CANADA: Staff Concluding Statement of the 2018 Article IV Mission
IMF News, June 4, 2018
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- Published: June 4, 2018
Context
- Growth has been robust and a key domestic vulnerability has moderated somewhat, as the housing market is finally showing signs of cooling down in response to several rounds of macroprudential measures and monetary tightening.
- Economic anxiety is high due to trade tensions, uncertainty about the outcome of NAFTA negotiations, and the impact of the U.S Tax Cuts and Jobs Act on Canada’s medium-term competitiveness.
- Near-term growth will be supported by higher oil prices and strong U.S. growth, but weak productivity continues to weigh on longer-term prospects.
- The current favorable economic environment presents an opportunity to rebuild policy buffers, and forge ahead with structural reforms to boost Canada’s global competitiveness.
- The 2018 Article IV consultation focused on:
- the growth and risk outlook;
- policies and reforms to sustain the recent recovery and raise long-term potential growth;
- the implications of the U.S. tax reform for Canada;
- housing market imbalances and affordability issues;
- policies to strengthen financial system resilience as household and corporate debt climbed to historic highs.
Outlook and Risks
- 2017 performance and near-term projection:
- Real GDP expanded by 3 percent in 2017, the highest growth rate among G7 economies in the year.
- Real GDP is projected to slow to 2.1 percent in 2018 and to 2.0 percent in 2019.
- Contributors to recent growth:
- Private consumption has been the largest contributor to Canada’s recent rapid growth.
- Exports and business investment are still lagging.
- Medium-term growth constraints:
- Weak external competitiveness, sluggish labor productivity growth, and population aging are expected to limit potential growth to about 1¾ percent, significantly lower than its historical average.
- Risk scenarios and magnitudes:
- A sharp correction in the housing market could be triggered by a sudden shift in price expectations or a faster-than-expected increase in mortgage interest rates; if accompanied by a rise in unemployment and sharp contraction in private consumption, risks to financial stability and growth could emerge.
- External risks relate to policy changes in the U.S. and NAFTA:
- The impact of U.S. tax reform on near-term growth in the U.S. and Canada is subject to considerable uncertainty, with some provisions without historical precedent.
- The medium-term impact of lower tax rates in the U.S. could make Canada a less attractive destination for investment, affecting Canada’s medium-term growth prospects.
- If NAFTA negotiations fail and there is a reversion to tariff rates that satisfy WTO rules, long-run Canadian real GDP could be reduced by 0.4 percent relative to the baseline forecast and by even more if non-tariff trade costs increase.
- Other risks include structurally weaker growth in key advanced economies, a sharp slowdown in China, and tighter global financial conditions triggered by an abrupt change in global risk appetite.
- Upside risk: higher oil prices prompted by rising global prices or easing domestic transportation constraints.
Key Policy Messages
- Fiscal policy and buffers:
- With growth above potential, the priority of fiscal policy should be on rebuilding buffers.
- Provinces, especially those running high deficits or debt, should restore fiscal discipline and take the lead in implementing more ambitious fiscal adjustments.
- At the federal level, the overall size of the planned adjustment is appropriate, but it could be frontloaded to build buffers faster.
- If the economy overperforms, a larger portion of fiscal savings could be used for deficit and debt reduction.
- Rebuilding fiscal space creates room to finance policies that promote growth and reduce income inequality, and to enhance resilience to adverse shocks.
- Fiscal framework and rules:
- The fiscal framework could explicitly incorporate fiscal rules that are simple, flexible, and enforceable.
- The federal fiscal rule could include both a debt rule to anchor medium-term fiscal policy, with the aim of reducing net federal debt to less than 30 percent of GDP as envisaged in the Budget 2018 forecast, and operational rules to guide annual budget decisions.
- Provincial fiscal rules should consider sources of budget deficits and balance stabilizing debt levels with protecting public investment.
- Corporate taxation:
- A careful, holistic rethink of corporate taxation is needed to improve efficiency and preserve Canada’s position in a rapidly changing international tax environment.
- The U.S. tax reform increases the urgency of this review; options include incremental approaches (e.g., more generous capital cost allowance) and more radical options (e.g., moving to some form of rent tax at the corporate level).
- Any changes should be implemented in a fiscally responsible way, including appropriate revenue-raising measures, recognizing corporate taxation is one of several determinants of business investment.
- Monetary policy:
- Monetary policy should be tightened gradually.
- Inflationary pressures are building and higher interest rates will help activity and inflation converge toward more sustainable levels.
- Given the balance of risks, the Bank of Canada’s approach appears to be broadly appropriate.
- Macroprudential and financial stability measures:
- Current macroprudential policy settings are appropriate but continued vigilance is needed.
- Current measures appear to be containing housing-related financial sector risk, but the banking system remains highly exposed to household debt and vulnerable to a sharp reversal in house prices.
- If housing vulnerabilities continue to rise, new lending by banks should be subject to loan-to-income limits.
- Coordinated monitoring between federal and provincial regulators is required to mitigate other potential and emerging risks, including:
- increasing use of home-equity lines of credit;
- the rise of less regulated mortgage lending;
- rapid growth in exchange-traded funds.
- Improving access to beneficial ownership information and financial intelligence, in line with Canada’s recent AML/CFT assessment, would help mitigate money laundering risks in the real estate sector.
- Housing affordability and supply-side policies:
- A broad set of supply-side policies is needed to durably manage housing affordability concerns.
- Addressing housing supply issues, particularly around Toronto and Vancouver, requires complementary transportation, immigration, and housing strategies at all levels of government.
- Policy actions include increasing urban density, accelerating delivery of land ready for development, shortening approval processes for building permits and re-zoning applications, and re-evaluating rent control policies to ensure they do not constrain rental property supply.
- Assess current funding and incentives to ensure development of the right type of housing supply (e.g., purpose-built rental housing).
- Trade, structural reform, and competitiveness:
- Trade policies and structural reforms targeted at boosting productivity and medium-term growth should remain a key focus.
- A NAFTA agreement that improves trade opportunities and promotes competition should be reached within a reasonable timeframe.
- Rapid ratification of CPTPP would enhance Canada’s ability to seize benefits from greater market access and export diversification.
- Federal and provincial governments should do more to reduce inter-provincial barriers to trade and the free-movement of skilled labor; regulatory red-tape remains substantial despite CFTA.
- Establish clear performance targets for innovation programs (such as the Supercluster Initiatives) and ensure funding is stage-gated conditional on performance; projects should be selected based on arms-length criteria.
- Closer coordination between federal and subnational governments is important for efficient infrastructure investments; the Canada Infrastructure Bank should move expeditiously to attract private sector and institutional investment to new revenue-generating infrastructure projects.
- Further deregulation in some product markets (e.g., electricity, transportation, retail distribution and professional services) should help attract foreign direct investment and could mitigate risks from the U.S. tax reform.
- Immigration:
- Canada’s immigration policies can help counteract population aging and strengthen the labor force, but immigrant flows need to be carefully managed to maintain public support.
- Authorities should strive to improve labor market outcomes of immigrants, expand regional absorptive capacity, and facilitate integration into local communities.
IMF Staff Concluding Statement, June 4, 2018.