Budget improves pace of debt consolidation, but warns of economic uncertainty

Finance Minister Chrystia Freeland tables the federal budget in the House of Commons in Ottawa on April 7.Adrian Wyld/The Canadian Press

The federal government is promising to put the country’s finances back on solid footing after a period of explosive spending growth, while warning that the pace of fiscal consolidation could be thrown off balance by mounting global economic turmoil.

Thursday’s budget starts from a better place than expected, with the fiscal year 2021-22 deficit coming in at $113.8 billion, about $30 billion better than projected in the December update. of the government. It’s the result of rapid economic growth resulting from pandemic shutdowns and skyrocketing inflation, which has driven up prices for consumers but also put more tax money in government coffers.

Deficits are expected to decline over the next five years, and the federal debt-to-GDP ratio is expected to steadily decline to 41.5% by 2027 from 46.5% in 2021.

Kelli Bissett-Tom, Canada rating analyst at Fitch Ratings, said the federal government’s debt reduction trajectory is moving in a positive direction. At the same time, the government still has a long way to go to consolidate the huge debt accumulated during the pandemic, she said.

“Given the current level of federal debt, we are unlikely to see any rapid consolidation. But certainly this [budget]in conjunction with more positive than previously expected provincial results, … supports a gradual, but better than expected, downward trajectory,” she said.

In 2020, Fitch downgraded Canada’s credit rating by one notch to AA+. Other debt rating agencies, including S&P Global Ratings and Moody’s, maintained their highest rating for Canada.

The trajectory of government debt comes with caveats. Basically, the global economy is entering a period of high volatility due to rapid monetary policy tightening and heightened geopolitical uncertainty, which could deflect the fiscal path.

Central banks embarked on the most aggressive cycle of raising interest rates in decades in an effort to rein in high inflation. At the same time, the war in Ukraine has driven up commodity prices sharply and disrupted supply chains that still face challenges caused by the COVID-19 pandemic.

The government’s central economic scenario is based on a February survey of private sector economists. These figures look increasingly outdated given Russia’s invasion of Ukraine and central banks’ hawkish turn over the past month.

The rapidly changing economic outlook has led the government to include two alternative scenarios in the budget. In the downside forecast, if the war in Ukraine drags on and central banks become hyper-aggressive in raising interest rates, it could trigger a major economic shock that could reduce the real GDP growth in 2022 and 2023 and increasing unemployment. by 0.7 percent. This would put the debt-to-GDP ratio back on an upward trajectory for several years, before starting to fall again.

Rebekah Young, director of fiscal and provincial economics at the Bank of Nova Scotia, said this downside scenario is unlikely given that Canadian household balance sheets are generally in good shape as they emerge from the pandemic. . But she said the government was right to think about downside risks.

“It speaks to the challenge of creating a budget right now, because you can think of so many possible events that could happen. We now have a global conflict, we still have a pandemic. We have runaway inflation and this political risk, so there are easily five different scenarios that are less desirable,” Ms Young said.

One of the main points of uncertainty is the cost of servicing the debt. As the government’s debt load has skyrocketed during the pandemic — to $1.16 trillion in fiscal year 2021-22 from around $721 billion in 2019-20 — the service charge for the debt remained low, thanks to the ultra-low interest rates maintained by the Bank of Canada.

Now, rates are expected to rise rapidly, which will increase debt servicing costs as the government rolls over maturing bonds and issues new debt. The budget argues that debt servicing costs will remain manageable, rising to $42.9 billion by 2026-27 (1.4% of GDP), from $26.9 billion in 2022-23 (about 1% of GDP).

However, if rates rise faster and higher, it could add pressure on government finances, said Randall Bartlett, senior director of the Canadian economy at Desjardins.

“The expectation is not just short rates, but long rates will start to rise, and in a significant way that we haven’t really seen since the Great Financial Crisis,” he said.

“And if that’s the case, that’s really where the rubber is going to meet the road, in terms of public debt charges.” … Because every 100 basis point increase in interest rates has as much impact on the deficit as a 1% drop in GDP, so it’s quite substantial.

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Nancy I. Romero