MONTREAL ― Canada’s stellar credit rating could be at risk as the country racks up new government debt faster than any other developed country, economists have warned.
According to projections in the latest fiscal monitor from the International Monetary Fund (IMF), the increase in Canada’s deficit will be equal to 12 per cent of the country’s economic output, when including the COVID-19 stimulus measures Canada’s federal and provincial governments announced as of the first week of April.
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“That’s not necessarily that remarkable (when compared to) the average advanced economy deficit. But it’s the year-over-year change that really stands out in Canada,” National Bank of Canada economists Warren Lovely and Taylor Schleich wrote in a report Wednesday.
“No advanced economy is expected to suffer as large a one-year fiscal deterioration as Canada.”
The good news is Canada’s governments went into this economic crisis in a much better financial position than most other developed countries. Net government debt (total government debt minus its cash holdings) was at 40 per cent of economic output before the crisis. The average for developed countries was 107 per cent.
The IMF’s projections show that, even after this year’s stimulus spending, Canada’s government debt will still be lower than the developed country average was before the crisis.
“Moreover, fiscal authorities would surely emphasize that a lot of measures are designed to be temporary,” Lovely and Schleich wrote.
“For Canada then, the largest fiscal deterioration in the advanced world in 2020 could give way to an unmatched year-over-year fiscal improvement in 2021.”
That may be why Canada’s governments have proven more willing to spend their way out of the crisis than some others.
Canada’s federal government has announced a series of emergency aid programs for people who have lost work and businesses that have lost revenue in the COVID-19 shutdowns. The most recent estimates suggest the federal Liberals will increase the size of the deficit this year by about $200 billion.
Provincial governments have also announced a number of tax deferrals and income supports for struggling households.
But it’s not just spending; the IMF numbers suggest Canada is giving up on a lot of tax revenue. This year’s tax haul will amount to 34.8 per cent of the country’s economic output, down from 40.8 per cent last year. That’s the largest drop among 35 developed and developing countries in the IMF’s data.
Credit rating at risk
One risk to Canada from this rapid run-up in debt is that the federal government could lose its coveted AAA credit rating. The National Bank economists note that Canada already has far higher debt levels than other countries with that credit rating. Australia, for example, has been put on notice by credit ratings agencies.
If a credit downgrade were to happen, Canada’s government would face potentially higher borrowing costs, making it harder to pay off this large debt.
“Clearly, if we continued to run large scale federal deficit spending ... when the economy was back in gear, inflation would inevitably rear its head.”
But the Bank of Canada is taking steps to ensure borrowing costs stay low. Among other things, it has launched a number of programs to buy federal and provincial government debt.
In a report Thursday, CIBC economist Avery Shenfeld noted the Bank’s spending spree will be enough to hoover up all the extra debt the government is racking up this year. This added demand for Canadian debt will help ensure the interest rates the government pays stay low.
All that deficit spending won’t cause inflation in the economy for the time being, Shenfeld said, because demand is collapsing even faster than supply. But if the government were to keep up these levels of spending past the crisis, we could see serious inflation, the CIBC economist warned.
“Clearly, if we continued to run large scale federal deficit spending and (the Bank of Canada kept buying that debt) when the economy was back in gear, inflation would inevitably rear its head,” Shenfeld wrote.