Fiscal anchor needed amid borrowing spree
The days of outsiders coveting our debt are probably over, Kevin Carmichael writes.
Fitch Ratings’ wobble last week on Canada’s credit worthiness has forced the Finance Department to adjust its marketing material.
“Canada remains among the top rated countries in the G7 and continues to hold a AAA rating, with a stable outlook, from all major credit rating agencies
except Fitch,” Finance wrote in the Economic and Fiscal Snapshot, which Bill Morneau, the minister, tabled in the House of Commons on Wednesday. Emphasis mine.
Fitch’s downgrade foreshadowed the finance minister’s update, the most comprehensive tally to date on the tremendous costs associated with fighting the COVID-19 pandemic.
The federal deficit will surge to about 16 per cent of gross domestic product in the fiscal year that ends March 31, 2021, from less than one per cent two years ago, and the debt will expand to 49 per cent from about 31 per cent in 2019, according to the Finance Department’s forecasts.
Morneau didn’t make much news with his update, since the keenest watchers of fiscal policy have known for months where the federal government’s finances were heading.
However, he did say some things that will get the attention of credit markets. The finance minister emphasized he would like to take advantage of the opportunity presented to him by the world’s central banks and issue more longer-term debt while rates for trusted sovereigns such as Canada are near zero.
It’s a good idea, but one that could be more complicated in the aftermath of the Fitch decision to drop Canada’s debt to AA+ from AAA. Canada’s debt is still valuable, but perhaps not as valuable as it used to be, so Morneau might have to work harder to get the yield he wants, starting with a concrete commitment to keep the budget under control.
For now, he has little to worry about.
Remarkably, the federal government’s actual cost of borrowing is on track to be about $4-billion lower this year because the Bank of Canada dropped the benchmark rate to 0.25 per cent and is creating hundreds of billions of dollars to purchase government bonds. It’s the one reason why the COVID-19 recession hasn’t been exacerbated by a financial crisis.
Debt-service charges are now about one per cent of GDP, compared with about 14 per cent in the early 1980s and around 12 per cent in the mid-1990s, two earlier periods of economic weakness.
That’s by design. The Bank of Canada and its peers have acknowledged that one of the reasons they intend to keep interest rates pinned near zero is to make it easier for politicians to borrow in order to combat the recession. Central bankers learned during the Great Recession that they can be very aggressive without stoking inflation and they are applying those lessons now.
But it would probably be a mistake to assume that current monetary policy can continue indefinitely without consequence. The risk is that investors will start to worry about inflation and demand higher interest rates to compensate for it. That’s especially true for potential buyers of the 10- and 30-year bonds that Finance has been issuing in greater numbers.
“Fiscal management will require a medium-term plan with a solid anchor and a significant reserve for contingency in an uncertain world,” Bennett Jones, the Toronto-based law firm, said in a June economic outlook written by several former Finance officials, including David Dodge, who also served as Bank of Canada governor.
Dodge was deputy minister at Finance in the 1990s, the last time Canada had to work at convincing creditors to buy its debt at a favourable yield. He helped devise and manage the spending cuts that Jean Chrétien and Paul Martin implemented to balance the budget for the first time in a generation and avoid a debt crisis. Their efforts restored Canada’s status as a AAA borrower.
Life has been easier for the prime ministers and finance ministers that have followed Chrétien and Martin. Chrétien’s Liberal governments instilled a commitment to fiscal discipline that was unique among rich economies. For years, Canada’s AAA boast thundered in global debt markets, because fewer and fewer countries and companies proved themselves worthy of pristine credit scores from all the major rating agencies.
At times, Canada has even been described as a safe haven, putting upward pressure on the currency as outsiders clamoured for its debt.
But those days probably are over.
Now, we’re no different than the United States, which was downgraded by Standard & Poor’s in 2011 when that agency lost faith in the ability of Congress to responsibly restrain spending.
Politics is also responsible for Canada getting kicked out of the club.
Fitch dropped Canada to AA+ partly because Justin Trudeau’s minority government had shown little interest in constraining spending before the COVID-19 crisis. Fitch also expressed doubt about the relationship between the feds and the provinces, observing that Canada’s “decentralized fiscal framework increases the complexity” of doing something about a combined federal-provincial debt that is on track to reach 115 per cent of gross domestic product.
Morneau appeared to acknowledge that convincing investors to commit to Canada for a decade, 30 years or even longer could be a challenge given the size of the deficit. “We, the collective we, will have to face up to our borrowing and ensure it is sustainable for future generations,” he said in prepared remarks for the Commons.
The finance minister will probably have to do more than plead with voters to remember the 1990s. It’s time for a proper fiscal anchor that isn’t easily unmoored. He needs a new one anyway. In the last election, the Liberals said they would ensure Canada retained a top mark from all the main rating agencies. It must have looked like such an easy bar to clear. Then the world changed.
Fiscal management will require a medium-term plan with a solid anchor and a significant reserve for contingency.