Focus
December 04, 2020 | 13:46
Federal Budget Update: Moby Deficit
Economics
Economics
Fixed Income Strategy
Economics
Economics
Economics
Economics
Economics
Fixed Income Strategy
Economics
Economics
Economics
Federal Budget Update: Moby DeficitDouglas Porter, CFA, Robert Kavcic and Benjamin Reitzes |
Ottawa’s budget update reveals the fiscal cost of the ongoing pandemic, with this year’s deficit now expected to clock in at a towering $381.6 billion (up from the July estimate of $343.2 billion), or 17.5% of GDP. While some deterioration was expected in view of the series of spending announcements in the past three months, the widening is a bit larger than generally anticipated, partly reflecting some of the measures announced this week. Ottawa has also set out a forecast for where finances will go in the next few fiscal years, a first since the pandemic began—and the picture is mildly reassuring. Here are some of the key questions surrounding Ottawa's fiscal situation—some appear answered, while more remain open. |
We finally got a fiscal outlook beyond this year—how does it look?Finance looks for the underlying deficit to narrow substantially in the coming fiscal year (starts April 1, 2021) to $121.2 billion, or 5.2% of GDP, pending further stimulus. Looking further afield, the shortfall before extra stimulus is expected to moderate to $50.7 billion in the next year (just over 2% of GDP, versus a pre-virus trend of around 1% of GDP). Meantime, federal debt is projected to rise to $1.3 trillion by FY23/24, up from $1.1 trillion this fiscal year (Table 1). As a share of GDP, federal debt is expected to peak next year at 52.6% of GDP, and then gradually fade back toward the 50% mark; planned added stimulus will tack on 3%-to-4% of GDP to that tally in the out years. |
|
What could lead to a worse fiscal outcome?The relatively quick drop in the deficit does not factor in some more negative potential scenarios for the economy (under various levels of lockdown), nor does it account for a planned $70 billion to $100 billion of additional stimulus spending over the next three fiscal years as the economy recovers. What could lead to a better fiscal outcome?The economic scenario is generally reasonable, but seems a tad on the cautious side for 2021, even with the likelihood of a short-term hit to growth from second-wave restrictions. Fiscal projections are based on an assumed 5.8% drop in GDP this year and then a 4.8% rebound next year; our latest call is for -5.7% and +5.5% (Table 2). Note that since the spring depths, the Canadian and global economies have managed to perform better than widely expected. And part of that better-than-expected outcome has been driven by the extreme level of fiscal support on hand, notably in Canada. Second, it appears that a high degree of caution is built into the spending and revenue figures. Finally, there is the uncertainty on the degree of take-up for some of the new spending measures; Ottawa has often over-estimated the costs of new programs (e.g., CEWS). These multi-tiered layers of prudence are perfectly understandable given the murky near-term economic outlook, but also seem to leave plenty of room for a better-than-projected fiscal outcome. Is there a fiscal anchor again?The short answer is no. Ottawa notes that stimulus will be appropriate until it determines that the economy has recovered from the pandemic, using data on the employment rate, total hours worked and the unemployment level as 'guardrails' for government finances. When this is achieved, Ottawa will shift to a fiscal anchor with longer-term sustainability in mind. It remains to be seen what that anchor looks like. In the meantime, the fiscal 'guardrails', while sounding good in concept, still leave much open to interpretation. |
For example, we don’t know what levels of these indicators are being targeted. If a return to pre-COVID levels is the goal, history reveals that it could take anywhere from about 3 years to never at all (Table 3). Which outcomes get more weight? Plus, given the nature of this shock, some sectors have already surged back to pre-COVID levels of activity, while a few have suffered acute damage that could take years to recoup. How is that weighted? All in, these guardrails are a good concept—unwind stimulus as the economy no longer needs it. But despite the attempt to make this appear objective, there will probably be enough open to interpretation that allows spending to evolve however policymakers choose… What are the key new measures?There were $25.1 billion worth of new measures announced this week. An expanded wage subsidy carries the largest dollar amount, with the maximum subsidy rate lifted to 75 per cent for the period beginning December 20, 2020, and extending this rate until March 13, 2021. Other measures cover commercial rent relief; support for hard-hit industries; parents with young children; dairy farmers; home energy retrofits; home-office tax relief; taxes on digital service providers and (eventually) foreign investors in Canadian real estate; as well an increase stabilization funding to the provinces. |
|
Will this update have an economic impact?Net new spending measures for the current fiscal year announced in the Update will add incrementally to the near-term growth outlook. But the bigger underlying message is that fiscal policy in Canada will remain extraordinarily generous. Clearly, the massive wildcard for the near-term outlook is what path the virus and any additional restriction measures take in coming weeks and months. Finance has set out a variety of scenarios with different degrees of economic shutdowns—the extended and escalated shutdown scenarios. These lead to softer growth in 2021 of 4.1% and 2.9%, respectively. Yet, perhaps the key point here is that even under the “escalated shutdown” scenario, and even with heavy new stimulus spending, Finance is still expecting a budget deficit of $166.7 billion next year. We wouldn’t quite consider that a “worst case” outlook, but it’s close, and yet the deficit would still be less than half of this year’s expected outcome. |
Where does this leave Canada relative to its peers?By a number of metrics, Canada’s fiscal policy has been as generous as any other major economy in the world in 2020, and that looks to be sustained in the coming year. This is one key factor behind our call of a sturdy (and well above consensus) 5.5% rebound in growth in 2021. Chart 1 shows that among the largest advanced economies, Canada will post the meatiest deficit for the broad general government sector (i.e., including the provinces). And, note that these figures from the IMF pre-date this week's Update, and Canada's combined deficit appears headed to closer to 22% of GDP. What really sticks out is that Canada entered this year with one of the smaller deficits (projected at around 2% of GDP at the start of the year). A fair and reasonable question is whether policy overshot the mark with this extraordinary degree of support, especially since Canada's GDP decline was middle-of-the-pack in the OECD. This massive support is a big reason why Canadian personal incomes have bolted higher this year—extremely unusual for a recession. |
|
Has the borrowing program changed?Despite a larger deficit for FY20/21, borrowing needs are little-changed overall at $703 billion. What has changed is the make-up of the borrowing, with a larger share in T-bills and a modest decline in bonds with a maturity of 5 years and under. Demand for T-bills has been consistently solid with yields trading through the Bank of Canada's 0.25% overnight target rate driving the increase from $294 billion to $329 billion. Bond issuance is falling to $374 billion from $409 billion, with cuts in the 2-year, 3-year and 5-year sectors. The 10-year and 30-year issuance plans were unchanged. Indeed, the focus on extending the average maturity of the debt stock remains. The government will again look at potentially re-opening the 50-year bond, last issued in 2017. Looking ahead to FY21/22, there weren't any issuance projections, but we can make some assumptions based on coming maturities and the deficit scenarios provided. For starters, we'll assume that the T-bill stock will remain steady. The deficit scenarios for next year (ranging from $136.7 billion to $166.7 billion), along with approximately $96 billion in maturities, puts gross bond issuance in the $233-to-$263 billion range. That's down at least $100 billion from this year and about in line with our assumption heading into the update. The federal government is also planning on entering the Green Bond market to fund "green infrastructure and other green initiatives", with initial issuance planned in FY21/22. Will lower expected issuance next year impact the Bank of Canada?Assuming the above estimates for FY21/22 issuance are close, there will be an impact on the Bank of Canada. Currently, the BoC buys 13% of every auction and $4 billion per week in QE. Over 52 weeks, that adds up to $238 billion (using the bottom of the issuance range above). The BoC won't want to be absorbing all the issuance, so another QE taper is possible in the early part of next year. For FY20/21 QE is on track to total around $246 billion, which is about two-thirds of gross issuance. Using the $238 billion estimate, a similar QE share would mean about $157 billion in buying from the BoC, or around $3 billion per week (below the current $4 billion pace). Note that including the BoC's auction purchases, they're on track to buy just under 80% of gross issuance this year. What's the takeaway?Ottawa’s long-awaited fiscal plan marks the first glimpses of a potential transition away from the highly aggressive short-term measures to support the economy through the pandemic to a medium-term plan to stabilize finances. The update highlights the fiscal damage from the pandemic, but also suggests that the repair to the government’s balance sheet won’t be fast. Beyond some of the moderate sector-specific measures announced on Monday, and a small down-payment on some new focus areas (such as child care), the big news was the upgrade to the budget deficit estimates for this year and a much more moderate path for shortfalls in coming years. A key question will be whether the government will manage to stick with this medium-term plan, especially given the lofty ambitions on a variety of files and still-heavy needs from a number of hard-hit sectors. |