Transcript

Transcript of a Conference Call on Canada's 2008 Article IV Consultation

December 19, 2007

MS. LOTZE: Thank you very much. Good morning and welcome to the staff conference call on the conclusion of the discussions on the Article IV Consultation with Canada. I'm Conny Lotze of the External Relations Department, and I'm joined in this call by Anoop Singh, Director of the Western Hemisphere Department, Tamim Bayoumi, Assistant Director and Mission Chief to Canada, and Thomas Helbling, Deputy Division Chief. This call is on the record.

Mr. Singh will make some opening remarks, and then we'll open the floor to questions. Mr. Singh, please.

MR. SINGH: Thank you very much, and thank you all for joining us for this conference call.

Just on Monday we concluded a series of very useful meetings with the Department of Finance, the Bank of Canada, private sector economists, and others. These were part of the 2008 Article for Consultations of Canada. These will be discussed by the Executive Board shortly in the new year, and our report should be available publicly thereafter.

But we'd hope that, following the practice with other countries, we will have this conference call to give you a quick overview of our main messages before taking your questions. And, very briefly, I'll make a few points.

First, as you all know, Canada has enjoyed an enviable macroeconomic performance over the past decade. This includes having the fastest growth in the G7. And this has, in turn, reflected strong macroeconomic frameworks which have delivered a string of budget surpluses, low inflation, and continuing structural reform.

These trends will serve the economy well, particularly as we face a more challenging period ahead. After five years of strong growth in which the economy adjusted smoothly to strong commodity prices and the associated currency appreciation, it is not surprising that growth is likely to slow next year. And as generally true in Canada and other countries, the sources of these concerns come from external developments, most notably the likely slowdown in the United States, and global financial strengths in an environment where the Canadian dollar has strengthened rapidly since the start of the year.

I should say that, on balance as you look at the risks ahead to our forecast, we believe that downside risks dominate, given the slowing in the United States—the key partner for Canada—and the possibility of yet tighter global financial conditions. However, against that, domestic demand in Canada could remain stronger than expected, as we have seen in recent quarters.

Next on monetary policy, in this environment the Bank of Canada, we believe, has appropriately shifted to guarding against near-term downside risks and cut interest rates in early December. Tight financial conditions and weaker external prospects are now a greater concern than inflation, partly because with the dollar's rise to parity, appreciation gains have passed on to consumers very rapidly.

I should also mention that the modest fiscal stimulus coming from the tax cuts announced in November's economic statement would also be helpful to cushioning the economy. I should add that this tax relief is a direct benefit of Canada's recent budget over performance and the country's enviable fiscal position.

Now, coming very briefly to the financial sector, our sense is that the national system in Canada is in a good position to resist financial turbulence. Canadian banks generally have capital positions that allow them to absorb balance sheet losses. However, as elsewhere, financial conditions have tightened, which together with the rise in credit risk from a slowing economy and from banks' exposure to U.S. markets, will restrain somewhat financing to nonfinancial corporates and households.

And now a last word on productivity improvements. These have supported competitiveness and helped cope with appreciation, and we certainly support the government's structural policy agenda which is outlined in Advantage Canada. Certainly, we are pleased that the government remains focused on structural policy reform even at a time of heightened short-term risks.

The recently approved legislation to lower the federal corporate income tax gradually to 15 percent by 2012 is, we believe, a welcome step to lowering the high marginal effective tax rate on capital in Canada. At the same time, we would emphasize the importance, as we've seen in other countries, of boosting productivity by reducing restrictions on inverted foreign direct investment and by lowering barriers to interprovincial trade and labor mobility.

So here are my few opening remarks, and certainly we are now very happy to take questions from you, my colleagues and I.

QUESTIONER: I'm wondering, since we didn't get the staff report, and we don't have the details of the staff forecast, you say growth in Canada will slow. Can you quantify that for the next couple of years 2008, 2009 what you're looking for?

MR. BAYOUMI: Yes, what I can tell you is that, obviously, we published a World Economic Outlook in October, and that had growth slowing to 2.3 percent in 2008—that's year on year.

Now, I think that since then events have been less favorable than may have been fully anticipated, and therefore, I would anticipate that in the final staff report when we publish, the growth forecast would come down modestly. But we don't have a separate official forecast at this point.

And may I say I think the reasons that we think it may have come down are not only that there's a somewhat worsening in the U.S. outlook, but also that, of course, global financial strains have become more difficult than what would have been anticipated in October.

MR. SINGH: May I just add one comment on that, and that is, obviously as you all know, there is a high correlation between developments in the U.S. and developments in Canada in terms of GDP growth. And our projections for Canada therefore are based on a baseline prediction for the United States. And certainly, if that were to change, that would have knock-on effects on the projection for Canada.

So at this stage we are comfortable in saying that the outlook for 2008, based on our current view of the U.S. economy, places Canada at half a shade below 2.3 for next year.

QUESTIONER: I wanted to ask about the Point 11 in the Summary, the point about restrictions on inward foreign direct investment in network industries weighing on productivity growth. Could you elaborate a little bit on that and what industries in particular you think would benefit from reduced barriers to foreign investment?

MR. BAYOUMI: Thank you very much. As you no doubt are aware, Canada has significant barriers on foreign direct investment in a number of network industries. The most notable ones are airlines, telecoms, media, and utilities.

And there has been considerable work looking at the impact of foreign ownership on productivity, including some quite good work by Industry Canada, all of which seems to indicate that, by and large—and, of course, there's variations—but, by and large, foreign-run firms tend to have somewhat higher productivity than domestically-run firms.

And this illustrates the potential benefits of foreign direct investment. These come through the transfer of knowledge and techniques from abroad. And, for this reason, we think that reducing restrictions to foreign direct investment in these particular industries, as well as looking hard at the overall regulations of foreign direct investment in terms of application would be useful.

Indeed, the Canadian government has started to do this. It's got an expert panel looking at competition, and there's going to be some analysis, particularly, of these industries, and we will have to wait for the report from that expert commission and then see how the government will respond. So the government has clearly recognized that competition in some sectors is at least a potential concern and is looking at that.

The Commission also seems to have some interest in the financial sector where we also have concerns that restrictions which are not FDI restrictions but do limit takeovers of large banks may also limit competition, as we also discuss in the report.

QUESTIONER: You mentioned the Canadian dollar and whether it's been in line with fundamentals or overvalued this year, and you say overvalued or fairly valued by some measure or most measures. Can you give me an idea of what metrics you're looking at to figure that out?

MR. HELBLING: Broadly speaking at parity, as we note in the report, we see the dollar broadly in line with fundamentals, notably at current oil prices. In terms of metrics, we have been using a number of approaches, some of which are similar to those used by the Bank of Canada. In particular, we have used so-called equilibrium exchange rate equations. The metrics based on these equations are a bit sensitive to the underlying model, but, broadly speaking, they do indicate that the dollar is broadly in line with fundamentals when the uncertainty associated with such metrics is recognized.

At the IMF, we also use other techniques mostly based on the concept of external balance or long-term external stability considerations. At the moment, taking into account that Canada's current account balance is in surplus, these techniques also indicate that the dollar is broadly in line with fundamentals.

MR. BAYOUMI: If I may add to that, these exchange rate equations which the Bank of Canada has developed, which include essentially interest rate differentials, are mainly driven by commodity prices, both energy and nonenergy, and, as you know, Canada's exchange rate is generally regarded as being a commodity currency which does react to rising commodity prices by appreciating.

And that's, of course, what we've seen since 2002. The very significant appreciation since 2002 has to a large extent reflected booming commodity prices, although it's less clear that that's fully true this year.

MR. SINGH: Let me just add one comment, and link the last two questions. Although the rise in the Canadian dollar has been in line with fundamentals, its strength has directly increased imported competition into the Canadian economy from overseas. And what this therefore means is it puts a greater premium on raising productivity, certainly closing the gap that may still exist in some sectors with the United States. And, therefore, I would link the two efforts with the strengthening of the dollar.

QUESTIONER: You talked about the link between the Canadian and U.S. economies. Are you expecting the housing troubles that we've seen in the United States to replicate themselves in Canada?

MR. BAYOUMI: I think the short answer to that is not to the same extent. The housing problems in the United States are particularly severe and have caused a very, very large downturn, which, of course, has been occurring over the last year and a half already. Canada did not have the same kind of rise in housing prices as occurred in the United States or in several other industrial countries.

And we did in our consultations talk with a whole series of representatives of the housing market because it's an obvious concern. They indicated the risk is limited. We agree that while you'd have, obviously, conditions varying across areas and in particular, there have been rising house prices out West in part because of strong oil prices, but overall the Canadian housing market does not seem to be particularly out of equilibrium. And, therefore, we certainly wouldn't expect the kind of downturn we've seen in the United States.

I think that the downturn in the housing in the United States has affected certain industries in Canada and, obviously, the most notable one is forestry—and I think that the housing cycle in the United States is more likely to affect Canada through that direction than through a big downturn in the domestic housing market.

MR. SINGH: And, Tamim, am I right that recent data on housing starts and building permits continue to indicate that housing market remains at least on track?

MR. BAYOUMI: Yes, I think that's right. We certainly don't see any evidence of a slowing at this point.

QUESTIONER: On the nonbank ABCP process in place in Canada, the restructuring process that's still ongoing, can you talk a little bit about how that might affect industrial confidence if, you know, in the worst case scenario, if this thing is very messy in its unwinding and an agreement is not reached. Just how important is that outside Canada, to investors outside Canada?

MR. BAYOUMI: Well, I'm glad you asked that question. Obviously, the standstill is a very important factor in Canada. For a start, I mean we don't anticipate that there will be a problem in this area. There's a mutual interest in all parties in coming to an orderly resolution of this situation.

Now, clearly, despite progress, a full solution to the standstill has not been achieved at this point, but it is important to recognize how challenging an undertaking this has been, even given the fact that there's common interest in goodwill. It involves the difficulties of valuing leveraged and structured asset, and the continuing decline in the value of U.S. subprime asset and illiquidity in markets.

Because of that there are these difficulties, and it has been a complex negotiation. We're certainly encouraged by the fact the Investment Committee has indicated that it remains on target for closing and restructuring on or before March the 14th.

Now, coming to the why this is an important agreement and why everybody has an interest, well, it is twofold: The first is that were the standstill not to be resolved in an orderly manner, one would have a situation where the underlying assets behind the asset-backed commercial paper would be sold in a situation in which the underlying market for much of that collateral is relatively weak. This would cause losses to Canadian investors and put further strain on these markets.

But, as I emphasized, this means that there is a great interest for all concerned in coming to an agreement, and we do believe that such an agreement is both likely and, in fact, probably imminent at the end of January.

MS. LOTZE: Let me just add one thing that was brought up earlier that there is no staff report at this point. This is a concluding statement, preliminary conclusions of the Article IV Mission. So as Mr. Singh mentioned at the beginning the Board discussion will likely happen in February—early February. So this is the document that we have for now, and other documents will be published later.

If there are no more questions, then we will complete the conference call here. Thank you very much for participating.