Canada: Staff Concluding Statement of the 2023 Article IV Mission
IMF News, June 20, 2023
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- Published: June 20, 2023
Recent developments, outlook, and risks
- The Canadian economy is gradually slowing but has been more resilient than expected.
- Activity: After slowing sharply in Q4:2022 (partly reflecting a drawdown of inventories), activity accelerated in Q1:2023 on the back of strong trade and consumption, which offset weaker investment.
- Output gap: estimated at +0.4 percent.
- Labor market:
- Vacancies have dropped noticeably and firms report fewer labor bottlenecks and shortages.
- Supported by a significant increase in immigration and in labor force participation, potentially bolstered by the government’s investment in a Canada-wide early learning and childcare system.
- Unemployment rate: 5.2 percent (very low).
- Wage growth: elevated.
- Housing:
- After a sharp correction, the housing market is rebounding.
- About half of the pandemic surge in house prices was erased during 2022, but prices have risen again since the start of 2023; rents have climbed throughout.
- Drivers include strong demand from rapid post-pandemic immigration and reduced turnover from owners locked into cheaper mortgages.
- Inflation:
- Headline inflation fell from a peak of 8.1 percent y/y in June 2022 to 4.4 percent in April (aided by base effects related to energy prices).
- Core inflation declined more moderately—from around 6 percent y/y at its peak last year to 4.1 percent in April.
- On a three-month annualized basis, the BoC’s preferred measures of core inflation rose to 3.9 percent on average in April, from 3.6 percent in March.
- Financial system resilience:
- Six largest banks account for 92 percent of total assets.
- Banks are well capitalized, liquid, and profitable; funding sources well diversified amid robust deposit growth; SMSBs have weathered recent turmoil reasonably well.
- Commercial real estate performing better than in other countries; CRE concentration in SMSBs is not present in Canada.
- Pension funds generally less leveraged and have access to liquidity backstops.
- Outlook (staff projections and timing):
- Tight monetary policies are expected to slow activity.
- Real GDP growth projected to fall from an average of 3.4 percent in 2022 to 1.7 percent in 2023, with the economy bottoming out by the third quarter.
- Unemployment expected to rise gradually to slightly above its long-term level of 6 percent in 2024.
- Headline inflation should ease to around 3 percent by September 2023.
- Core inflation should reach around 3 percent by early 2024.
- Inflation is projected to return to the 2-percent target by end-2024.
- Risks to the outlook:
- Elevated; the economy could slip into a mild recession if downside risks materialize.
- Downside scenarios: abrupt slowdown in the rest of the world (e.g., related to banking turmoil) with spillovers; inflation proving stickier requiring additional BoC tightening; upcoming mortgage resets weighing on household consumption and debt service; rising interest rates posing risks to some banks.
- Financial stability concerns: need for strong oversight, especially of SMSBs which are less diversified and more vulnerable.
- Upside scenarios: higher-than-expected U.S. growth, quicker normalization of supply chains, faster moderation in inflation permitting a less restrictive monetary stance.
Macroeconomic and financial policy recommendations
- Monetary policy:
- The Bank of Canada’s recent rate hike following a “conditional pause” was appropriate and reinforces commitment to bring inflation down to target.
- The BoC should maintain a data-dependent posture given stickiness of core inflation and strength in some labor and housing indicators.
- Be ready to hike again or keep the policy rate high for longer if incoming data warrant.
- Communication enhancements suggested:
- Provide quarterly (not just annual) paths for key variables in the Monetary Policy Report (MPR).
- Conduct regular ex post evaluations of inflation-forecast errors.
- Consider, at an appropriate time, publishing a policy rate path consistent with economic projections and revise it regularly in response to incoming data.
- Fiscal policy:
- Fiscal policy should be kept tight to support disinflation goals.
- 2023 federal budget introduced important new spending; about two-thirds was accommodated by slowing the pace of fiscal consolidation—cyclically-adjusted general-government deficit now expected to narrow only slightly this year.
- Federal debt ratio projected to rise briefly before resuming a downward path; ends the horizon slightly higher than previously projected.
- Rebuilding fiscal buffers is a priority.
- Consider adopting a quantitative fiscal framework to enhance credibility and accountability:
- Could include a debt anchor with escape clauses for large shocks and an operational rule to return to the anchor.
- Staff analysis suggests such a framework could reduce the output costs of consolidation.
- Financial regulation and supervision (areas for strengthening):
- Banks:
- Deposit insurance appears adequate, with more than 90 percent of depositors covered, but scope may exist to further protect depositors at small banks.
- Consider extending the Domestic Stability Buffer, recently increased for larger banks, to SMSBs as well.
- Nonbank financial institutions (NBFIs):
- Implement more routine and compulsory top-down stress tests by federal and provincial regulators to complement institution-led exercises.
- Supervisors may need additional powers to compel information from pension funds and asset managers; current voluntary approaches have limits.
- Coordination and data sharing:
- Strengthen coordination between federal and provincial supervisors.
- Address data privacy legal provisions that constrain sharing of supervisory information.
- AML/CFT:
- Continue progress in strengthening AML/CFT frameworks.
- Special attention to cross-border money laundering risks in banking and real estate sectors.
- Further engagement with provinces to ensure pan-Canadian coverage and harmonized approaches to beneficial ownership data collection and publication.
- After British Columbia’s real property beneficial ownership registry, similar registries are needed in other vulnerable real estate markets.
- Crisis response:
- Allow fiscal automatic stabilizers to operate in downturns.
- Monetary policy could be adjusted in either direction depending on inflation persistence and external demand.
- Deploy macroprudential and liquidity-provision tools in case of financial stress.
- If stress is severe and both credit growth and inflation are dampened, the BoC might need to rein in rate hikes.
- Consider activating temporary authorities under discussion to allow the Minister of Finance to increase deposit insurance coverage in a crisis.
Climate and housing policies
- Climate mitigation:
- Canada’s multipronged climate mitigation strategy centered around carbon pricing is commended.
- Staff analysis suggests carbon pricing and other policies could produce a 30 percent reduction in emissions by 2030 relative to 2005.
- Expeditious implementation of all elements of Canada’s Emissions Reduction Plan (including a separate cap on emissions in the oil and gas industry and clean electricity regulations) could deliver the 40-45 percent commitment in the NDC.
- These steps, plus future technological advances, should help Canada on the road to net zero by 2050.
- To mitigate negative competitiveness spillovers from carbon taxation, consider effective recycling of revenues and exchange rate flexibility.
- Consideration could be given to a differentiated international carbon price floor, an effort Canada could help lead.
- Green subsidies and industrial policy:
- Investment tax credits to clean electricity and green energy and technology in the 2023 federal budget, complementary 2022 measures, and production subsidies to automakers can support the green transition.
- Risks and design recommendations:
- Greater international coordination desirable to mitigate a “race to the bottom” and investment-location distortions.
- Exercise caution on heavy focus on electric vehicles and batteries given rapid technological change.
- Prefer a standard, time-bound incentive regime rather than negotiating company-specific packages to ensure evenhandedness and transparency.
- Ensure subsidies are designed in a WTO-consistent manner to counter geoeconomic fragmentation.
- Housing supply and affordability:
- Additional policy steps needed to boost housing supply and promote affordability amid rising mortgage rates and rapid immigration.
- Housing Accelerator Fund (2022 budget) is a positive step but more is needed to expedite permitting and promote densification.
- Consider creating a permanent discussion forum for federal, provincial, and municipal officials responsible for housing and immigration, and stakeholders from construction industry and advocacy groups.
Key statistics and projections (Table highlights)
- Nominal GDP (2022): Can$ 2,785 billion (US$ 2,139 billion)
- Quota: SDR 11,023.9 million
- Population (2022): 39.6 million
- GDP per capita (2022): US$ 54,015
- Main exports: Oil and gas, autos and auto parts, gold, lumber, copper.
Selected projections and historical values (percentage change, unless otherwise indicated):
- Real GDP growth:
- 2020: -5.1
- 2021: 5.0
- 2022: 3.4
- 2023: 1.7
- 2024: 1.4
- 2025: 2.2
- 2026: 1.9
- Total domestic demand:
- 2020: -6.0
- 2021: 6.6
- 2022: 4.7
- 2023: -0.5
- 2024: 1.5
- 2025: 2.6
- 2026: 2.1
- 2027: 2.0
- Private consumption:
- 2020: -6.1
- 2021: 4.8
- 2022: 3.9
- 2023: 2.3
- 2024: 3.5
- Total investment:
- 2020: -7.4
- 2021: 13.9
- 2022: 7.0
- 2023: -9.5
- 2024: 0.8
- 2025: 2.5
- 2026: 1.8
- Unemployment rate (average) 2/:
- 2020: 9.7
- 2021: 7.5
- 2022: 5.3
- 2023: 5.5
- 2024: 6.2
- 2025: 6.1
- 2026: 6.0
- CPI inflation (average):
- 2020: 0.7
- 2021: 6.8
- 2022: 3.6
- Gross national saving (percent of GDP) 1/:
- 2020: 20.1
- 2021: 23.5
- 2022: 24.2
- 2023: 21.5
- 2024: 21.4
- 2025: 21.2
- 2026: 21.0
- 2027: 20.8
- 2028: 20.5
- General government fiscal indicators (NA basis, percent of GDP) 1/:
- Revenue:
- 2020: 41.8
- 2021: 41.5
- 2022: 40.6
- 2023: 40.7
- 2024: 40.9
- 2025: 41.0
- Expenditures:
- 2020: 52.7
- 2021: 45.9
- 2022: 41.4
- 2023: 41.3
- 2024: 41.2
- 2025: 41.1
- Overall balance:
- 2020: -10.9
- 2021: -4.4
- 2022: -0.8
- 2023: -0.6
- Gross Debt:
- 2020: 118.9
- 2021: 115.1
- 2022: 106.7
- 2023: 105.8
- 2024: 103.5
- 2025: 101.0
- 2026: 98.8
- 2027: 96.7
- 2028: 94.7
- Net debt:
- 2020: 15.7
- 2021: 15.4
- 2022: 14.3
- 2023: 14.4
- 2024: 14.2
- 2025: 14.0
- 2026: 13.6
- Money and credit (annual average):
- Household Credit Growth:
- 2020: 5.2
- 2021: 10.8
- 2022: 9.9
- Business Credit Growth:
- 2020: -0.9
- 2021: -12.7
- 2022: 6.4
- Balance of Payments:
- Current account balance 1/: -1.7 (2020), -1.9 (2021), -2.4 (2022)
- Merchandise Trade balance 1/: 0.2 (2020), -1.1 (2021), -1.4 (2022)
- Export volume (percent change): -7.9 (2020), 5.9 (2021), 1.2 (2022), 3.1 (projection)
- Import volume (percent change): -7.1 (2020), 8.7 (2021), 3.8 (2022), 4.2 (projection), 4.6, 4.5
- Terms of trade: -3.4 (2020), -9.0 (2021), 0.0 (2022)
Source: IMF staff concluding statement of the 2023 Article IV mission for Canada.