a higher and sustainable growth path over the medium term.

Canada has taken a historic step forward in reducing barriers to internal trade, investment, and labor mobility with the new Canadian Free Trade Agreement that will come into effect in July 2017. The government has also unveiled an ambitious “Innovation and Skills Plan” to enhance innovation in “superclusters” that have the greatest potential to accelerate economic growth, and upgrade labor skills through education and training, smart immigration policies, and empowering women in the workplace. These priorities are consistent with Fund and OECD advice. Nevertheless, several caveats are in order:
  • Policies to promote innovation should be transparent and well targeted, with the aim of creating an “innovation- and competition-friendly” business environment. They should not be used to choose winners and losers.

  • A holistic review of the overall tax system would help assess whether there is scope for reducing distortions, minimizing administration and compliance costs, and enhancing equity, while generating sufficient revenues to cover government spending. A more simple and efficient tax system is important to encourage greater participation in the labor market, and promote investment and innovation, so that Canada’s tax competitiveness will be preserved with the rest of the world.

  • Shared responsibility for structural reform policies will require coordination across all jurisdictions to reduce overlaps, competing objectives, and inefficiencies that arise from operating too many programs at too small a scale. The federal authorities in partnership with provincial governments, should coordinate policies, establish uniform metrics of success, and institute a transparent and regular reporting mechanism to monitor progress.

  • Progress has been slow in improving the regulatory environment and reducing FDI restrictions in the telecommunications, broadcasting, and transportation. Lowering these restrictions is crucial to reduce costs and improve business efficiency, hasten the adoption of new technology, and expand exports of services and high-value, information-intensive products.

16. Diversifying Canada’s export markets will facilitate its integration into global supply chains and reduce its dependence on the U.S. market. The CETA agreement with the EU is a major step forward in establishing new trade relationships. Canada should also tap new sources of growth in Asia, with bilateral trade agreements with China, India and Japan.

We extend our gratitude to the authorities and to the private sector participants for a constructive dialogue and for their gracious hospitality .

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