Special Report

November 21, 2023 | 18:25

Fall Economic Statement — 40 is the New 30

Economist

Chief Economist and Managing Director
Economics

Douglas Porter has over 30 years of experience analyzing global economies and financial markets. As Chief Econom... (Read more)

Robert Kavcic

Senior Economist and Director
Economics

Robert has been with BMO Capital Markets since 2006. He plays a key role... (Read more)

Benjamin Reitzes

Managing Director, Canadian Rates & Macro Strategist
Fixed Income Strategy

Benjamin has been with the Bank of Montreal nearly two decades. He is re-sponsible for the Canadian macro-econom... (Read more)

Douglas Porter , CFA

Chief Economist and Managing Director
Economics

Douglas Porter has over 30 years of experience analyzing global economies and financial markets. As Chief Econom... (Read more)

Robert Kavcic

Senior Economist and Director
Economics

Robert has been with BMO Capital Markets since 2006. He plays a key role... (Read more)

Benjamin Reitzes

Managing Director, Canadian Rates & Macro Strategist
Fixed Income Strategy

Benjamin has been with the Bank of Montreal nearly two decades. He is re-sponsible for the Canadian macro-econom... (Read more)

Ottawa’s finances are tracking roughly in-line with expectations set out in the 2023 budget for this fiscal year, but the picture gets notably weaker over the forecast horizon. The FY23/24 budget deficit is now estimated at $40.0 billion, or 1.4% of GDP, effectively in-line with $40.1 billion penciled into the 2023 budget. Recall that last fiscal year finished better than expected, at $35.3 billion versus $43.0 billion, but deficit levels over the forecast beyond this year run substantially deeper. The deficit for next fiscal year is pegged at $38.4 billion, with the shortfall narrowing to $18.4 billion by F28/29, but annual deficits run roughly $10 billion per year deeper between FY25/26 and FY27/28. Cumulatively, including last year's improvement, total deficits over the forecast horizon are now tracking $28 billion deeper. Meantime, the debt-to-GDP ratio rises by 0.7 ppts this year, to 42.4%, and further to 42.7% next fiscal year before falling gradually to 39.1% by the end of the forecast horizon. While deteriorating, the ratio this year and through the forecast is lower than expected in the budget plan.

This year’s unchanged budget deficit comes as positive economic and fiscal developments are countered by further new spending measures, both since the budget and in this update. Indeed, there have been $2.7 billion worth of new measures rolled out since the budget, including today’s update. Looking ahead, things get more interesting over the coming years as a slower economy and higher interest rates weigh heavier, while spending priorities increase further. Economic and fiscal developments deepen the deficit by more than $7 billion starting in FY25/26, which reflects a combination of softer income tax revenues, some program spending pressure and higher debt service costs. And, new spending measures cost a further $4.2 billion by FY25/26. All told, Ottawa is facing a softer economy, higher borrowing costs and is spending modestly more on priorities, leading to a deeper deficit profile.

We might be reaching a point where the immediate revenue benefits of high inflation have given way to softer economic growth (resulting from higher interest rates to combat that inflation) and cost pressures (think public-sector pay increases). At the same time, interest costs continue to rise, and are averaging almost $5 billion higher per year between FY24/25 and FY27/28. Ottawa now expects debt-service costs to rise from $35 billion in the prior fiscal year to $46.5 billion this year and then $55 billion three years down the road. That will come in at 10.2% of revenues this year compared to recent low of 5.9% in FY21/22, and is expected to edge up further to 10.6% by the end of the forecast. That’s still a long way from the dark days of the 1990s (north of 33% of revenues), but it’s a notable move higher.

Summary of Major New Measures

New measures announced since the spring come in at $2.7 billion this fiscal year, and average $3.6 billion per year over the following five fiscal years. We have long questioned (and the Bank of Canada has more recently as well) the appropriateness of fiscal stimulus when the economy is running hot and inflation is a problem for most Canadians. While Ottawa continues to incrementally push more dollars into the economy, the total in this document is relatively small at just 0.1% of GDP. And, some of it at least well intended, with the goal of adding to the supply side.

Here are some of the notable items announced in this update:

Measures to incentivize housing supply have mostly been announced. Removing HST from new rental housing carries the largest cost to Ottawa at $1.1 billion by FY26/27. There are various financing programs aimed at affordable housing development; and a $20 billion increase in the CMB program hopes to funnel more funding into multi-unit housing.

The CMB program will continue to operate, and Ottawa will buy up to $30 billion of CMBs annually starting in February 2024.

Tax treatment of non-compliant short-term rentals: Ottawa will deny income tax deductions (e.g., interest and maintenance costs) for short-term rental units in provinces and municipalities that have prohibited those units. The same will apply for operators not following licensing requirements. While this will take a larger enforcement effort, it should disincentivize those units for many, while still allowing regions that benefit from short-term rentals to continue uninterrupted.

Canada Mortgage Charter: This will build on existing guidelines, and highlights include allowing temporary amortization extensions; waiving fees on relief measures; eliminating re-qualification on changing lenders; early renewal warnings; more flexibility on lump-sum payments or early selling of a property; and not charging interest on interest when amortizations turn negative.

Clean Economy Industrial Supports: The cost of measures previously announced, including subsidies for battery production, run $8.5 billion higher than last expected through the forecast horizon ($1.4 billion per year).

Open Banking will be addressed with legislation in Budget 2024 to establish a consumer-driven banking framework that would regulate access to financial data.

Economic Outlook

Ottawa is basing this fiscal update on 1.1% real GDP growth this year, followed by just 0.4% growth in 2024 and a pick-up to 2.2% by 2025. The assumption for next year, which is based on the consensus of private sector forecasters roughly a month ago, is in-line with our call of 0.5% for real GDP growth in 2024, and 2.0% for 2025. Of course, nominal GDP has been the big factor helping support revenues, and this year's mild 2.0% rise could actually improve modestly in 2024 and the year beyond. Overall, the economic growth assumptions are reasonable.

We would also highlight the interest rate assumptions underlying the projections. Normally, this forecast does not provide much drama, but these are patently not normal times. The consensus looks for 3-month T-bills to average 4.3% next year, and pegs 10-year GoC bond yields at 3.3%. Both look at risk of again undershooting reality, as bills are currently above 5% (and BoC rate cuts are a distant prospect) and 10s are above 3.6%. This is where our call lines up better with Ottawa's downside scenario, and imparts a bit of downside risk to the fiscal outlook.

Debt Management Strategy Update

The Debt Management Strategy Update increased issuance across the curve. Total gross bond issuance jumps $32 billion (or 19%) to $204 billion for FY23/24. The two-year sector faces the largest increase, up $10 billion (13%) to $86 billion, while 5-year and 10-year borrowing rises $7 billion (18%) to $47 billion for both maturities. Perhaps most importantly, 30-year issuance is up $4 billion (40%) to $14 billion, with the government responding to market calls for more supply in the sector. The increased funding needs are driven largely by cash management needs. In addition, the government announced that they are shelving their plans to fully consolidate the Canada Mortgage Bond (CMB) program. Instead, the government will buy up to $30 billion in CMBs annually (out of the $60 billion program), starting in February 2024. A portion of the increased bond issuance will cover the CMBs purchases. The borrowing to fund those purchases will ramp up issuance further in FY24/25. In addition, green bonds are coming back into the framework with the intention to issue $4 billion for FY23/24. Finally, Treasury Bill issuance rises $39 billion (16%) to $281 billion, and the introduction of a 1-month T-bill is being considered.

The Bottom Line

Fiscal policy is now largely hemmed in by markedly higher borrowing costs and the broader priority of containing inflation, while also confronted with deep affordability issues in housing, and chilly economic growth. Today's Statement attempts to navigate this narrow channel, and leans into maintaining the deficit over the short term. Looking further out, the reality of high-for-longer weighs much more heavily on the medium term outlook, although the debt/GDP ratio is still expected to resume gradually descending to back below 40%.