Canada: Concluding Statement of the 2014 Article IV Mission
IMF News, November 25, 2014
Source details
- Canonical URL
- Canada: Concluding Statement of the 2014 Article IV Mission
Other formats
Bibliographic details
- Published: November 25, 2014
Overview and near-term outlook
- GDP growth for 2014 is estimated to be about 2¼ percent.
- Economic slack has been gradually declining with growth running modestly above potential in most quarters since 2013.
- Improving labor market: unemployment rate fell to a post-crisis low of 6½ percent in October.
- Inflation has edged higher from last year’s subdued levels, partly driven by temporary factors; wage pressures remained modest.
- Outlook: strong U.S. demand and a weaker Canadian dollar should support above-potential growth and a broadening recovery; inflation expected to remain close to the Bank of Canada’s target rate of 2 percent.
External sector, exports, and investment
- Trade balance turned positive in the first half of 2014; net exports provided a sizeable contribution to growth.
- Non-energy exports led the rebound—benefiting from the firming U.S. recovery and a weaker Canadian dollar.
- Energy exports strong; Canadian crude oil continued gaining market share in the United States amid some easing in infrastructure bottlenecks.
- Business investment remains tentative despite higher exports; firms cautious about demand outlook.
- Investment has tended to replace or upgrade capital; hiring has focused on adding temporary capacity (one-third of jobs added so far in 2014 have been part-time—a share above its historical average).
Households and housing
- Private consumption resilient, supported by higher household wealth, rising disposable incomes, and relaxed financial conditions.
- Household debt ratio has broadly stabilized—hovering over 150 percent of disposable income since 2013.
- Housing markets reaccelerated, driven by major metropolitan areas (Toronto, Vancouver, Calgary).
- Supply-side constraints and population/household formation support fundamentals in major markets; single-family homes are a major source of price increases.
- Signs of overvaluation, especially associated with high-end buyers (reflected by uninsured mortgage credit growth).
- Tighter mortgage insurance rules, reduced affordability, and new multi-family construction have contained price growth in other segments.
- Mission welcomes OSFI guidelines to strengthen residential mortgage insurance underwriting practices.
Financial sector resilience and reforms
- Canadian banks: highly profitable, favorable loan quality, low nonperforming loans, improving capitalization.
- Stress tests from the 2013 FSAP Update suggest resilience to credit, liquidity, and contagion risks due to strong capital positions, stable funding, low interbank exposures, and extensive government-guaranteed mortgage insurance.
- Increasing bank exposure to capital markets and foreign operations warrants close attention.
- Life insurance and pension fund performance has improved noticeably.
- Progress on international financial reform: Basel III Liquidity Coverage Ratio and leverage standards implemented and will take effect in January 2015; banks well positioned to meet proposed requirements in advance.
- OSFI draft guideline for Derivatives Sound Practices and progress on federal stress-testing framework welcomed.
- Outstanding FSAP recommendations remain on financial sector oversight, safety nets, and macro-prudential frameworks:
- Need enhanced coordination across federal and provincial authorities in supervision and stress-testing; subject all systemic federally- and provincially-regulated entities to common stress-testing frameworks.
- Provide a mandate for macro-prudential oversight to a single entity with broad participation and powers to collect necessary data.
- Establish a mandate for crisis preparedness and an operational coordination framework to test authorities’ capacity to respond to crises.
Monetary and macro-prudential policy
- Policy rate appropriately on hold at 1 percent since September 2010 to support domestic demand.
- Recent fall in oil prices should have a mild dampening effect on growth and CPI inflation.
- Given well-anchored inflation expectations and downside risks to export-driven growth, tightening can await firmer signs of a balanced and durable recovery with stronger business investment.
- Rising long-term interest rates from expected U.S. monetary normalization could help moderate Canada’s housing sector.
- Macro-prudential measures since 2008 broadly effective in mitigating financial stability risks: curbed growth in insured mortgage credit, strengthened credit standards, and damped house price increases.
- Uninsured (low LTV) mortgages are rising noticeably (by 10 percent per year) and comprise the bulk of mortgage originations.
- Further targeted actions could include tighter standards such as lower amortization limits for uninsured mortgages.
Fiscal policy, intergovernmental coordination, and frameworks
- Fiscal consolidation should proceed at the general government level; federal government can adopt a more neutral stance going forward.
- Improvement in fiscal position largely reflects federal consolidation while provincial fiscal adjustment has lagged.
- Federal government expected to reach its balanced budget target in FY2015–16 and put debt on a downward path.
- Given strong federal fiscal footing, shifting to a neutral stance is consistent with remaining fiscal goals; recently announced tax cuts and enhanced child benefits align with this direction.
- Merit in using fiscal resources for targeted growth-friendly measures (e.g., R&D, SMEs, venture capital, strategic infrastructure) or reducing federal income taxes to provide more tax space to provinces.
- Provincial consolidation plans should proceed, especially in provinces with higher public debt; plans rely on ambitious expenditure restraint and should be supported by strategic spending reviews and possibly revenue measures.
- Strengthening medium-term frameworks:
- Federal level: explicit medium-term fiscal targets and regular spending reviews; if balanced budget legislation introduced, rule should be transparent, easy-to-communicate, ensure convergence to medium-term objectives, and allow flexibility to avoid procyclicality. Parliamentary Budget Office could monitor implementation.
- Provincial level: regular spending reviews, possible role for independent fiscal agencies; extend long-term fiscal forecasts and publish consolidated general government fiscal forecasts in consultation with provinces; consider data sharing mechanism for long-term fiscal assumptions and forecasts.
Structural policies and productivity
- Continue reform efforts to increase productivity: improve skills-job matching, promote penetration of information and communication technologies, foster business investment in R&D.
- Enhance interprovincial and international trade (including implementation of major trade agreements), improve competition in network sectors, and address infrastructure constraints in energy exports to boost medium-term growth.
Risks, distributional effects, and scenarios
- Balance of risks modestly tilted to the downside.
- Key external downside risks: faster-than-expected tightening of global financial conditions and further decline in global oil prices from weaker demand.
- Deeper downside risks: combination of external shocks amplified by high household balance sheet vulnerabilities and a sharper-than-expected correction in house prices.
- Upside possibilities: stronger-than-expected U.S. demand and faster resolution of infrastructure bottlenecks supporting energy sector activity.
- Lower oil prices present a challenge and opportunity: likely to cool activity in oil-rich provinces but benefit provinces reliant on manufacturing and services; narrower price discount for Canadian oil and strong U.S. growth would cushion impact; productivity gains in other sectors will be increasingly important.
Key policy recommendations and near-term actions
- Monetary policy: remain accommodative until firmer signs of a balanced, durable recovery with stronger business investment.
- Macro-prudential: maintain and, if necessary, tighten targeted measures to contain housing vulnerabilities (e.g., lower amortization limits for uninsured mortgages).
- Reduce taxpayers’ exposure to housing market and increase private sector risk retention:
- Implement plans to prohibit government-backed insured mortgages in non-CMHC securitization programs and gradually limit insurance of low-LTV mortgages to those used in CMHC securitization.
- Consider further reduction of portfolio insurance for CMHC and private mortgage insurers and introduce more risk-sharing.
- Re-examine dimensions of extensive government-backed mortgage insurance as a longer-term agenda, including managing transition from market reliance on government-backed instruments.
- Strengthen financial oversight, macro-prudential frameworks, and crisis management by enhancing federal-provincial coordination and providing clear mandates and data powers to responsible entities.
- Fiscal policy: proceed with consolidation at the general government level; federal government may shift to a more neutral stance and use fiscal space for targeted growth-friendly measures; provinces should pursue durable adjustment supported by spending reviews and possible revenue measures.
- Structural reforms: continue reforms to boost productivity, competition, trade, and address infrastructure constraints.
Source: Canada: Concluding Statement of the 2014 Article IV Mission (November 25–26, 2014).