03/28/2012 02:04 EDT | Updated 03/28/2012 02:15 EDT

Canada Budget 2012: Economy Will Feel Drag From Cuts, Analysts Say


OTTAWA -- Finance Minister Jim Flaherty's austere budget Thursday will place speed bumps on -- but not derail -- Canada's economic recovery, economists say.

Sources have told The Canadian Press that Flaherty's cuts will build to $7 billion in annual savings over the next three years, in addition to the $17.7 billion in cuts announced by Ontario this week for the same period.

Asked Wednesday morning about the $7-billion figure reported by The Canadian Press, Flaherty declined comment.

As well, Flaherty is expected to announce measures to restrain growth in elderly benefits by pushing public pension eligibility to 67 years from 65, and require public servants to pay a greater share of their gold-plated pensions.

Ottawa has already dealt with fast-rising health care costs by tying future transfers to the growth of the economy.

"It's about eliminating the deficit and making commitments to run balanced budgets in the future,'' said TD Bank chief economist Craig Alexander.

"The challenge Canada faces is with an aging population. There's going to be more demand for health care, for social services and as a consequence ... (the government) may want to make adjustments to entitlements.''

Alexander estimates the fiscal drag of austerity measures by the country's two largest governments will shave about half a per cent of gross domestic product this year, but noted economists had already anticipated the actions and plugged in the drag into their forecasts.

Flaherty is expected to count on growth of 2.1 per cent in 2012 and 2.4 per cent in 2013 in his budget projections.

Bank of Montreal economist Douglas Porter, who had earlier advised Flaherty to keep cuts at the minimum of the $4 billion to $8 billion previously announced, also played down the overall effect of a more aggressive stance from Ottawa.

"It will act as a moderating force, and a fairly important moderating force, for a number of years. But by itself it's not enough to endanger the recovery,'' he said, noting that in the mid-1990s Liberal finance minister Paul Martin ushered in deeper cuts without causing a recession.

It does mean the private sector will have to carry the economy going forward, he said.

The minister appear in good spirits entering caucus, however, having already notified media that in the afternoon he would be shopping for new shoes to wear at Thursday's budget presentation to the House. Last year, Flaherty had old brogues repaired in keeping with the sombre state of the economy and the high deficit.

An analysis from the Royal Bank suggests the minister is in position to report this year's deficit has shrunk to between $20 billion and $25 billion, well down from the expected $31-billion shortfall estimated in November.

"Things are looking up,'' Flaherty said. "We have a long-term plan. We have some good fiscal numbers to report Thursday, and the budget situation is improving.''

Analysts say there are political and well as economic reasons why Flaherty might want to do the heavy lifting in first year of the government's four-year majority mandate.

Balancing the budget before heading to the polls in the fall of 2015 would allow the Conservative government to keep expensive promises made in last year's campaign, including income-splitting for families with children under the age of 18, as well as a doubling of the limit individuals can put in tax-free savings accounts to $10,000. Both of those promises were contingent on eliminating the deficit.

Former Liberal finance minister John Manley, now head of the country's most influential business lobby group, said it makes political sense for the government to tackle the hard issues early in the mandate.

"Any of the hard things you believe you are going to have to do, you got to get them out of the way early,'' said Manley, head of the Canadian Council of Chief Executives.

"First of all it shows a direction, and secondly it enables you to have time to deal with any political fallout.''

Alexander said financial markets trust Ottawa to keep its word on fiscal prudence and that should it appear to be wavering, interest rates on government bonds would likely rise.

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