Liberals trim deficit forecast

No path for return to balanced budget spurs warning about rising spending

The federal deficit is expected to shrink to well below earlier expectations on higher government revenues, according to Ottawa’s fall budget update, but some analysts warn future spending increases and economic headwinds could crimp the government’s fiscal standing.

In its Fall Economic Statement released Tuesday, the Department of Finance projected a deficit of $19.9 billion in the fiscal year 201718, down from the $28.5 billion predicted in the last budget.

The reduced deficit projection follows several quarters of powerful economic figures, with Canada expected to have the fastest-growing economy among G7 countries in 2017. The Canadian economy grew 3.7 per cent over the last four quarters, the highest in recent memory.

The rosy economic data has come alongside a sizable fiscal stimulus plan under the Trudeau Liberals, who have promised major infrastructure investments and other programs in a bid to spur growth.

Some analysts, however, are warning the spending threatens to squander Canada’s recent economic gains, which might more wisely be used to provide more fiscal room when growth begins to taper off.

“We’re at this point in the economic cycle where the economy is pretty close to full capacity, so this usually wouldn’t be the time for pro-cyclical fiscal policy,” said Josh Nye, an economist at RBC.

“Our preference would be to see the government targeting a return to a balanced budget, at least over the next few years.”

Finance Minister Bill Morneau did not provide a specific plan to return to balance Tuesday, saying that falling debt-to- GDP ratios will provide the federal government plenty of financial cushion. The ministry expects Canadian debt-to-GDP to fall below 30 per cent in coming years, from above 31 per cent today.

Meanwhile, spending is expected to rise sharply as the government rolls out its infrastructure program.

Delays in planned spending inside the program, as well as high economic growth, caused most analysts to estimate a much lower projected deficit from six months ago. RBC analysts expected the deficit for 2017-18 to fall anywhere between $10 billion and $20 billion.

“This is definitely at the very high end of that, so it certainly looks like they’ve used some of that fiscal room from higher GDP growth,” Nye said.

The Department of Finance increased spending by $1.8 billion in the Tuesday statement. Total program expenses are expected to reach $304 billion in fiscal year 2017-18 and continue rising to $347 billion in 2022-23, compared with $287 billion in 2016-2017.

Lower deficit expectations come as GDP growth is widely expected to slow to around half its current levels. Growth levels popped in the second quarter to 4.5 per cent, but will soon fall to around three per cent next year, and closer to two per cent or lower in the years following, according to analyst expectations.

Within Canada in particular, high household debt-to-income levels, and threats from the Trump administration to tear up the North American Free Trade Agreement, could cause a significant shock to the economy.

Analysts at Desjardins said in a recent research note the Canadian economy is now “catching its breath” following several quarters of higher-than-expected growth. Real GDP on an industry-by-industry basis was flat in July, while the value of merchandise exports fell in August for the third month in a row.

The bank expects real GDP growth to fall to two per cent in the third quarter, and has revised its expectations for the year to 3.1 per cent, down from 3.2 per cent.

Many observers have pointed to tepid figures in recent months in Canadian exports and in business investment. Business investment in particular could have been artificially inflated due to a few one-time investments in Canada’s oil and gas sector, analysts have said.

The federal government’s update comes one day before the Bank of Canada is set to make a decision on its overnight interest rate. The consensus among analysts is that the bank will stay at the current level after its governor Stephen Poloz struck a decidedly cautious tone in a speech last month.

Poloz had apparently aimed to temper recent optimism over Canadian economic results, suggesting the bank would take a more data-driven approach to future interest rate hikes.

He said at the time that growth was expected to fall away dramatically, and that non-inflationary growth of about 1.5 per cent in coming years was “about the best we can hope for.”

The BoC will announce its decision on Wednesday at 10 a.m.