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A shout of “Anchors Aweigh” heralded the start of countless ships embarking on sea voyages down through the ages.  A similar cry was heard across Canada on September 1 when Prime Minister Trudeau released his party’s 2021 election platform.  

 “Fiscal anchors aweigh” reverberated across the nation when Trudeau announced that if re-elected, his government plans to spend another $78 billion over five years, which he believes is totally acceptable as Canada’s debt-to-GDP ratio is the fiscal anchor that will weigh in at around the 46.5%-48.5% area over the term.

And therein lies the problem.

The Canadian government had a balanced budget in the 2014-2015 fiscal year that ended March 31.

Government expenditures equaled government revenues. Six years later, it was a COVID-19-infected, $334.7 billion deficit. The 2021-2022 deficit is expected to narrow to $138.2, then shrink to $42.7 billion the following year.  The improvements will come from a rebound in economic growth and a reduction in large-scale income support measures.

That makes sense. However, the deliberate shift from a hard dollar-deficit target to the much more fluid debt to GDP ratio is an issue. It is too difficult to quantify as the calculation components are flexible.

The Liberal government embraced the debt-to-GDP ratio with all the enthusiasm of a sailor meeting a lover after a lengthy cruise. 

A cynic would suggest it’s because over or undershooting a dollar value deficit target is easily understood by voters.  A government gets kudos if its deficit is lower than forecast and criticism for spending more than predicted.

For a government that has missed every deficit target since taking power in November 2015, targeting a ratio calculated using a mix of interchangeable variables is ideal as it is difficult to prove they overspent.

The Liberal election platform claims their mix of revenue and expenses will boost the 2021-2022 deficit from the forecast of $138.2 billion to $156.9 billion but reduce the debt to GDP ratio from 51.2% to 48.5%.

Fun with figures.

In March 2021, the Parliamentary Budget Office estimated Canada’s debt to GDP ratio would be 49.8% with a deficit of $121.1 billion.  Perhaps “new math” accounts for the discrepancy.

Making things even harder to calculate is that there isn’t one hard and fast rule for the calculation. Economists and accountants are of different opinions about what should be included in the deficit or GDP calculation, leaving scope for a wide range of results.

Another issue is GDP growth assumptions. Everyone knew Canada’s Q2 GDP would rise 2.5% q/q.

Except it didn’t.  GDP contracted 1.1% due to the impact of third-wave coronavirus restrictions. What happens to the debt-to-GDP projections if COVID-19 delta and Mu variants continue to impact the economy?

The deficit to GDP ratio is not the entire problem.  Indirectly, the government is responsible for all provincial debt. That is an ugly number.

In February 2021, the Fraser Institute pegged the combined provincial and federal debt at 96% of GDP.

Source: The growing debt burden for Canadians 2021 edition, Fraser institute.

Canada isn’t the only G-10 country with high debt-to-GDP ratios.  Japan leads the pack at 266% as of December 2020, followed by Italy (156%), then Canada (listed at 118%).

Canada’s commodity currency cousins are in far better shape.  Australia is 24.8%, while New Zealand is at 27%. Rising interest rates could slow economic growth, which would negatively impact Canada’s debt-to-GDP ratio.  The antipodeans are in far better shape to weather that storm, which may also weigh on the Canadian dollar.

The Bank of Canada certainly isn’t worried about slowing economic growth.  The monetary policy statement released on September 8 dismissed the weak Q2 GDP numbers, blaming the contraction on supply chain disruptions reducing exports.

The statement said that inflation above 3% is due to base-year effects, gasoline prices, and supply bottlenecks and is expected to be transitory.  They said interest rates aren’t going anywhere until economic slack is absorbed so that the 2 percent inflation target is sustainably achieved. In the Bank’s July projection, this happens in the second half of 2022.

Hmm, if inflation is currently above 3.0%, and a sustainable rate of 2.0% inflation will not be achieved until the H2, 2022, it suggests “transitory” is a minimum of 12 months.

That also means the Canadian dollar will not get any support from BOC policies. 

USDCAD prices are being driven by external forces.  They climbed steadily since June underpinned by fears of a global economic slowdown from rising COVID-19 delta-variant cases, China issues, and geopolitical tensions with Afghanistan at the forefront.  Global growth worries and increased Opec production have stalled oil price gains in the $70.00/barrel area.

If it is “anchors aweigh” for budget deficits, what will anchor the Canadian dollar?