Canada: Staff Concluding Statement of the 2022 Article IV Mission
IMF News, October 12, 2022
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- Published: October 12, 2022
Recent developments and outlook
- Canada has come through the pandemic relatively well and, as a commodity exporter, has been hit less hard than many other countries by the war in Ukraine.
- Principal macroeconomic challenge: inflation is well above target.
- Drivers of inflation:
- Surge in commodity prices, especially after the Russian invasion of Ukraine.
- Supply-chain disruptions.
- Excess demand and a tight labor market, partly fueled by a shortfall in immigration since the pandemic.
- Monetary policy action:
- Bank of Canada (BoC) began reducing the size of its balance sheet and raising policy rates in March 2022.
- The BoC has now hiked by a cumulative 300 bps, leaving the policy rate at 3.25 percent, and has indicated that further rate increases will be forthcoming.
- Fiscal stance: emergency pandemic support is unwound and the fiscal stance has tightened.
- Recent activity:
- Growth remained strong in the first half of 2022, supported by relaxation of pandemic restrictions and improved terms of trade.
- More recent indicators, such as retail sales, suggest a slowing of activity.
- Labor-market conditions remain tight, with elevated vacancies, though the unemployment rate is now half a point above the historic low of 4.9 percent reached in June.
- Inflation rose to 8.1 percent in June and has retreated to 7 percent, with core inflation just under 6 percent.
- Housing market:
- Prices climbed more than 50 percent from April 2020 to February 2022.
- With rates up sharply, house prices have started to come off their peak even as rents continue to rise.
- Financial stability:
- Banks are generally well capitalized and liquid; net interest margins are widening as rates rise.
- Nonbanks, including large pension funds and insurers, hold a larger share of riskier and less liquid assets and rely on repo financing and derivative hedging; comprehensive data are not publicly available.
- Staff baseline outlook and risks:
- Growth is expected to slow, registering 3.3 percent on average in 2022 and 1.5 percent in 2023.
- Unemployment could rise to above 6 percent.
- Inflation is expected to continue slowing, reaching the 2-percent target by end-2024.
- House prices are expected to fall 20 percent or more from their peak.
- Historical distribution of risks suggests a roughly 10-percent chance that the economy would contract for 2023 as a whole.
- Downside scenarios: persistently higher inflation prompting sharper BoC tightening; an abrupt slowdown in the rest of the world, particularly the U.S.; shocks could easily push the economy into a mild recession.
Supporting affordability (inflation and housing)
- Monetary policy guidance:
- Bringing inflation swiftly back to target is key.
- The BoC should continue reducing the size of its balance sheet and will likely need to continue hiking the policy rate to at least 4 percent by end-year and remain around that level for several quarters to put inflation decisively on a downward path.
- Rates could need to move even higher, especially in light of the Federal Reserve’s recent decision and forward guidance; alternatively, faster normalization of global supply chains or faster phase-out of pandemic restrictions in China could call for a less aggressive rate path.
- Fiscal policy guidance:
- Revenue windfalls at both federal and provincial levels should be saved.
- Limited and highly targeted programs to buffer vulnerable households from high fuel and food prices could be accommodated.
- More generalized spending increases should be avoided so as not to undercut monetary policy.
- The trajectory of deficit reduction from next year’s budget onward could be made more ambitious to help rein in inflation and bring debt down more quickly.
- Housing affordability: supply-side focus and calibrated demand measures
- Supply-side recommendations:
- The new Housing Accelerator Fund should help boost housing development.
- Additional measures at the local level to expedite permitting and promote densification are needed.
- Additional federal support for critical infrastructure could complement local measures.
- Demand-side considerations:
- OSFI’s intention not to loosen the stress test appears appropriate given expectation of an orderly correction.
- Targeted support (as in the budget) could help first-time homebuyers and other groups, but scaling up or generalizing such support could add to demand and worsen affordability.
- Measures to disincentivize investors and second homebuyers—e.g., increased stamp duties and capital gains taxes, or lower LTV limits—could be helpful in easing affordability, though implications for the rental market would need careful consideration; such measures may also boost aggregate productivity by reallocating investment.
- Expected medium-term effect of higher rates: curb demand, reduce prices, and lower required down payments—making homeownership more affordable over time, especially for younger and cash-constrained households.
Strengthening the policy toolkit (fiscal, monetary, macroprudential)
- Fiscal framework improvements:
- Canada has a history of prudent fiscal policymaking, but the medium-term framework could benefit from the adoption of an explicit debt anchor and supporting operational rule.
- Benefits of a specific debt anchor and operational rule: guide market expectations, enhance credibility and accountability, and reduce the output costs of consolidation.
- Oil-rich provinces have saved much of recent revenue windfalls; codifying this via rules to shield provincial budgets from commodity-revenue volatility would be beneficial.
- Rules-based automatic stimulus:
- Proposal: adopt a mechanism that mandates temporary spending increases (e.g., on household transfers) based on a pre-set macroeconomic trigger, such as a rise in unemployment above a certain level.
- Rationale: provide a clear signal of government support, reduce uncertainty, induce spending, help the economy recover faster, and complement rapid monetary policy.
- Monetary policy communication:
- Recent improvements: publishing summaries of Governing Council deliberations; introducing scenario analysis in the July Monetary Policy Report.
- Further improvements suggested:
- Add more quantitative discussion of changes in the policy stance associated with alternative scenarios.
- Publish the rate path underpinning the quarterly economic forecast (with clear caveat that this is not a commitment and policy would respond to incoming data).
- Financial regulation enhancements:
- Establish a clear regulatory regime for cryptoassets; OSFI’s interim advisory on cryptoasset exposures and Finance Canada’s work are important steps.
- AML/CFT framework needs improvements, particularly risk-based supervision of designated nonfinancial sectors such as real estate, casinos, and the legal profession.
- The planned introduction of a federal beneficial-ownership registry in 2024 should be followed by similar, compatible provincial initiatives.
- Further build on progress in interagency cooperation among federal and provincial financial regulators and supervisors.
Transitioning to a low-carbon economy
- Canada’s targets and policy stance:
- Canada aims, by 2030, to cut emissions to 40-45 percent below 2005 levels.
- Canada has proposed a steady increase in the federal carbon tax to CAD 170/ton by 2030.
- Canada is well placed to catalyze an international agreement on a differentiated carbon price floor.
- Canada has generous commitments of climate financing for developing nations.
- Transition risks and policy responses:
- Oil and gas demand decline will put pressure on exporting nations; many existing Canadian projects may remain in production for an extended period but with reduced profitability; new developments may become uneconomic and incentives should not be provided for potentially stranded assets.
- A comprehensive strategy is needed to transition the economy and workers away from carbon-intensive products and processes, which may require some fiscal support while maintaining a prudent overall fiscal stance.
- Recommended policy tools:
- Tax credits and other policies to incentivize private green investments (including in critical “transition” minerals and clean fuels).
- Direct public green investments.
- Policies for a “just transition” to protect affected people, including First Nations, help workers redeploy skills or train in new skills, and provide for regional development and diversification.
- The Bank of Canada may be able to play a role in the climate transition, consistent with its mandate.
Financial stability assessment
- Banking sector:
- Banks are generally well capitalized and liquid.
- Net interest margins are widening as rates rise.
- Majority of main borrowers are expected to remain sound; households generally should be able to continue servicing mortgages.[1]
- Nonbank sector:
- Large pension funds and insurers appear financially healthy but hold more riskier and less liquid assets and rely on repo financing and derivative hedging.
- Comprehensive public data on nonbanks are limited.
- Mortgage risk details (footnote summary):
- Share of variable-rate mortgages among new originations has increased, but most feature fixed payments.
- Stock of mortgages is still heavily tilted to 5-year fixed-rate products.
- Mitigants for borrowers facing higher near-term payments:
- Market rates are not far beyond the Minimum Qualifying Rate at which recent borrowers were stress-tested.
- Canadian households have high debt burdens in international comparison but are cash rich on average, with substantial excess savings remaining from pandemic support and strong labor market.
- Borrowers generally have substantial equity in their homes due to conservative lending practices plus sharp price run-up since 2020.
Key statistics and projections (selected)
- Nominal GDP (2021): Can$ 2,496 billion (US$ 1,990 billion)
- Quota: SDR 11,023.9 million
- Population (2021): 38.0 million
- GDP per capita (2021): US$ 52,079
- Main exports: Oil and gas, autos and auto parts, gold, lumber, copper.
Projections (selected series, percentage change unless otherwise indicated)
- Real GDP:
- 2019: 1.9
- 2020: -5.2
- 2021: 4.5
- 2022: 3.3
- 2023: 1.5
- 2024: 1.6
- 2025: 2.3
- 2026: 1.7
- Total domestic demand:
- 2019: 1.2
- 2020: -6.4
- 2021: 6.1
- 2022: 5.5
- 2023: 1.8
- 2024: 1.3
- 2025: 2.6
- 2026: 1.4
- Unemployment rate (average):
- 2019: 5.8
- 2020: 9.6
- 2021: 7.4
- 2022: 5.3
- 2023: 5.9
- 2024: 6.2
- 2025: 6.0
- CPI inflation (average):
- 2019: 0.7
- 2020: 3.4
- 2021: 6.9
- 2022: 4.2
- 2023: 2.4
- 2024: 2.0
- Gross national saving (percent of GDP):
- 2019: 21.0
- 2020: 20.5
- 2021: 23.8
- 2022: 22.8
- 2023: 23.1
- 2024: 22.7
- 2025: 22.5
- 2026: 22.3
- General government overall balance (NA basis):
- 2019: 0.0
- 2020: -11.4
- 2021: -5.0
- 2022: -1.2
- 2023: -0.9
- 2024: -0.6
- 2025: -0.5
- Gross Debt (percent of GDP):
- 2019: 87.2
- 2020: 117.8
- 2021: 112.9
- 2022: 102.2
- 2023: 98.7
- 2024: 96.3
- 2025: 93.3
- 2026: 90.9
- 2027: 88.7
- Net debt (percent of GDP):
- 2019: 33.6
- 2020: 31.6
- 2021: 30.5
- 2022: 30.3
- 2023: 30.2
- 2024: 29.7
- 2025: 28.4
- 2026: 27.3
- Household Credit Growth:
- 2019: 3.7
- 2020: 10.8
- 2021: 9.9
- 2022: 5.0
- 2023: 3.6
- 2024: 3.5
- Terms of trade:
- 2019: -3.3
- 2020: 14.1
- 2021: 9.8
- 2022: -1.7
Source: IMF staff concluding statement of the 2022 Article IV mission to Canada.