Canada Country Update

Implications for Investors

The CPC government will face few legislative obstacles to implementing a low-tax, pro-business agenda. The centerpiece of the government’s economic program is a plan to reduce corporate tax rates while also eliminating a $60 billion budget deficit by 2015. As the government also plans to boost spending on defense, including the purchase of fighter jets from the US, the clear implication is that deep cuts will be made to social programs and steps will be taken to privatize some public services.
The main risk for Prime Minister Stephen Harper and his party is that they might overreach, and provoke a public backlash. Although the CPC won a parliamentary majority, it did so with barely more than 40% of the vote nationwide, and some of its proposals are sure to generate polarizing debate. Barring an unlikely schism within the CPC, the prime minister will have five years to implement his party’s program, and his chances of success will probably be better if he proceeds at a measured pace.
In the near term, economic realities, rather than political impediments, pose the biggest obstacle to smooth implementation of the government’s economic program. Canada is feeling the effects of slowing growth in the US and Europe, and Harper has stated that he is prepared to postpone plans to close the budget deficit if circumstances point to the need for a fresh round of stimulus measures.
Finance Minister Jim Flaherty has stated that he sees no pressing need to revise the government’s current budget plan, which relies heavily on tax credits to spur investment, hiring, and private spending, while relying on “responsible spending” (i.e., more efficient use of funds by government agencies) rather than wholesale cuts to limit the growth of expenditures.
It is unlikely that inflation will ease to any significant degree in the final quarter of 2011, as both capacity utilization and the percentage of firms reporting labor shortages are increasing. However, the growth bias of monetary policy means that the Bank of Canada will tolerate above-target inflation in the near term.
Clear Path for Conservative Agenda
The political landscape was considerably altered at an early general election held on May 2, at which Stephen Harper’s Conservative Party of Canada (CPC) won a third term. The CPC put in a surprisingly strong performance, as the party won a total of 166 seats in the 308-member Parliament, securing its first-ever majority.
While that was unexpected—even Harper had suggested that a bare majority was probably the best the CPC could hope for—the far more stunning developments were the 66-seat gain for the left-leaning New Democratic Party (NDP) and the disastrous showing of the Liberal Party and the regional Bloc Québécois (BQ), both of which suffered devastating losses. The NDP took 103 seats, putting the party miles ahead of the Liberal Party, which made its worst showing in nearly 150 years, losing 43 of its 77 seats. The BQ fared even worse, holding on to just four of its 49 seats, as even party leader Gilles Duceppe went down to defeat.
Numerically, the Tories control a 12-seat majority in the Parliament. However, Harper’s legislative position is actually far stronger than that, as neither the Liberals, who are in disarray and face the task of choosing yet another leader, nor the BQ figures to be much of a factor during the current term. Moreover, the death of NDP leader Jack Layton, who succumbed to cancer in August, has sapped some of the energy generated by the party’s best-ever showing. Moreover, the NDP was already in the process of adopting a more centrist position, in hopes of permanently supplanting the Liberals as the main alternative to the CPC, a strategy that suggests that the party will adopt a less reflexively anti-market stance.
In general, the CPC government will face few legislative obstacles to implementing a low-tax, pro-business agenda. The new administration’s program, which was laid out in early June, amounts to a wish-list for the social and economic conservatives that form the governing party’s base. In addition to tougher anti-crime measures, including the imposition of mandatory sentences for some crimes and increased spending on prisons, Harper pledged to abolish Canada’s national registry of gun owners and promised to work more closely with the US on border security.
The centerpiece of the government’s economic program is a plan to reduce corporate tax rates while also eliminating a $60 billion budget deficit by 2015. As Harper also plans to boost spending on defense, including the purchase of fighter jets from the US, the clear implication is that deep cuts will be made to social programs and steps will be taken to privatize some public services.
The main risk for Harper and his party is that they might overreach, and provoke a public backlash. Although the CPC won a parliamentary majority, it did so with barely more than 40% of the vote nationwide, and some of its proposals are sure to generate polarizing debate. Barring an unlikely schism within the CPC, the prime minister will have five years to implement his party’s program, and his chances of success will probably be better if he proceeds at a measured pace, rather than trying to get everything out of the way quickly. In that regard, Harper’s experience governing without a majority, which if nothing else has taught him how to be patient, may serve him well.
Economy Losing Steam
In the near term, economic realities, rather than political impediments, pose the biggest obstacle to smooth implementation of the government’s economic program. Canada is feeling the effects of slowing growth in the US and Europe, and Harper has stated that he is prepared to postpone plans to close the budget deficit if circumstances point to the need for a fresh round of stimulus measures.
Although the growth forecast for 2011 has been lowered since mid-year, anticipated real expansion of 2.3% figures to put Canada in the lead among the G-7 economies. Nevertheless, with the outlook for the US economy becoming more pessimistic by the day, and the leading members of the euro zone continuing to squabble over how to resolve an increasingly worrisome debt crisis, officials cannot rule out the possibility that global conditions might send the local economy into a downturn.
Finance Minister Jim Flaherty has stated that he sees no pressing need to revise the government’s current budget plan, which relies heavily on tax credits to spur investment, hiring, and private spending, while relying on “responsible spending” (i.e., more efficient use of funds by government agencies) rather than wholesale cuts to limit the growth of expenditures.
However, numerous market signals point to rising anxiety among investors that could encourage caution, with negative implications for the growth outlook. The Canadian dollar (loonie) has weakened against its US counterpart since July, as growing fears of a debt-triggered meltdown in Europe have prompted a shift in capital flows to perceived safe havens. Moreover, analysts are forecasting a near double-digit decline in the composite stock market index in 2011, following impressive gains in both 2009 and 2010, as investors shy away from banks and resources.
On a more positive note, job growth has surprised on the upside, pushing the unemployment rate down to 7.1% in September. Additionally, given the weaker growth outlook, the resumption of monetary tightening will likely be delayed until late 2012, a prospect that has eased fears of a housing slump that could drag the economy into recession.
The consumer price index rose by 3.2% (year-on-year) in September, while the core inflation rate went above the midpoint of the target range of 1%–3% for the first time since early 2009. It is unlikely that inflation will ease to any significant degree in the final quarter of 2011, as both capacity utilization and the percentage of firms reporting labor shortages are increasing. However, the growth bias of monetary policy means that the Bank of Canada will tolerate above-target inflation in the near term, and consumer prices are forecast to increase by an average of 3.1% in 2011.
The current account deficit widened by just 1.5% (year-on-year) in the first half of 2011, as smaller income and transfers deficits mostly offset the effect of a larger goods and services deficit. The goods shortfall will widen further over the second half of the year, resulting in a current account deficit of $56.3 billion, only slightly bigger than last year’s deficit as a percentage of GDP.

Economic Forecasts for the Three Alternative Regimes

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