April 23, 2021 | 12:58
Federal Budget 2021: Spending to Immunity and Beyond
Spending to Immunity and Beyond
Douglas Porter, CFA, Robert Kavcic and Benjamin Reitzes
Canada’s federal government budget for FY21/22 is a wide-ranging and ambitious document. Clocking in at a bulky 724 pages, this is a highly detailed budget that sets the stage for post-pandemic policy in Canada or, if necessary, has all the makings of an election platform. Indeed, a wide range of policy measures spans well beyond just extending current support measures through the current wave of the pandemic, including steps to propel post-COVID re-hiring, address climate change, housing policy and a new national childcare and early learning plan. There are also a few minor and targeted tax measures, but no broad-based tax hikes—more serious changes are held back at this point. All told, the amount of spending deployed over the coming three years hits the high end of the $70 billion-to-$100 billion guidance set in the fall. Net new measures announced in this budget amount to $49 billion this fiscal year (or 2% of GDP), and total $101.4 billion over three years.
Against that spending backdrop, but also amid a more resilient economy than expected, the deficit will remain wide at $154.7 billion in FY21/22. That is down sharply from the record $354.2 billion in FY20/21, thanks in part to a forceful rebound in the economy and some emergency spending measures winding down. Still, the gap remains a hefty 6.4% of GDP (versus 16.1% last year), and lands in the middle of the range of outcomes set in the fall. Total revenues are tracking much better than expected for FY21/22, but that is largely absorbed by new spending measures and the extension of some existing programs. The debt-to-GDP ratio will rise again to 51.2%, up from 49.0% in FY20/21 and just over 31% before the pandemic. However, this year should mark the peak before declining below 50% by FY25/26.
Further ahead, the deficit is pegged at $59.7 billion (2.3% of GDP) in FY22/23, before fading to $30.7 billion (1.1%) by FY25/26. The medium-term fiscal path settles in the mid-to-lower end of the range projected in the fall, thanks to an economy that has trounced prior budget expectations and supported revenues. In other words, Ottawa has been provided the space to double down on stimulus and spending, without significantly denting the medium-term budget outlook.
Fiscal Outlook and Anchor
There is no plan in place to balance the budget, but one area of focus ahead of the budget was whether Ottawa would commit to a specific fiscal anchor. And while a precise figure was not mentioned, the budget states: “The government is committed to unwinding COVID-related deficits and reducing the federal debt as a share of the economy over the medium-term.” With the proviso that the economy recovers roughly in line with consensus expectations, and that borrowing costs don’t flare dramatically higher, this suggests that the anchor is a 50% debt/GDP ratio. For the deficit, this implies a reversion to pre-pandemic levels of around 1% of GDP (or about $30 billion later in the decade). In a sense, then, the pandemic has been “paid for” by a one-time level step-up in the debt/GDP ratio from 30% to 50%.
Notably, the so-called fiscal guardrails—meant to guide when stimulus could be reined in—were relegated to a side-bar box in the document. These measures of labour market developments may have been downplayed a bit, simply because they have mostly recovered much more forcefully than expected in the past five months. For example, total hours worked are now almost back within 1% of pre-pandemic levels, and could easily recoup all recession losses in the months ahead. We suspect that these metrics may well fade from prominence.
The budget is based on consensus GDP growth of 5.8% this year (we are now at 6.0%), 4.0% next (4.5%) and then slipping to a more trend-like 2.1% in 2023 (2.5%). The 2021 growth rate is a full percentage point above the fall assumption, even with the second- and third-wave restrictions. Notably, the private sector consensus (and we) look for growth in the longer-term to trend steadily lower to an average growth rate of just 1.8% in the 2024-26 period, which is back in line with the listless pre-pandemic trend. It will be fascinating to see if any of these forecasts change significantly as a result of the budget moves—we suspect not.
Above and beyond the upgrade in real growth assumptions, we would highlight the big bump-up in nominal GDP growth forecasts, especially for the current year. Thanks to higher oil and other commodity prices, the GDP deflator has also taken a big step up, and the consensus now expects nominal GDP to rise a whopping 9.3% this year (up from 7.0% last fall). And, the level of nominal GDP will be 3.6% higher than expected by next year than expected, a big support for the revenue outlook. For example, the projected level of revenues is now clocking in roughly $20 billion higher even for the past fiscal year (which ended in March) and again this year.
The only downbeat note on the economic forecast front is that long-term borrowing costs have jumped since the start of the year. The 10-year bond yield assumptions have been lifted by 0.6 percentage points both this year and next, bringing them in better alignment with current yields. However, even that is not entirely bad news for government finances, since its large pension obligations are now discounted at a higher rate. Moreover, it takes time for rate increases to hit the fiscal position; Finance estimates that a 1 percentage point rise in interest rates boosts the deficit by just $1 billion in the first year, rising to $2.5 billion in year two. The bottom line is that economic and financial developments just since last fall leave finances in a stronger underlying position to the tune of nearly $16 billion this year and more than $19 billion next year. And, we do not regard the forecasts as particularly optimistic.
A fundamental question we have often been asked is whether the economy can effectively grow its way out of the problematic deficit of last year, without resorting to big tax increases. We believe that the fiscal forecasts suggest that this is indeed possible, even with the spending increases aimed at priorities such as child care.
Debt Management Strategy
Following a record deficit and issuance in FY20/21, both are expected to decline sharply in the current fiscal year. Gross bond issuance is expected to drop to $286 billion, down $88 bln from the prior year’s record $374 bln. After accounting for maturities, that pegs net issuance at $181 bln, or a bit above the expected budget deficit (of $155 bln). While the issuance figure remains sky-high from a historical perspective, it’s important to keep in mind that the Bank of Canada continues to buy huge amounts of GoCs. The BoC currently buys 13% of auctions and targets $3 bln per week in QE.
Last year’s major shift in the Debt Management Strategy to extend the term of the debt with more issuance in the 10-year and 30-year sectors, remains a notable theme in FY21/22. Planned issuance is $84 bln in the 10-year sector (29% of total) and $32 bln in the 30-year sector (11% of total), versus $74 bln (19.8%) and $32 bln (8.6%) respectively in the prior fiscal year. As well, $4 billion in ultra-long bond issuance is anticipated. On the flip side, combined 2-, 3-, & 5-year issuance is falling $107 bln. Benchmark sizes change accordingly, with big declines in 2s, 3s, & 5s, while the 10-year range narrows a bit, and 30-year rises substantially. Along similar lines, Treasury bill issuance is planned at $226 bln, broadly consistent with the $218.8 bln outstanding at the end of March.
A special mention includes plans for the first-ever green bond from Ottawa, with $5 billion in issuance targeted, dependent on market conditions.
It’s no secret that we had misgivings around Ottawa’s proposal to pour an additional $100 billion of stimulus into an economy that appeared primed to recover on its own and following last year’s record deficit. However, there are some important mitigating factors that make us somewhat more comfortable with the plan. First, the deficit is still projected to come off quickly in the next two years, to less than 2% of GDP. Second, Ottawa has set at least a loose fiscal anchor of holding debt at around 50% of GDP. Third, nearly half of the new spending is aimed at the current fiscal year, and not back-end loaded, when it would not be needed. Finally, some of the additional spending will support labour force participation (notably child care and the Canada Worker Benefit), and thus potential growth. Still, the medium-term fiscal outlook depends heavily on a strong recovery over the next year without a big back-up in borrowing costs; both underlying assumptions are key risks to the plan.