Budget Do-or-Die for Canadian Government

January 26, 2009

Prime Minister Stephen Harper’s minority Conservative government has been sweetening the stimulus it will offer in tomorrow’s Federal 2009-10 budget (due at 21:00 GMT).  Initial resistance by Harper to fiscal pump-priming has given way to endorsement.  Eleven consecutive surpluses, a streak of great pride in Ottawa, will give way to an expected deficit of about 2.5% of GDP. A similar sized deficit will be penciled in for the following financial year.   At least C$ 13 billion of new spending plans next have been leaked in recent days.  One impetus for the change of heart has naturally been a rapidly deteriorating global and Canadian economy, but that is not the only factor nor the main one.  The government’s continuing hold on power may depend on securing the endorsement of some oppositions parties, mainly the Liberals.  Otherwise, the opponents will make good on a threat to turn the budget into a vote of no confidence.

The Bank of Canada last Tuesday cut its overnight target by 50 basis points to 1.5%, bringing cumulative relief to 350 basis points Since December 2007 and 200 bps since October.  The central bank updated its economic outlook two days later.

  • In contrast to annualized growth of 0.4% during the first three quarters of 2008, officials projected negative GDP growth of 2.7% at a seasonally adjusted annual rate during the next three quarters to mid-2009.  On-year growth over that period would average negative 1.1%. The weakest quarter of the recession will be the present one, when real GDP is forecast to drop 4.8% saar, twice as much as last quarter.  Negative growth of 1.2% in 2009 as a whole is forecast to be half-concentrated in inventories, and net exports are seen exerting a much lighter drag than in recent years.
  • Actual GDP was already 1% lower than potential GDP last quarter.  Excess supply will increase substantially in 2009, depressing the core CPI rate from 2.2% last quarter to 1.1% in the final quarter of this year.  Total inflation is forecast to drop even more sharply due to the halving of oil prices since the central bank’s previous Monetary Policy Report in October.  Bank officials expect total CPI to post on-year declines of 0.6% in 2Q09 and 1.0% in the third quarter before converging on core CPI by the fourth quarter.
  • The negative 1.2% of Canadian growth in 2009 is not quite as bad as forecast declines of 1.7% each in U.S. and Japanese GDP this year.  Projected growth in the EU and China and Asian NIE’s have been trimmed to -1.0% and +5.6% from +0.3% and +7.3% assumed in the October report.
  • The biggest surprise of the Bank of Canada Update is the optimism about the other end of the recessionOfficials looks for a faster recovery than after recessions in 1990-2 or 1981-82, with positive growth averaging 2.7% in the second half of 2009, 4.7% saar in 1H10 and 4.9% in 2H10.  Officials cite stable inflation expectations, a quicker and more pronounced easing of monetary policy, “greater fiscal flexibility and stronger corporate balance sheets” than in those earlier episodes.
  • Excess economic supplies are eliminated by the middle of 2011, and inflation returns to the 2% target by that same time.  Long-term price risks associated with the new forecast are considered balanced but substantial on both sides.  It all depends on the severity and length of the unfolding global recession.  Any exit strategy for the United States and thus the global economy needs the housing industry to bottom out.  A chunk of the extra Federal spending to be proposed in the Canadian budget will be earmarked for construction.
  • The Bank of Canada frequently mentions confidence as a key component that must be turned around to normalize the economy.  Pep talks go only so far.  U.S. share prices never plumbed new cyclical lows after Roosevelt’s fear-itself speech, and GDP growth was positive in 1934, 1935, 1936 and 1937. But 1938 saw a terrible setback, and economic  normalcy didn’t return in a sustainable way until 1942. Likewise, a Japanese approach of trying to talk the economy into self-repair and supplementing the cheerleading with numerous fiscal packages flopped infamously through much of the 1990’s.

Meanwhile, recent Canadian data have been awful. Both retail sales (-2.4%, the steepest drop since the January 1998 ice storm) and wholesale turnover (-1.6%) were worse in November than anticipated.  Manufacturing sales and orders each tumbled 10.3% in the four months between July and November including drops of 6.4% and 12.9%, respectively, in November alone.  The IVEY-PMI index fell to 39.1 at yearend from 52.2 just two months earlier.  Inflation has also receded faster than expected.  Consumer prices fell 0.7% in December, while producer prices plunged 2.6% in November compared to the prior month.  The Bank of Canada assumes an exchange rate against the U.S. dollar averaging C$ 1.22 during 2009-10.

Copyright 2009 Larry Greenberg. All rights reserved.  No secondary distribution without express permission.



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