We'll be in the red for a while

Finance Minister Bill Morneau’s “fiscal snapshot” will land on July 8, as the federal government wages a battle on two fronts. Just as it’s spending historic sums to support a Canadian economy severely strained by COVID-19 and energy-sector weakness, slowing growth is dealing a blow to government revenue. The result, we believe, is a budget deficit of $265 billion this year, a far uglier picture than the $28 billion the Department of Finance had predicted in December.

Turbulent economic times mean tighter revenues and bigger deficits

It’s hard to fathom how much has changed in a few months. In early 2020, Canadian unemployment was near cycle lows at 5.5%, growth was trucking along, and “coronavirus” was just starting to enter North American vocabulary. Since then, unemployment has soared to 13.7%, higher than even the dire 1980s. We expect the precipitous fall in GDP of the past few months to partly reverse over the rest of the year. But we’re still penciling in an economy nearly 6% smaller at the end of this year relative to 2019.

Central banks have kicked monetary stimulus into high gear to support the economy, sending interest rates lower after a brief upswing. This will keep Ottawa’s borrowing costs near historic lows in the near term: five-year money cost the federal government just 0.39% in late May.

Still, summing up the impact of a slowing economy, anemic inflation, and existing spending, we expect the government would have run a deficit around $73 billion absent any significant stimulus. That would have eclipsed spending in recent history, and in nominal terms exceeded spending during the last recession.

Weaker expectations around future economic conditions also worsen the fiscal picture for the coming years. Based on our economic forecasts out to 2024, deficits could be close to double those predicted by the government just six months ago, as weaker tax revenues take a significant toll. We expect the revenue shortfall over the same period could total nearly $120 billion, largely this year and next.

Needed stimulus spending will also add to the bill

The costs of supporting the economy through its current rough patch have added to the impact of slower growth: stimulus already announced totals about $192 billion, and only pencils in wage subsidies to the end of the summer, and a $14 billion opening offer for provincial support payments. This spending is needed, and if largely contained to this year won’t meaningfully darken the fiscal outlook.

However, some programs have suffered slow uptake. Rent assistance via CECRA is projected to cost some $2.9 billion (without last week’s one-month extension). Only about $150 million has been disbursed so far, according to Department of Finance filings. Uptake may never accelerate, given the onerous conditions for the program. In response to slow uptake, the government has extended some timelines, in some cases at significant cost.

In contrast, CERB applications have unfolded at a blistering pace. Over 8 million Canadians have received benefits as compared with about 3 million official job losses. Coupled with the wage subsidy, income supports total nearly two-thirds of Ottawa’s spending package. Forgivable small business loans also appear to have rolled out speedily, after early delays, and total some $27 billion (or about half the envelope for such loans).

Uncertainty adds to risk of downgrades and bigger deficits

Late last month, Fitch lowered the federal government’s credit rating to AA+ from AAA, citing pandemic spending as the primary culprit. Fitch maintained a stable outlook on the view that increasing debt would likely be short-lived. Falling revenues may worsen the ratings outlook, but it’s critical that Ottawa stay the course and avoid austerity while the economy is still recovering.

Altogether, we see potential for the deficit to surpass even the estimates above. Any negative virus developments that worsen the recovery would further weigh on revenues. If unemployment benefits via CERB are extended further, or adjustments to EI are forthcoming once CERB benefits expire, spending could also increase or bleed into future years. More firms, too, may apply to CEWS as the economy reopens at a limited capacity, using wage subsidies to stem operating losses. Should that occur, the deficit in fiscal 2020/21 may exceed our $265 billion estimate.

Some cabinet ministers have discussed the opportunity for recovery spending in the wake of COVID-19, and such spending would drag on the government’s bottom line. While scaling such spending would be speculative at this point, we see potential for added stimulus heading into next year. We believe any longer-term stimulus should be focused on investments that add to the productive capacity of the economy and help the government maintain a sustainable debt position.

As it stands, the long-term fiscal picture isn’t that bad. Canada is far off historical indebtedness, at least at the federal level. Even with as large a deficit as we expect this year, the federal debt remains on a sustainable track and is well below levels in the high-debt 1990s. Interest costs are lower than they have ever been, and look poised to remain near lows for some time. With smart management going forward (and no further coronavirus surprises) the debt remains sustainable.

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This report was authored by SVP & Chief Economist, Craig Wright , and Economist, Colin Guldimann.

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