Gas station in downtown Toronto, Canada. Fall in oil prices will hurt growth, says IMF (photo: Andrew Wallace/Reuters/ Newscom)
Economic Health Check
The economy has been expanding at an above-potential rate since 2013, with a growth rate of 2.4 percent last year. The awaited pickup in exports, driven by a stronger U.S. recovery and a depreciating Canadian dollar, is encouraging. But rebalancing of growth away from private consumption and housing remains incomplete. Shifting the composition of growth toward exports and investment would generate a broader, more durable recovery, the report said.
In terms of key domestic risks, household debt has stabilized, but is still high. Housing markets remain strong, with estimated house price overvaluation ranging between 7–20 percent, but with large differences across regions and markets.
Growth is expected to edge down slightly in 2015—to 2.3 percent—mainly because of the significant drop in oil prices, which hurts investment in the oil sector, but will be offset in part by the weaker loonie and stronger U.S. growth. Risks to the outlook have increased, given sluggish global growth, still-unfolding effects from lower oil prices, and housing market risks.
Effects of lower oil prices
Canada is a net energy exporter, where the energy sector plays an important role in the economy, accounting for about 10 percent of GDP, a quarter of exports, and a quarter of non-housing private investment. A persistent and large decline in oil prices is expected to dampen Canada’s growth, mainly through weaker investment in the energy sector, although the impact on oil production may be more muted given existing capacity and growing market share in the United States.
On the upside, lower oil prices are expected to benefit consumers and non-energy sectors, especially in the context of a weaker currency and stronger U.S. growth. Lower oil prices will contribute to the necessary rebalancing of the economy also through the cooling impact on the most overheated housing markets. With the main engine of Canada’s recent growth—the energy sector—taking the hit, the economy’s ability to overcome longer-standing weaknesses in the non-energy sector by boosting its productivity will be increasingly important.
Continue monetary policy support
In the wake of significantly lower oil prices and increased uncertainty around an otherwise solid economic outlook, the Bank of Canada cut its policy rate by 25 basis points to ¾ percent on January 21, to provide insurance against downside risks.
While the move came as a surprise to markets, the policy action is in line with IMF staff advice to use available monetary policy space if downside risks to the outlook intensified. With inflation expectations well-anchored and downside risks to growth, the Bank of Canada can afford to stay accommodative for now until firmer signs emerge of a more balanced and durable recovery led by stronger non-energy investment.
Step up provincial fiscal consolidation plans
Public finances continued improving in 2014, and the federal government is essentially on track to achieve its balanced budget target this fiscal year, despite lower oil prices. Given these consolidation gains and low public debt, the IMF saw scope for shifting the fiscal stance into neutral at the federal level and encouraged the government to use the available fiscal resources for growth-friendly measures.
But fiscal space is much more limited at the provincial level, in light of mixed progress on consolidation and looming ageing-related spending pressures. Thus, fiscal adjustment should continue at the provincial level, including through containing health care spending. Fiscal sustainability challenges call for extending long-term fiscal forecasts at the provincial level and improving coordination across levels of government, such as through publishing consolidated general government fiscal forecasts in consultation with provinces.
Scope for enhancing financial sector resilience
While there are some recent signs of cooling, Canada’s housing markets remain overvalued, according to IMF staff estimates. A significant rise in uninsured mortgages alongside still-strong housing markets in some areas may require additional targeted macroprudential policies if household balance sheets and housing market vulnerabilities resume rising and pose risks to financial stability.
The IMF noted that Canadian banks remain well capitalized and profitable. Financial stability risks—including from domestic vulnerabilities in the housing market and the household sector as well as from lower oil prices—appear contained, given extensive government-guaranteed mortgage insurance and banks’ limited exposure to the energy sector. Some progress has been made on the recommendations of the 2013 financial sector assessment of Canada, and the international financial reform agenda has advanced. The IMF noted that improving complex coordination across federal and provincial authorities in supervision and stress testing of depository institutions and strengthening macroprudential and crisis management frameworks will further reinforce the resilience of Canada’s financial system.
