Finance Minister Bill Morneau has estimated the deficit for FY 2020/21 at $343 billion – a figure that eclipses even the lofty forecast we made on Monday. Indeed, today’s fiscal update acknowledged that any material worsening of the virus outlook will pose a significant risk to the government’s bottom line. It also left the door open for more recovery spending even after the virus is contained, to help manage the longer-term consequences of the crisis.

Falling revenue, rising costs paint a much darker economic and fiscal picture

Ottawa’s projections envision a more severe economic downturn this year compared to our snapshot. Averaging several forecasters’ numbers, the government expects GDP to plunge 6.8% in 2020, before recovering 5.5% in 2021.

Morneau’s “fiscal snapshot” included updated costs for the emergency wage subsidy, pegging the extended program at $82 billion. This new estimate adds over $35 billion to the costs of recent government actions, though given slow uptake of the wage subsidy thus far, may overshoot. Overall, the stimulus measures announced total nearly $230 billion this year.

As we noted on Monday, the fiscal picture has also deteriorated significantly due to the economic disruption from COVID-19. The government projects it will have about $50 billion less revenue than it previously expected this year, and that expenses will rise $14 billion, mostly due to higher EI claims as CERB benefits start to run out. The pandemic-induced fall in interest rates will save about $4 billion in interest costs on the public debt.

Altogether, the lower revenues and higher costs associated with COVID-19 will bring the government to a record deficit of $343 billion, or about 16% of GDP. The federal debt will climb to over $1 trillion, about 49% of GDP. Without worsening virus news or significant additional stimulus needed to aid an ailing economy, it should peak there and decline slowly as economic growth resumes.

Accounting losses deepen the pain

Usually monetary policy impacts government deficits only via interest costs on public debt. This time, though, the Bank of Canada’s bouts of quantitative easing have hit the government with an accounting loss in the range of $20 billion. When the bank buys back bonds on the Government’s behalf to support financial markets, any premium they pay to buy older bonds with higher interest rates increases the deficit. Over the medium term, this should improve debt charges for the government by taking higher coupon bonds out of circulation (though this is outweighed by the premiums paid for this fiscal year).

Interest cost savings are also more than offset this year by rising pension liabilities. As rates decline, and the return on pension assets follow them, the government must set aside more money today to pay for future pension benefits for public servants. They estimate this adjustment will cost about $5 billion. Together, these accounting adjustments are nearly the same size as what Ottawa thought its deficit for the year would be in December.

But Canada’s in good company: more borrowing, more downgrades likely for several countries

The deterioration in the fiscal picture puts the federal government at risk of further downgrades, with other ratings agencies likely following Fitch’s lead in bringing Canada down one notch to AA+. While a downgrade may be likely, Canada is far from alone in this situation: the OECD projects several other AAA countries will breach the average indebtedness among peers last year.

While Canada’s AAA rating was a strong talking point, Fitch’s downgrade did little to stir government debt markets. But the gargantuan financial requirement announced in the fiscal update—the government will borrow some $713 billion from markets this year—has already put some pressure on yields, especially for longer term government borrowing.

As Morneau emphasized in his update today, there is much uncertainty around how quickly, and to what degree, the economy will recover. Uncertainty remains around how Ottawa will manage spending in the future, too. Should it be contained to the near-term, we think the debt is sustainable. But if high program spending bleeds into future years, and economic recovery is slower than we currently expect, the red ink could keep flowing. Future deficits adding to a now-higher debt pile could become more difficult to manage if the government isn’t careful in the coming months.

RBC Chief Economist, Craig Wright, joins the 10-Minute Take podcast to shares his take on the 2020 fiscal snapshot.

 

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

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