Focus
April 16, 2021 | 13:27
Ottawa’s Budget: 10 Things to Watch
Ottawa’s Budget: 10 Things to Watch |
Anticipation is running high ahead of the long-awaited federal budget on April 19, the first in 25 months. Addressing the pandemic and its enormous costs will dominate the proceedings, with the clear possibility of an election later this year rumbling in the background. While there will no doubt be scores of sub-plots and a raft of spending announcements competing for attention, here are the top 10 concepts we will be focused on: 1) Deficits: How big, and how fast do they come down? The world has changed considerably in the five months since the November 30th Fall Economic Statement (or FES). We’ve seen second- and now third-wave restrictions, the vaccine rollout, a rebound in commodity prices, rollicking financial markets, and a resilient North American economy. And, yet, the net effect on Ottawa’s fiscal landscape is likely to be moderate, with a surprisingly firm economy offset by the heavy costs of relief program extensions. Moreover, Finance will likely continue to build a massive amount of caution into the fiscal forecasts, given the still very wide range of possible economic outcomes. Thus, it would be a (pleasant) surprise if any of the deficit estimates are meaningfully revised down from the FES (Chart 1). Based purely on the economic backdrop, the FY20/21 record deficit would be trimmed slightly from the $382 bln estimate (the PBO estimates $360 bln, or above 16% of GDP). However, the $121 bln estimate for the current fiscal year (which began on April 1) will almost certainly be bumped up due to program extensions as well as new spending measures—we would expect something in the $150 bln-to-$175 bln range (or about 7% of GDP). Similarly, next year’s gap will likely be raised from $51 bln to closer to $100 bln (nearly 4% of GDP). The long-term forecast is likely to still see the deficit recede to around 1.5% of GDP, or a bit below $40 bln. |
2) A new fiscal anchor? In the FES, Ottawa suggested that a more stable outlook for the economy could set the conditions for a new fiscal anchor. Prior to the pandemic, the goal was a stable, or downward drifting, debt/GDP ratio at around 30%. Last year’s blow-out pushed that ratio well above 50% of GDP, and the deficit forecasts above will see it continue to rise right out to the middle part of the decade to nearly 60% (Chart 2). This is still below the highs seen in the mid-1990s, and in a much lower real interest rate environment—and Ottawa may choose to set anchor in this new range. Another possibility, which some provinces are also considering, is to set interest costs as a share of revenues as the anchor (at, say, 10%). Last year, they were about 7% of revenues, falling to about 6% this year. The issue here is that if interest rates fundamentally ratchet higher, this measure would signal real trouble far too late. |
Ottawa will likely implicitly build a rough anchor into its long-term forecasts—on the debt/GDP ratio—but will not be pinned down to a point target given the still high degree of economic uncertainty. 3) Cautious economic assumptions? Look for an upgrade to the economic outlook versus the FES, despite the latest restrictions. Not only were last year’s GDP figures a bit less negative than expected, but growth rates for this year and next should see a modest upgrade (Table 1). Finance employs the private sector consensus to drive fiscal projections, and normally adds a prudence factor. Our forecasts are above consensus for 2021, so look for a more modest assumption than our 6.5% GDP growth rate, but a step up from last November’s 4.8%. Curiously, Finance set out a few more negative scenarios last November to account for possible second-wave restrictions—and, yet, the economy performed even better than the private sector consensus base case. Perhaps mindful of that experience, Finance will revert to the traditional practice of relying on consensus, layered with some moderate prudence. |
One point to highlight on the forecast is nominal GDP, which, after all, is the ultimate driver of revenues. Above and beyond a better real GDP outlook, export prices have roared higher alongside the commodity price upswing. Even under a reasonably cautious commodity price outlook, we believe that the GDP deflator could rise 4% this year, yielding nominal GDP of above 10% in 2021. As a result, the level of nominal GDP could be a whopping 5% above what Ottawa assumed in the FES by 2022. If correct, that would provide a big windfall for government revenues. 4) Fiscal Guardrails? Ottawa suggested that it would be guided on when to rein in relief spending by its so-called fiscal guardrails, which were all job market metrics. The appendix dives into the specifics. 5) Extra stimulus spending? It would be shocking if they didn’t, at least at the low end of the $70 bln-to-$100 bln range, even with widespread calls that this extra outlay is not needed. We continue to maintain that when the economy is able to safely reopen, it will recover rapidly on its own, juiced by the tidal wave of support over the past year. Strengthened household finances, a mass of excess savings, and the wealth effect from soaring asset prices (including homes) point to a robust rebound in consumer spending. It is unwise to “jumpstart” an economy that doesn't need a further boost. However, and without delving into the political waters, this is where the possibility of an election will likely outweigh economic realities. Perhaps emboldened by President Biden's massive U.S. fiscal stimulus, Ottawa is likely to plow ahead with its plan to spend an additional $40 bln this year (or roughly 1.5% of GDP), and keep that flowing at nearly the same pace in the next two years. 6) Permanent spending increases? PM Trudeau’s supplementary mandate letter instructed FM Freeland to use “whatever fiscal firepower is needed in the short term” but “avoid creating new permanent spending.” And, with the budget’s key focus on using the $70-to-$100 bln of additional temporary stimulus, major new permanent spending will likely be kept to a minimum. However, the government has already committed that the budget will outline (and fund) a national child care program. And, temporary measures have a funny way of sometimes becoming permanent. 7) Pharmacare? This was mentioned in last September’s Throne Speech and the FES, and endorsed again at the recent Liberal policy convention. It would cost about $15 bln annually according to 2019’s advisory council report. Having been bandied about for a while now, and with fiscal spending still flowing freely, we could actually see some concrete action, particularly in the wake of the nation’s worst health crisis ever. 8) Tax increases? Almost since the first day that the fiscal floodgates opened a year ago, a top question has been: How will we pay for this? Our assertion is that the best cure for the massive budget deficit is a complete economic recovery. And anything that may thwart or blunt that recovery—such as tax increases—would be counter-productive. It appears that Ottawa is on board for now. Only when the pandemic is over, and we have a more complete and accurate fiscal picture, will it be appropriate to consider serious restraint—either through revenues or program spending. Still, this does not rule out some targeted tax measures, aimed at driving certain policy goals. For example, the FES proposed at least two smaller tax measures, including on digital giants and on vacant homes held by non-residents. 9) Major housing measures? Normally, big housing policy announcements have not been in the budget, with a few exceptions. We suspect that the government does not want to see the housing file draw all the oxygen on budget day, when there will no doubt be so many show-piece announcements in other key areas. Still, look for some fleshing out of the vacant home tax, as well as some possible moderate measures to curb speculation (particularly by non-residents). And, despite skepticism over the efficacy of such, there likely will be at least a nod at supporting first-time buyers. 10) Shifts in the Debt Management Strategy? Total borrowing requirements for FY21/22 should be noticeably below the FES’ estimate of $703 bln for FY20/21. The latter reflected the $382 bln budget deficit, the $66 bln shortfall in non-budgetary transactions (various loan programs get booked here), and $255 bln in refinancing. We expect the FY21/22 budget deficit will be cut in half, with borrowing requirements decreasing commensurately. This will likely contribute to the Bank of Canada decision to pare its current asset purchase pace of $4 bln/week, perhaps as early as its April 21st meeting. The Bank has already acknowledged that it is absorbing a higher proportion of the government’s borrowing requirements than other central banks. Meanwhile, we expect the strategy for FY21/22 will continue along the same course charted in the FES. This includes keeping the share of gross bond issuance via long tenors (10 years and over) at least at FY20/21’s 29% slice (this was up from 15% in FY19/20), issuing an inaugural green bond and possibly reopening the ultra-long, 50-year bond. Although longer-term interest rates have backed up some 75-to-85 bps since the FES, the goal “to extend the maturity of the debt in future years” will likely be reiterated although perhaps with a more pronounced nod to the other part of the dual objective—to minimize interest costs over time. |
Appendix: Ottawa’s Fiscal GuardrailsLast year’s Fall Economic Statement introduced the notion of fiscal guardrails. These are labour market metrics used to determine “when recovery stimulus will be wound down.” The metrics are the employment rate, total hours worked and the level of unemployment. Presumably, these indicators, collectively, returning to their pre-pandemic marks would be the signal to start. It’s noteworthy that economic performance is being assessed through the labour market, instead of GDP or the output gap. The pandemic negatively affected some industries and individuals more profoundly than others, and they could still be suffering significantly by the time GDP has returned to pre-pandemic or potential levels. The jobless rate is not among the metrics tracked, but the unemployment level and the unemployment rate tend to give comparable labour market insights over the shorter run. Meanwhile, there are benefits to tracking a collection of metrics; their combined return to pre-pandemic readings are more indicative of a broad-based labour market recovery. This is important because the pandemic also negatively affected some income and demographic groups more profoundly than others, such as lower-wage workers, women and those under the age of 25. |
Between February and April/May 2020, the employment rate fell by 9.7 ppts, hours worked dropped by 27.6% and the unemployment level surged by 128% (Chart 3). When the fiscal guardrails were first introduced, the most recent data already showed massive improvements. Compared to their pre-pandemic marks, the employment rate was down 2.4 ppts, hours worked were lower by 6.1% and unemployment was up 60%. But, there was concern that further progress would be difficult. Looking back at the 2008-09 recession, the employment rate and the unemployment level never returned to their pre-recession positions, despite the jobless rate hitting a 45-year low. Strong population and labour force growth during the interim also influenced these metrics. In any event, these concerns were a rationale for extending relief measures through the summer of 2021 and proposing up to $100 bln of additional fiscal stimulus. |
But further progress is being made. As of March 2021, and compared to 13 months earlier, the employment rate is down by 1.5 ppts, hours worked are lower by 1.2% and the unemployment level is up by 32%. At the current pace, all three metrics should return to their pre-pandemic marks later this year, even with some likely setbacks owing to renewed lockdowns and restrictions. There’s a good chance the fiscal guardrails will signal time to wind down stimulus by the end of 2021. |