Canada: Staff Concluding Statement of the 2019 Article IV Mission
IMF News, May 21, 2019
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- Published: May 21, 2019
Context
- Over the past five years, Canada employed a mix of policies to support inclusive growth and reduce financial system vulnerabilities.
- Fiscal space and accommodative monetary policy at the onset of the 2014 oil price shock helped overcome the recession in 2015.
- The economy posted the strongest growth rate among G7 economies in 2017; the unemployment rate fell to its lowest level in forty years.
- Policy actions and reforms cited:
- Overhaul of NAFTA (USMCA signed, awaiting legislative approval).
- Canada Infrastructure Bank opened.
- Expansion of tax allowances for business investment following the 2018 U.S. Tax Cuts and Jobs Act.
- Macroprudential tightening to slow household debt rise amid a booming housing market.
- The 2019 Staff Report incorporates findings from the 2019 Financial Sector Assessment Program (FSAP), conducted every five years for G-20 countries.
Outlook and Risks
- Near-term growth projection:
- Real GDP growth is projected to decline to 1.5 percent in 2019.
- Growth is expected to pick up in 2020 as oil-related activity effects wane.
- Over the medium term, potential growth is limited to around 1.7 percent.
- Factors weighing on growth:
- Slowing global growth.
- Low oil prices and domestic pipeline constraints dampening exports and business investment.
- Deceleration in private consumption and residential investment due to housing slowdown, rising interest rates, and slower real income growth.
- Trade tensions (including risk to USMCA ratification) increasing uncertainty.
- Risks (tilted to the downside):
- Domestic: a sharp correction in the housing market that could coincide with a rise in unemployment and collapse in private consumption.
- External: larger-than-expected global slowdown, sharp tightening of global financial conditions, escalation of trade tensions, failure to ratify USMCA, or break-up of NAFTA.
- Upside risks: stronger-than-expected U.S. growth and an increase in oil prices.
- Monetary and fiscal stance:
- With the output gap becoming more negative in 2019, monetary policy is expected to remain on hold in the near term.
- Fiscal stance is expected to be broadly neutral.
Financial Sector Resilience and FSAP Findings
- FSAP adverse scenario assumptions:
- A severe recession concurrent with significant financial market stress, large exchange rate depreciation, and a sharp housing market correction.
- Resilience:
- Domestic systemically important banks would remain resilient due to strong revenue-generating capacity and existing capital buffers.
- Corporates would be able to withstand sizable income and funding cost shocks.
- Vulnerabilities:
- Household mortgage defaults would rise significantly, with larger effects where household debt is high.
- CMHC and private insurers would need a capital injection totaling $15-23 billion (around 1 percent of GDP) to meet the supervisory target ratio under the severe scenario.
Key Policy Messages
- Fiscal policy
- Fiscal consolidation should be gradual as growth moderates.
- Planned federal fiscal adjustment is appropriate; provinces need to increase the size of their adjustment to achieve overall balance for the general government by 2024.
- Any unexpected fiscal savings should target deficit and debt reduction.
- If downside risks materialize and growth underperforms, automatic stabilizers should operate fully; discretionary measures could be used depending on downturn severity.
- The federal government could explicitly incorporate a fiscal rule that includes a debt anchor and an operational rule balancing enforcement, flexibility, and simplicity.
- Regularly scheduled reviews and PBO monitoring are recommended to ensure compliance and prevent circumvention.
- Provincial fiscal rules should strengthen the link with debt while protecting public investment; identify sources of fiscal imbalance (e.g., excessive current spending or under-taxation) and consider demographic challenges.
- Tax and investment policy
- Continue to monitor and evaluate tax system effectiveness and efficiency.
- Recent tax changes allowing immediate and accelerated expensing are positive.
- Further steps toward a cash-flow based system could include permanently allowing immediate expensing of all capital investments and removing interest deductibility.
- Monetary policy
- Monetary policy should remain on hold in the near term.
- Further monetary tightening warranted as the output gap closes, implemented at a gradual pace.
- If downside risks materialize, the Bank of Canada should be prepared to cut the policy rate.
- Macroprudential policy and housing
- Macroprudential policy has been effective; current stance is appropriate.
- Avoid diluting measures with home buyer initiatives that increase household debt.
- In event of sharper contraction in credit growth, consider adjustments to macroprudential tools.
- Harmonize provincial and municipal tax measures into broad-based measures targeted at speculative activity.
- Complement macroprudential policy with supply-side policies: develop a comprehensive housing supply strategy to increase density and alleviate construction bottlenecks.
- The establishment of an Expert Panel on the Future of Housing Supply and Affordability is a step in the right direction.
- Systemic risk surveillance and crisis management
- Current framework has worked well but should be modernized.
- Responsibilities for systemic risk oversight are dispersed; develop a Canada-wide framework for systemic risk surveillance and oversight.
- A revamped Heads of Agencies Committee including all relevant agencies could carry out economy-wide systemic risk analysis, increase transparency and cooperation, and broaden dialogue on macroprudential policy.
- The envisaged Capital Markets Stability Act can strengthen systemic risk surveillance and management in capital markets.
- The Senior Advisory Committee should oversee Canada-wide crisis preparedness in collaboration with key provincial authorities.
- Microprudential supervision and safety nets
- Address gaps in bank resolution (e.g., compensation to support bail-in), liquidity support (e.g., testing contingency plans), and pension fund risk monitoring (e.g., disclosure requirements).
- OSFI should have authority to issue its own legally enforceable regulations.
- Memorandums of understanding between OSFI and provincial authorities are still lacking, constraining information exchange and coordination.
- Further harmonization of provincial regulatory frameworks is needed; the Cooperative Capital Markets Regulatory System initiative can help.
- Additional capital buffers for mortgage exposures and measures to increase risk-based differentiation in mortgage pricing are desirable.
Productivity, Structural Reform, and Trade
- Productivity challenge:
- Current levels of productivity growth are insufficient to sustain long-term growth.
- Need to attract productivity-enhancing investment to diversify beyond traditional sectors and leverage new trade agreements.
- Domestic barriers:
- Significant opportunities from reducing domestic barriers to inter-provincial trade; longstanding issue requiring sustained collective effort.
- The Canadian Free Trade Agreement (2017) provides a platform, but problematic aspects need resolution (e.g., clear targets for reducing exemptions and strengthening regulatory reconciliation).
- Potential gains from removing internal trade barriers could increase real GDP by almost 4 percent.
- Finance, business services, and insurance would be the most important sectors to benefit.
- Efforts to unify securities regulations across provinces and enhance labor mobility are reinforced.
- Infrastructure and project execution:
- Encouragement for infrastructure investment and progress on Canada Infrastructure Bank noted.
- Challenges in project selection, execution and coordination at provincial and municipal levels must be overcome.
- A more detailed strategic plan is needed to prioritize infrastructure projects serving the long-term national interest.
- Federal and provincial authorities should improve financial reporting and cost-tracking to facilitate federal infrastructure funds flow.
- Trade developments:
- Reduction in trade uncertainty from USMCA is welcome; elimination of U.S. tariffs on steel and aluminum and Canada’s retaliatory measures enhance benefits.
- Rapid ratification of CPTPP is commended for diversification opportunities.
- Canada’s leadership in reaffirming multilateral trading system importance is noted.
Governance and Anti-Corruption
- Canada volunteered for assessment under the IMF’s Enhanced Governance Framework on the supply and facilitation of corruption.
- Authorities are encouraged to continue enforcement actions against foreign bribery and enhance AML/CFT frameworks to tackle proceeds of crime, including foreign corruption.
IMF Communications Department — May 21, 2019